http://curiouscapitalist.blogs.time.com/2010/10/19/will-bankers-go-to-jail-for-foreclosure-gate
Will Bankers go to Jail for Foreclosure-gate?
Stephen Gandel
Tuesday, October 19, 2010
Foreclosure-gate is getting uglier by the day
More and more, Foreclosure-gate is looking like the housing bust's Enron.
One of the amazing developments of the unraveling of the financial crisis has been the fact that there have been so few people we can actually point to and say without a doubt that guy or gal is a crook. Yes, Bernie Madoff and his fellow ponziers, but they were only flushed out by the financial crisis. They didn't really cause it. The Bear Stearns hedgies beat their case. The mastermind of AIG's demise Joe Cassano looks to have made a clean getaway. Lehman's Dick Fuld is still in the clear. Goldman and just last week Countrywide's executives had to pay out large fines. But none of them are headed to jail. John Paulson and other hedge funds that help construct CDO debt bombs and bet against them, haven't even been forced to give some of their winnings back. I can't think of anyone of any real consequence who is facing hard time.
Thanks to foreclosure-gate that may soon change.
CNN is reporting that law enforcement officials are investigating whether banks and their employees broke federal law in the handling of foreclosures:
Two sources familiar with the Financial Fraud Enforcement Task Force indicated the multi-agency effort by investigators in the Justice, Treasury and Housing Departments would determine whether prosecutors would ultimately pursue criminal or civil penalties - or both.
The Task Force has scheduled a meeting for Wednesday morning at the Department of Housing and Urban Development. Upon conclusion a briefing is likely at the White House, officials said.
"The administration's Federal Housing Administration and Financial Fraud Enforcement Task Force have undertaken their own regulatory and enforcement investigation into the foreclosure process," White House Press Secretary Robert Gibbs confirmed Tuesday. "We remain committed to holding accountable any bank that has violated the law," he said.
So who is likely to go to jail? Obviously the first candidates are the robo-signers who were putting their names to documents that attested they had reviewed the loans documents when they hadn't. But here's the problem with just putting those people in jail. A number of the robo-signers have already admitted that they didn't know what they were signing. Jeffrey Stephan, the robo-signer at GMAC who got the current crisis started, has said that it wasn't actually his job to review the loans, just sign the paperwork. So clearly someone must have told him that was his job. Federal prosecutors are trained to use the small fish to catch the big ones.
The question when it comes to the paperwork is just how high up the chain of command the order to sign without reviewing goes. Bank of America CEO Brian Moynihan was B of A's chief legal officer for a brief time. Did he know that the bank was filing potentially fraudulent documents with courts around the country? Did he look to make sure the bank's foreclosure processes were sound? I mean at the end of 2008, when Moynihan was the head of B of A's law department, foreclosures were becoming a very big part of the bank's daily life. So I would think that a chief legal officer would look into that. FULL DISCLOSURE, I have no knowledge about Moynihan's situation, and have not asked B of A for a comment. He was only in the job for a little while, so it is entirely possible this is an area he skipped over. I'm just saying it could get messy for some bank higher-ups.
But the real blood on the Street would be if the Feds are looking into the some of the more salacious charges that are coming out about the securitization of mortgage bonds. One being that the bankers knew many of the loans they sold to investors were deficient, and got a discount when they bought them, but then passed those loans along to investors at full face value anyway. Or, two, a charge that surfaced again today, that bankers sold the same mortgage to numerous bond pools ensuring that investors would lose money.
Barry Ritholtz's The Big Picture has a very good round-up of most recent developments in the continuing to unfold foreclosure-gate scandal. And there are a lot of them. Enjoy, unless you are a banker or someone facing foreclosure or really anyone who used to think our financial system was, well, functional, then cry.
Showing posts with label Bear Stearns. Show all posts
Showing posts with label Bear Stearns. Show all posts
Thursday, October 28, 2010
Thursday, September 23, 2010
“Letting Prices Fall” Versus Resetting the Housing Market
http://news.firedoglake.com/2010/09/12/letting-prices-fall-versus-resetting-the-housing-market/
“Letting Prices Fall” Versus Resetting the Housing Market
David Dayen
Sunday September 12, 2010
This week, an argument broke out in the blogosphere and the traditional media over whether “we should let housing prices fall.” Tyler Cowen sums up the argument:
Should we let housing prices fall?
Many smart people say we should. It seems increasingly clear that we must. For how long can the government prop them up? Are we never to have a private market in mortgages again?
Yet what happens if we let them fall? Arguably many banks would once again be “under water.” Enthusiasm for another set of bailouts is weak, to say the least. Our government would end up nationalizing these banks and it still would be on the hook for their debts. The blow to confidence would be a major one, especially if along the way we saw a recreation of a Lehman or Bear Stearns or A.I.G. episode.
I’d like to know what “let” means in this context. Because the government’s actions, with their light touch, avoidance of principal write-downs and handing over of discretion to the banks, have stopped working to prop up the market. Basically the only policy that succeeded in that context (though it was a pure tax giveaway to people who didn’t need it) was the homebuyer’s tax credit, which won’t be coming back. Everything else has neither stabilized housing prices nor kept borrowers in their homes. Rates are near all-time lows and home sales are near all-time bottoms, while foreclosures are at record highs.
The only way to fix this is for everyone to recognize the way out. Joseph Stiglitz explains.
In short, government policies to support the housing market not only have failed to fix the problem, but are prolonging the deleveraging process and creating the conditions for Japanese-style malaise. Avoiding this dismal “new normal” will be difficult, but there are alternative policies with far better prospects of returning the US and the global economy to prosperity.
Corporations have learned how to take bad news in stride, write down losses, and move on, but our governments have not. For one out of four US mortgages, the debt exceeds the home’s value. Evictions merely create more homeless people and more vacant homes. What is needed is a quick write-down of the value of the mortgages. Banks will have to recognize the losses and, if necessary, find the additional capital to meet reserve requirements.
This, of course, will be painful for banks, but their pain will be nothing in comparison to the suffering they have inflicted on people throughout the rest of the global economy.
By contrast, “letting prices fall” just massively increases the number of homeowners with negative equity and accelerates the problem. And while some of the other ideas on refinancing and short sales may help at the margins, without principal reductions we’re still basically on the margins. You need to reset the market, not allow it to work its “invisible hand” magic that will result in destruction for millions of borrowers.
This latest Administration foreclosure plan would require principal reductions, in exchange for the refinanced loan getting government backing. But again, this comes at the discretion of the investors who hold the mortgage. This amounts to a wish and a hope that investors will make the right decision for borrowers and take the hit rather than foreclosing. And the funding for this, in the form of incentive payments to servicers, totals only $14 billion, maybe enough to reach 300,000 of the 11 million underwater homeowners in the country (a Neighborhood Stabilization Program out of HUD, which would redevelop vacant homes and resell them to low- and middle-income families who get down payment assistance, tacks on just $1 billion more).
The National Community Reinvestment Coalition has the right idea. CEO John Taylor thinks the White House needs to mandate loan principal reductions:
“A civilized country cannot embrace an economic policy that ignores human suffering. We can’t just turn away from the millions of families who are facing foreclosure for reasons beyond their control,” said Taylor, who has been advocating for mandated loan principal reductions since 2007.
“In the past four years we lost $6 trillion in real estate values. Somebody has to eat that, and it shouldn’t be the people who had nothing to do with creating the economic crisis in the first place. We need big solutions for very big problems, not half way measures and certainly not intentional neglect,” said Taylor.
The HAMP program, incidentally, has produced modifications which lower principal for just .1% of all its successful borrowers, which amounts to a grand total of 400 loans.
“Letting Prices Fall” Versus Resetting the Housing Market
David Dayen
Sunday September 12, 2010
This week, an argument broke out in the blogosphere and the traditional media over whether “we should let housing prices fall.” Tyler Cowen sums up the argument:
Should we let housing prices fall?
Many smart people say we should. It seems increasingly clear that we must. For how long can the government prop them up? Are we never to have a private market in mortgages again?
Yet what happens if we let them fall? Arguably many banks would once again be “under water.” Enthusiasm for another set of bailouts is weak, to say the least. Our government would end up nationalizing these banks and it still would be on the hook for their debts. The blow to confidence would be a major one, especially if along the way we saw a recreation of a Lehman or Bear Stearns or A.I.G. episode.
I’d like to know what “let” means in this context. Because the government’s actions, with their light touch, avoidance of principal write-downs and handing over of discretion to the banks, have stopped working to prop up the market. Basically the only policy that succeeded in that context (though it was a pure tax giveaway to people who didn’t need it) was the homebuyer’s tax credit, which won’t be coming back. Everything else has neither stabilized housing prices nor kept borrowers in their homes. Rates are near all-time lows and home sales are near all-time bottoms, while foreclosures are at record highs.
The only way to fix this is for everyone to recognize the way out. Joseph Stiglitz explains.
In short, government policies to support the housing market not only have failed to fix the problem, but are prolonging the deleveraging process and creating the conditions for Japanese-style malaise. Avoiding this dismal “new normal” will be difficult, but there are alternative policies with far better prospects of returning the US and the global economy to prosperity.
Corporations have learned how to take bad news in stride, write down losses, and move on, but our governments have not. For one out of four US mortgages, the debt exceeds the home’s value. Evictions merely create more homeless people and more vacant homes. What is needed is a quick write-down of the value of the mortgages. Banks will have to recognize the losses and, if necessary, find the additional capital to meet reserve requirements.
This, of course, will be painful for banks, but their pain will be nothing in comparison to the suffering they have inflicted on people throughout the rest of the global economy.
By contrast, “letting prices fall” just massively increases the number of homeowners with negative equity and accelerates the problem. And while some of the other ideas on refinancing and short sales may help at the margins, without principal reductions we’re still basically on the margins. You need to reset the market, not allow it to work its “invisible hand” magic that will result in destruction for millions of borrowers.
This latest Administration foreclosure plan would require principal reductions, in exchange for the refinanced loan getting government backing. But again, this comes at the discretion of the investors who hold the mortgage. This amounts to a wish and a hope that investors will make the right decision for borrowers and take the hit rather than foreclosing. And the funding for this, in the form of incentive payments to servicers, totals only $14 billion, maybe enough to reach 300,000 of the 11 million underwater homeowners in the country (a Neighborhood Stabilization Program out of HUD, which would redevelop vacant homes and resell them to low- and middle-income families who get down payment assistance, tacks on just $1 billion more).
The National Community Reinvestment Coalition has the right idea. CEO John Taylor thinks the White House needs to mandate loan principal reductions:
“A civilized country cannot embrace an economic policy that ignores human suffering. We can’t just turn away from the millions of families who are facing foreclosure for reasons beyond their control,” said Taylor, who has been advocating for mandated loan principal reductions since 2007.
“In the past four years we lost $6 trillion in real estate values. Somebody has to eat that, and it shouldn’t be the people who had nothing to do with creating the economic crisis in the first place. We need big solutions for very big problems, not half way measures and certainly not intentional neglect,” said Taylor.
The HAMP program, incidentally, has produced modifications which lower principal for just .1% of all its successful borrowers, which amounts to a grand total of 400 loans.
Saturday, April 24, 2010
Big Banks Mask Risk Levels
http://online.wsj.com/article/SB10001424052702304830104575172280848939898.html
APRIL 9, 2010
Big Banks Mask Risk Levels
Quarter-End Loan Figures Sit 42% Below Peak, Then Rise as New Period Progresses; SEC Review
By KATE KELLY, TOM MCGINTY and DAN FITZPATRICK
Major banks have masked their risk levels in the past five quarters by temporarily lowering their debt just before reporting it to the public, according to data from the Federal Reserve Bank of New York.
A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.
Citi Execs Deny Responsibility Excessive borrowing by banks was one of the major causes of the financial crisis, leading to catastrophic bank runs in 2008 at firms including Bear Stearns Cos. and Lehman Brothers. Since then, banks have become more sensitive about showing high levels of debt and risk, worried that their stocks and credit ratings could be punished.
That practice, while legal, can give investors a skewed impression of the level of risk that financial firms are taking the vast majority of the time.
Major banks masked their risk levels during the most recent five quarters by lowering debt levels just before announcing quarterly earnings, according to data from the New York Federal Reserve Bank. Kate Kelly and Evan Newmark discuss.
"You want your leverage to look better at quarter-end than it actually was during the quarter, to suggest that you're taking less risk," says William Tanona, a former Goldman analyst who now heads U.S. financials research at Collins Stewart, a U.K. investment bank.
Though some banks privately confirm that they temporarily reduce their borrowings at quarter's end, representatives at Goldman, Morgan Stanley, J.P. Morgan and Citigroup declined to comment specifically on the New York Fed data. Some noted that their firm's financial filings include language saying borrowing levels can fluctuate during the quarter.
"The efforts to manage the size of our balance sheet are appropriate and our policies are consistent with all applicable accounting and legal requirements," a Bank of America spokesman said.
Masking Risk
An official at the Federal Reserve Board noted that the Fed continuously monitors asset levels at the large bank-holding companies, but the financing activities captured in the New York Fed's data fall under the purview of the Securities and Exchange Commission, which regulates brokerage firms. The New York Fed declined to comment.
The data highlight the banks' levels of short-term financing in the repurchase, or "repo," market. Financial firms use cash from the loans to buy securities, then use the purchased securities as collateral for other loans, and buy more securities. The loans boost the firms' trading power, or "leverage," allowing them to make big trades without putting up big money. This amplifies gains—and losses, which were disastrous in 2008.
According to the data, the banks' outstanding net repo borrowings at the end of each of the past five quarters were on average 42% below their peak in net borrowings in the same quarters. Though the repo market represents just a slice of banks' overall activities, it provides a window into the risks that financial institutions take to trade.
The SEC now is seeking detailed information from nearly two dozen large financial firms about repos, signaling that the agency is looking for accounting techniques that could hide a firm's risk-taking. The SEC's inquiry follows recent disclosures that Lehman used repos to mask some $50 billion in debt before it collapsed in 2008.
The practice of reducing quarter-end repo borrowings has occurred periodically for years, according to the data, which go back to 2001, but never as consistently as in 2009.
The repo market played a role in recent accusations leveled by an examiner in Lehman's bankruptcy case. But rather than reducing quarter-end debt, Lehman took steps to hide it.
Anxious to maintain favorable credit ratings, Lehman engaged in an accounting device known within the firm as "Repo 105" to essentially park about $50 billion of assets away from Lehman's balance sheet, according to the examiner. The move helped Lehman look like it had less debt on its books, the examiner said.
Other Wall Street firms, including Goldman and Morgan Stanley, have denied characterizing their short-term borrowings as sales, the way Lehman did in employing Repo 105. Both of those firms also make standard disclaimers about debt.
For instance, Goldman disclosed in its 2009 annual report that although its balance sheet can "fluctuate," asset levels at the ends of quarters are "typically not materially different" from their levels in the midst of the quarter. Total assets at the end of 2009 were 7% lower than average assets during the year, the report states.
Some banks make big trades that don't show up in quarter-end balance sheets. That is what happened recently at Bank of America involving a trade designed to mature before the end of 2009's first quarter, people familiar with the matter say.
Two Bank of America traders bought $40 billion of mortgage-backed securities from clients for one month, while at the same time agreeing to sell the securities back before quarter's end, according to people familiar with the matter. This "roll" trade provided the clients with cash and the bank with fees.
Robert Qutub, then Bank of America's chief financial officer for global markets, told Michael Nierenberg, a former Bear Stearns trader who oversaw the traders who made the roll trade, to cap the size of the short-term transaction, people familiar with the matter say.
A week later, however, the amount tied to the trade shot up to $60 billion, these people say, before dropping to $25 billion, one of these people said, appearing to some at headquarters that the group had defied the order to cap the trade.
A bank spokeswoman said "the team was aware of and worked within its risk limits."
Write to Kate Kelly at kate.kelly@wsj.com, Tom McGinty at tom.mcginty@wsj.com and Dan Fitzpatrick at dan.fitzpatrick@wsj.com
APRIL 9, 2010
Big Banks Mask Risk Levels
Quarter-End Loan Figures Sit 42% Below Peak, Then Rise as New Period Progresses; SEC Review
By KATE KELLY, TOM MCGINTY and DAN FITZPATRICK
Major banks have masked their risk levels in the past five quarters by temporarily lowering their debt just before reporting it to the public, according to data from the Federal Reserve Bank of New York.
A group of 18 banks—which includes Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc.—understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods, the data show. The banks, which publicly release debt data each quarter, then boosted the debt levels in the middle of successive quarters.
Citi Execs Deny Responsibility Excessive borrowing by banks was one of the major causes of the financial crisis, leading to catastrophic bank runs in 2008 at firms including Bear Stearns Cos. and Lehman Brothers. Since then, banks have become more sensitive about showing high levels of debt and risk, worried that their stocks and credit ratings could be punished.
That practice, while legal, can give investors a skewed impression of the level of risk that financial firms are taking the vast majority of the time.
Major banks masked their risk levels during the most recent five quarters by lowering debt levels just before announcing quarterly earnings, according to data from the New York Federal Reserve Bank. Kate Kelly and Evan Newmark discuss.
"You want your leverage to look better at quarter-end than it actually was during the quarter, to suggest that you're taking less risk," says William Tanona, a former Goldman analyst who now heads U.S. financials research at Collins Stewart, a U.K. investment bank.
Though some banks privately confirm that they temporarily reduce their borrowings at quarter's end, representatives at Goldman, Morgan Stanley, J.P. Morgan and Citigroup declined to comment specifically on the New York Fed data. Some noted that their firm's financial filings include language saying borrowing levels can fluctuate during the quarter.
"The efforts to manage the size of our balance sheet are appropriate and our policies are consistent with all applicable accounting and legal requirements," a Bank of America spokesman said.
Masking Risk
An official at the Federal Reserve Board noted that the Fed continuously monitors asset levels at the large bank-holding companies, but the financing activities captured in the New York Fed's data fall under the purview of the Securities and Exchange Commission, which regulates brokerage firms. The New York Fed declined to comment.
The data highlight the banks' levels of short-term financing in the repurchase, or "repo," market. Financial firms use cash from the loans to buy securities, then use the purchased securities as collateral for other loans, and buy more securities. The loans boost the firms' trading power, or "leverage," allowing them to make big trades without putting up big money. This amplifies gains—and losses, which were disastrous in 2008.
According to the data, the banks' outstanding net repo borrowings at the end of each of the past five quarters were on average 42% below their peak in net borrowings in the same quarters. Though the repo market represents just a slice of banks' overall activities, it provides a window into the risks that financial institutions take to trade.
The SEC now is seeking detailed information from nearly two dozen large financial firms about repos, signaling that the agency is looking for accounting techniques that could hide a firm's risk-taking. The SEC's inquiry follows recent disclosures that Lehman used repos to mask some $50 billion in debt before it collapsed in 2008.
The practice of reducing quarter-end repo borrowings has occurred periodically for years, according to the data, which go back to 2001, but never as consistently as in 2009.
The repo market played a role in recent accusations leveled by an examiner in Lehman's bankruptcy case. But rather than reducing quarter-end debt, Lehman took steps to hide it.
Anxious to maintain favorable credit ratings, Lehman engaged in an accounting device known within the firm as "Repo 105" to essentially park about $50 billion of assets away from Lehman's balance sheet, according to the examiner. The move helped Lehman look like it had less debt on its books, the examiner said.
Other Wall Street firms, including Goldman and Morgan Stanley, have denied characterizing their short-term borrowings as sales, the way Lehman did in employing Repo 105. Both of those firms also make standard disclaimers about debt.
For instance, Goldman disclosed in its 2009 annual report that although its balance sheet can "fluctuate," asset levels at the ends of quarters are "typically not materially different" from their levels in the midst of the quarter. Total assets at the end of 2009 were 7% lower than average assets during the year, the report states.
Some banks make big trades that don't show up in quarter-end balance sheets. That is what happened recently at Bank of America involving a trade designed to mature before the end of 2009's first quarter, people familiar with the matter say.
Two Bank of America traders bought $40 billion of mortgage-backed securities from clients for one month, while at the same time agreeing to sell the securities back before quarter's end, according to people familiar with the matter. This "roll" trade provided the clients with cash and the bank with fees.
Robert Qutub, then Bank of America's chief financial officer for global markets, told Michael Nierenberg, a former Bear Stearns trader who oversaw the traders who made the roll trade, to cap the size of the short-term transaction, people familiar with the matter say.
A week later, however, the amount tied to the trade shot up to $60 billion, these people say, before dropping to $25 billion, one of these people said, appearing to some at headquarters that the group had defied the order to cap the trade.
A bank spokeswoman said "the team was aware of and worked within its risk limits."
Write to Kate Kelly at kate.kelly@wsj.com, Tom McGinty at tom.mcginty@wsj.com and Dan Fitzpatrick at dan.fitzpatrick@wsj.com
Sunday, March 1, 2009
The Language of Looting
http://www.blackagendareport.com/index.php?option=com_content&task=view&id=1039&Itemid=1
The Language of Looting
Wednesday, 25 February 2009
by Michael Hudson
In order to steal literally everything, the Lords of Finance must render language incapable of describing the crime. "Society's basic grammar of thought, the vocabulary to discuss political and economic topics, is being turned inside-out." The banksters still think they can rule from the center of confusion. "Today's policy is to ‘rescue' these giant bank conglomerates by enabling them to ‘earn' their way out of debt - by selling yet more debt to an already over-indebted U.S. economy. The hope is to re-inflate real estate and other asset prices."
"Banking shares began to plunge Friday morning after Senator Dodd, the Connecticut Democrat who is chairman of the banking committee, said in an interview with Bloomberg Television that he was concerned the government might end up nationalizing some lenders "at least for a short time." Several other prominent policy makers - including Alan Greenspan, the former chairman of the Federal Reserve, and Senator Lindsey Graham of South Carolina - have echoed that view recently." -- Eric Dash, "Growing Worry on Rescue Takes a Toll on Banks," The New York Times, February 20, 2009
How is it that Alan Greenspan, free-market lobbyist for Wall Street, recently announced that he favored nationalization of America's banks - and indeed, mainly the biggest and most powerful? Has the old disciple of Ayn Rand gone Red in the night? Surely not.
The answer is that the rhetoric of "free markets," "nationalization" and even "socialism" (as in "socializing the losses") has been turned into the language of deception to help the financial sector mobilize government power to support its own special privileges. Having undermined the economy at large, Wall Street's public relations think tanks are now dismantling the language itself.
Exactly what does "a free market" mean? Is it what the classical economists advocated - a market free from monopoly power, business fraud, political insider dealing and special privileges for vested interests - a market protected by the rise in public regulation from the Sherman Anti-Trust law of 1890 to the Glass-Steagall Act and other New Deal legislation? Or is it a market free for predators to exploit victims without public regulation or economic policemen - the kind of free-for-all market that the Federal Reserve and Security and Exchange Commission (SEC) have created over the past decade or so? It seems incredible that people should accept today's neoliberal idea of "market freedom" in the sense of neutering government watchdogs, Alan Greenspan-style, letting Angelo Mozilo at Countrywide, Hank Greenberg at AIG, Bernie Madoff, Citibank, Bear Stearns and Lehman Brothers loot without hindrance or sanction, plunge the economy into crisis and then use Treasury bailout money to pay the highest salaries and bonuses in U.S. history.
"Having undermined the economy at large, Wall Street's public relations think tanks are now dismantling the language itself."
Terms that are the antithesis of "free market" also are being turned into the opposite of what they historically have meant. Take today's discussions about nationalizing the banks. For over a century nationalization has meant public takeover of monopolies or other sectors to operate them in the public interest rather than leaving them to special interests. But when neoliberals use the word "nationalization" they mean a bailout, a government giveaway to the financial interests.
Doublethink and doubletalk with regard to "nationalizing" or "socializing" the banks and other sectors is a travesty of political and economic discussion from the 17th through mid-20th centuries. Society's basic grammar of thought, the vocabulary to discuss political and economic topics, is being turned inside-out in an effort to ward off discussion of the policy solutions posed by the classical economists and political philosophers that made Western civilization "Western."
Today's clash of civilization is not really with the Orient; it is with our own past, with the Enlightenment itself and its evolution into classical political economy and Progressive Era social reforms aimed at freeing society from the surviving trammels of European feudalism. What we are seeing is propaganda designed to deceive, to distract attention from economic reality so as to promote the property and financial interests from whose predatory grasp classical economists set out to free the world. What is being attempted is nothing less than an attempt to destroy the intellectual and moral edifice of what took Western civilization eight centuries to develop, from the 12th century Schoolmen discussing Just Price through 19th and 20th century classical economic value theory.
"What we are seeing is propaganda designed to deceive, to distract attention from economic reality."
Any idea of "socialism from above," in the sense of "socializing the risk," is old-fashioned oligarchy - kleptocratic statism from above. Real nationalization occurs when governments act in the public interest to take over private property. The 19th-century program to nationalize the land (it was the first plank of the Communist Manifesto) did not mean anything remotely like the government taking over estates, paying off their mortgages at public expense and then giving it back to the former landlords free and clear of encumbrances and taxes. It meant taking the land and its rental income into the public domain, and leasing it out at a user fee ranging from actual operating cost to a subsidized rate or even freely as in the case of streets and roads.
Nationalizing the banks along these lines would mean that the government would supply the nation's credit needs. The Treasury would become the source of new money, replacing commercial bank credit. Presumably this credit would be lent out for economically and socially productive purposes, not merely to inflate asset prices while loading down households and business with debt as has occurred under today's commercial bank lending policies.
How neoliberals falsify the West's political history
The fact that today's neoliberals claim to be the intellectual descendants of Adam Smith make it necessary to restore a more accurate historical perspective. Their concept of "free markets" is the antithesis of Smith's. It is the opposite of that of the classical political economists down through John Stuart Mill, Karl Marx and the Progressive Era reforms that sought to create markets free of extractive rentier claims by special interests whose institutional power can be traced back to medieval Europe and its age of military conquest.
Economic writers from the 16th through 20th centuries recognized that free markets required government oversight to prevent monopoly pricing and other charges levied by special privilege. By contrast, today's neoliberal ideologues are public relations advocates for vested interests to depict a "free market" is one free of government regulation, "free" of anti-trust protection, and even of protection against fraud (as evidenced by the SEC's refusal to move against Madoff, Enron, Citibank et al.). The neoliberal ideal of free markets is thus basically that of a bank robber or embezzler, wishing for a world without police so as to be sufficiently free to siphon off other peoples' money without constraint.
The Chicago Boys in Chile realized that markets free for predatory finance and insider privatization could only be imposed at gunpoint. These free-marketers closed down every economics department in Chile, every social science department outside of the Catholic University where the Chicago Boys held sway. Operation Condor arrested, exiled or murdered tens of thousands of academics, intellectuals, labor leaders and artists. Only by totalitarian control over the academic curriculum and public media backed by an active secret police and army could "free markets" neoliberal style be imposed. The resulting privatization at gunpoint became an exercise in what Marx called "primitive accumulation" - seizure of the public domain by political elites backed by force. It is a free market William-the-Conqueror or Yeltsin-kleptocrat style, with property parceled out to the companions of the political or military leader.
"The neoliberal ideal of free markets is basically that of a bank robber or embezzler, wishing for a world without police."
All this was just the opposite of the kind of free markets that Adam Smith had in mind when he warned that businessmen rarely get together but to plot ways to fix markets to their advantage. This is not a problem that troubled Mr. Greenspan or the editorial writers of the New York Times and Washington Post. There really is no kinship between their neoliberal ideals and those of the Enlightenment political philosophers. For them to promote an idea of free markets as ones "free" for political insiders to pry away the public domain for themselves is to lower an intellectual Iron Curtain on the history of economic thought.
The classical economists and American Progressives envisioned markets free of economic rent and interest - free of rentier overhead charges and monopoly price gouging, free of land-rent, interest paid to bankers and wealthy financial institutions, and free of taxes to support an oligarchy. Governments were to base their tax systems on collecting the "free lunch" of economic rent, headed by that of favorable locations supplied by nature and given market value by public investment in transportation and other infrastructure, not by the efforts of landlords themselves.
The argument between Progressive Era reformers, socialists, anarchists and individualists thus turned on the political strategy of how best to free markets from debt and rent. Where they differed was on the best political means to achieve it, above all the role of the state. There was broad agreement that the state was controlled by vested interests inherited from feudal Europe's military conquests and the world that was colonized by European military force. The political question at the turn of the 20th century was whether peaceful democratic reform could overcome the political and even military resistance wielded by the Old Regime using violence to retain its "rights." The ensuing political revolutions were grounded in the Enlightenment, in the legal philosophy of men such as John Locke, political economists such as Adam Smith, John Stuart Mill and Marx. Power was to be used to free markets from the predatory property and financial systems inherited from feudalism. Markets were to be free of privilege and free lunches, so that people would obtain income and wealth only by their own labor and enterprise. This was the essence of the labor theory of value and its complement, the concept of economic rent as the excess of market price over socially necessary cost-value.
Although we now know that markets and prices, rent and interest, contractual formalities and nearly all the elements of economic enterprise originated in the "mixed economies" of Mesopotamia in the fourth millennium BC and continued throughout the mixed public/private economies of classical antiquity, the discussion was so politically polarized that the idea of a mixed economy with checks and balances received scant attention a century ago.
"Power was to be used to free markets from the predatory property and financial systems inherited from feudalism."
Individualists believed that shrinking central governments would shrink the control mechanism by which the vested interests extracted wealth without work or enterprise of their own. Socialists saw that a strong government was needed to protect society from the attempts of property and finance to use their gains to monopolize economic and political power. Both ends of the political spectrum aimed at the same objective - to bring prices down to actual costs of production. The common aim was to maximize economic efficiency so as to pass on the fruits of the Industrial and Agricultural Revolutions to the population at large. This required blocking the rentier class of interlopers from grabbing the public domain and controlling the allocation of resources. Socialists did not believe this could be done without taking the state's political and legal power into their own hands. Marxists believed that a revolution was necessary to reclaim property rent for the public domain, and to enable governments to create their own credit rather than borrow at interest from commercial bankers and wealthy bondholders. The aim was not to create a bureaucracy but to free society from the surviving absentee ownership power of the vested property and financial interests.
All this history of economic thought has been as thoroughly expunged from today's academic curriculum as it has from popular discussion. Few people remember the great debate at the turn of the 20th century: Would the world progress fairly quickly from Progressive Era reforms to outright socialism - public ownership of basic economic infrastructure, natural monopolies (including the banking system) and the land itself (and to Marxists, of industrial capital as well)? Or, could the liberal reformers of the day - individualists, land taxers, classical economists in the tradition of Mill, and American institutionalists such as Simon Patten - retain capitalism's basic structure and private property ownership? If they could do so, they recognized that it would have to be in the context of regulating markets and introducing progressive taxation of wealth and income. This was the alternative to outright "state" ownership. Today's extreme "free market" idea is a dumbed-down caricature of this position.
"A ‘free market' was an active political creation and required regulatory vigilance."
All sides viewed the government as society's "brain," its forward planning organ. Given the complexity of modern technology, humanity would shape its own evolution. Instead of evolution occurring by "primitive accumulation," it could be planned deliberately. Individualists countered that no human planner was sufficiently imaginative to manage the complexity of markets, but endorsed the need to strip away all forms of unearned income - economic rent and the rise in land prices that Mill called the "unearned increment." This involved government regulation to shape markets. A "free market" was an active political creation and required regulatory vigilance.
As public relations advocates for the vested interests and special rentier privilege, today's "neoliberal" advocates of "free" markets seek to maximize economic rent - the free lunch of price in excess of cost-value, not to free markets from rentier charges. So misleading a pedigree only could be achieved by outright suppression of knowledge of what Locke, Smith and Mill really wrote. Attempts to regulate "free markets" and limit monopoly pricing and privilege are conflated with "socialism," even with Soviet-style bureaucracy. The aim is to deter the analysis of what a "free market" really is: a market free of unnecessary costs: monopoly rents, property rents and financial charges for credit that governments can create freely.
Political reform to bring market prices in line with socially necessary cost-value was the great economic issue of the 19th century. The labor theory of intrinsic cost-value found its counterpart in the theory of economic rent: land rent, monopoly price gouging, interest and other returns to special privilege that increased market prices purely by institutional property claims. The discussion goes all the way back to the medieval churchmen defining Just Price. The doctrine originally was applied to the proper fees that bankers could charge, and later was extended to land rent, then to the monopolies that governments created and sold off to creditors in an attempt to extricate themselves from debt.
Reformists and more radical socialists alike sought to free capitalism of its egregious inequities, above all its legacy from Europe's Dark Age of military conquest when invading warlords seized lands and imposed an absentee landlord class to receive the rental income, which was used to finance wars of further land acquisition. As matters turned out, hopes that industrial capitalism could reform itself along progressive lines to purge itself of its legacy from feudalism have come crashing down. World War I hit the global economy like a comet, pushing it into a new trajectory and catalyzing its evolution into an unanticipated form of finance capitalism.
"Instead of industrial capitalism increasing capital formation we are seeing finance capitalism strip capital."
It was unanticipated largely because most reformers spent so much effort advocating progressive policies that they neglected what Thorstein Veblen called the vested interests. Their Counter-Enlightenment is creating a world that would have been deemed a dystopia a century ago - something so pessimistic that no futurist dared depict a world run by venal and corrupt bankers, protecting as their prime customers the monopolies, real estate speculators and hedge funds whose economic rent, financial gambling and asset-price inflation is turned into a flow of interest in today's rentier economy. Instead of industrial capitalism increasing capital formation we are seeing finance capitalism strip capital, and instead of the promised world of leisure we are being drawn into one of debt peonage.
The financial travesty of democracy
The financial sector has redefined democracy by making claims that the Federal Reserve must be "independent" from democratically elected representatives, in order to act as the bank lobbyist in Washington. This makes the financial sector exempt from the democratic political process, despite the fact that today's economic planning is now centralized in the banking system. The result is a regime of insider dealings and oligarchy - rule by the wealthy few.
The economic fallacy at work is that bank credit is a veritable factor of production, an almost Physiocratic source of fertility without which growth could not occur. The reality is that the monopoly right to create interest-bearing bank credit is a free transfer from society to a privileged elite. The moral is that when we see a "factor of production" that has no actual labor-cost of production, it is simply an institutional privilege.
So this brings us to the most recent debate about "nationalizing" or "socializing" the banks. The Troubled Asset Relief Program (TARP) so far has been used for the following uses that I think can be truly deemed anti-social, not "socialist" in any form.
By the end of last year, $20 billion was used to pay bonuses and salaries to financial mismanagers, despite the plunge of their banks into negative equity. And to protect their interests, these banks continued to pay lobbying fees to persuade legislators to give them yet more special privileges.
"Do we really want to let banks 'pay back taxpayers' by engaging in yet more predatory financial practices."
While Citibank and other major institutions threatened to bring the financial system crashing down by being "too big to fail," over $100 billion of TARP funds was used to make them even bigger. Already teetering banks bought affiliates that had grown by making irresponsible and outright fraudulent loans. Bank of America bought Angelo Mozilo's Countrywide Financial and Merrill Lynch, while JP Morgan Chase bought Bear Stearns and other big banks bought WaMu and Wachovia.
Today's policy is to "rescue" these giant bank conglomerates by enabling them to "earn" their way out of debt - by selling yet more debt to an already over-indebted U.S. economy. The hope is to re-inflate real estate and other asset prices. But do we really want to let banks "pay back taxpayers" by engaging in yet more predatory financial practices vis-à-vis the economy at large? It threatens to maximize the margin of market price over direct costs of production, by building in higher financial charges. This is just the opposite policy from trying to bring prices for housing and infrastructure in line with technologically necessary costs. It certainly is not a policy to make the U.S. economy more globally competitive.
The Treasury's plan to "socialize" the banks, insurance companies and other financial institutions is simply to step in and take bad loans off their books, shifting the loss onto the public sector. This is the antithesis of true nationalization or "socialization" of the financial system. The banks and insurance companies quickly got over their initial knee-jerk fear that a government bailout would occur on terms that would wipe out their bad management, along with the stockholders and bondholders who backed this bad management. The Treasury has assured these mismanagers that "socialism" for them is a free gift. The primacy of finance over the rest of the economy will be affirmed, leaving management in place and giving stockholders a chance to recover by earning more from the economy at large, with yet more tax favoritism. (This means yet heavier taxes shifted onto consumers, raising their living costs accordingly.)
"The Treasury has assured these mismanagers that ‘socialism' for them is a free gift."
The bulk of wealth under capitalism - as under feudalism -always has come primarily from the public domain, headed by the land and formerly public utilities, capped most recently by the Treasury's debt-creating power. In effect, the Treasury creates a new asset ($11 trillion of new Treasury bonds and guarantees, e.g. the $5.2 trillion to Fannie and Freddie). Interest on these bonds is to be paid by new levies on labor, not on property. This is what is supposed to re-inflate housing, stock and bond prices - the money freed from property and corporate taxes will be available to be capitalized into yet new loans.
So the revenue hitherto paid as business taxes will still be paid - in the form of interest - while the former taxes will still be collected, but from labor. The fiscal-financial burden thus will be doubled. This is not a program to make the economy more competitive or raise living standards for most people. It is a program to polarize the U.S. economy even further between finance, insurance and real estate (FIRE) at the top and labor at the bottom.
Neoliberal denunciations of public regulation and taxation as "socialism" is really an attack on classical political economy - the "original" liberalism whose ideal was to free society from the parasitic legacy of feudalism. A truly socialized Treasury policy would be for banks to lend for productive purposes that contribute to real economic growth, not merely to increase overhead and inflate asset prices by enough to extract interest charges. Fiscal policy would aim to minimize rather than maximizing the price of home ownership and doing business, by basing the tax system on collecting the rent that is now being paid out as interest. Shifting the tax burden off wages and profits onto rent and interest was the core of classical political economy in the 18th and 19th centuries, as well as the Progressive Era and Social Democratic reform movements in the United States and Europe prior to World War I. But this doctrine and its reform program has been buried by the rhetorical smokescreen organized by financial lobbyists seeking to muddy the ideological waters sufficiently to mute popular opposition to today's power grab by finance capital and monopoly capital. Their alternative to true nationalization and socialization of finance is debt peonage, oligarchy and neo-feudalism. They have called this program "free markets."
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com
The Language of Looting
Wednesday, 25 February 2009
by Michael Hudson
In order to steal literally everything, the Lords of Finance must render language incapable of describing the crime. "Society's basic grammar of thought, the vocabulary to discuss political and economic topics, is being turned inside-out." The banksters still think they can rule from the center of confusion. "Today's policy is to ‘rescue' these giant bank conglomerates by enabling them to ‘earn' their way out of debt - by selling yet more debt to an already over-indebted U.S. economy. The hope is to re-inflate real estate and other asset prices."
"Banking shares began to plunge Friday morning after Senator Dodd, the Connecticut Democrat who is chairman of the banking committee, said in an interview with Bloomberg Television that he was concerned the government might end up nationalizing some lenders "at least for a short time." Several other prominent policy makers - including Alan Greenspan, the former chairman of the Federal Reserve, and Senator Lindsey Graham of South Carolina - have echoed that view recently." -- Eric Dash, "Growing Worry on Rescue Takes a Toll on Banks," The New York Times, February 20, 2009
How is it that Alan Greenspan, free-market lobbyist for Wall Street, recently announced that he favored nationalization of America's banks - and indeed, mainly the biggest and most powerful? Has the old disciple of Ayn Rand gone Red in the night? Surely not.
The answer is that the rhetoric of "free markets," "nationalization" and even "socialism" (as in "socializing the losses") has been turned into the language of deception to help the financial sector mobilize government power to support its own special privileges. Having undermined the economy at large, Wall Street's public relations think tanks are now dismantling the language itself.
Exactly what does "a free market" mean? Is it what the classical economists advocated - a market free from monopoly power, business fraud, political insider dealing and special privileges for vested interests - a market protected by the rise in public regulation from the Sherman Anti-Trust law of 1890 to the Glass-Steagall Act and other New Deal legislation? Or is it a market free for predators to exploit victims without public regulation or economic policemen - the kind of free-for-all market that the Federal Reserve and Security and Exchange Commission (SEC) have created over the past decade or so? It seems incredible that people should accept today's neoliberal idea of "market freedom" in the sense of neutering government watchdogs, Alan Greenspan-style, letting Angelo Mozilo at Countrywide, Hank Greenberg at AIG, Bernie Madoff, Citibank, Bear Stearns and Lehman Brothers loot without hindrance or sanction, plunge the economy into crisis and then use Treasury bailout money to pay the highest salaries and bonuses in U.S. history.
"Having undermined the economy at large, Wall Street's public relations think tanks are now dismantling the language itself."
Terms that are the antithesis of "free market" also are being turned into the opposite of what they historically have meant. Take today's discussions about nationalizing the banks. For over a century nationalization has meant public takeover of monopolies or other sectors to operate them in the public interest rather than leaving them to special interests. But when neoliberals use the word "nationalization" they mean a bailout, a government giveaway to the financial interests.
Doublethink and doubletalk with regard to "nationalizing" or "socializing" the banks and other sectors is a travesty of political and economic discussion from the 17th through mid-20th centuries. Society's basic grammar of thought, the vocabulary to discuss political and economic topics, is being turned inside-out in an effort to ward off discussion of the policy solutions posed by the classical economists and political philosophers that made Western civilization "Western."
Today's clash of civilization is not really with the Orient; it is with our own past, with the Enlightenment itself and its evolution into classical political economy and Progressive Era social reforms aimed at freeing society from the surviving trammels of European feudalism. What we are seeing is propaganda designed to deceive, to distract attention from economic reality so as to promote the property and financial interests from whose predatory grasp classical economists set out to free the world. What is being attempted is nothing less than an attempt to destroy the intellectual and moral edifice of what took Western civilization eight centuries to develop, from the 12th century Schoolmen discussing Just Price through 19th and 20th century classical economic value theory.
"What we are seeing is propaganda designed to deceive, to distract attention from economic reality."
Any idea of "socialism from above," in the sense of "socializing the risk," is old-fashioned oligarchy - kleptocratic statism from above. Real nationalization occurs when governments act in the public interest to take over private property. The 19th-century program to nationalize the land (it was the first plank of the Communist Manifesto) did not mean anything remotely like the government taking over estates, paying off their mortgages at public expense and then giving it back to the former landlords free and clear of encumbrances and taxes. It meant taking the land and its rental income into the public domain, and leasing it out at a user fee ranging from actual operating cost to a subsidized rate or even freely as in the case of streets and roads.
Nationalizing the banks along these lines would mean that the government would supply the nation's credit needs. The Treasury would become the source of new money, replacing commercial bank credit. Presumably this credit would be lent out for economically and socially productive purposes, not merely to inflate asset prices while loading down households and business with debt as has occurred under today's commercial bank lending policies.
How neoliberals falsify the West's political history
The fact that today's neoliberals claim to be the intellectual descendants of Adam Smith make it necessary to restore a more accurate historical perspective. Their concept of "free markets" is the antithesis of Smith's. It is the opposite of that of the classical political economists down through John Stuart Mill, Karl Marx and the Progressive Era reforms that sought to create markets free of extractive rentier claims by special interests whose institutional power can be traced back to medieval Europe and its age of military conquest.
Economic writers from the 16th through 20th centuries recognized that free markets required government oversight to prevent monopoly pricing and other charges levied by special privilege. By contrast, today's neoliberal ideologues are public relations advocates for vested interests to depict a "free market" is one free of government regulation, "free" of anti-trust protection, and even of protection against fraud (as evidenced by the SEC's refusal to move against Madoff, Enron, Citibank et al.). The neoliberal ideal of free markets is thus basically that of a bank robber or embezzler, wishing for a world without police so as to be sufficiently free to siphon off other peoples' money without constraint.
The Chicago Boys in Chile realized that markets free for predatory finance and insider privatization could only be imposed at gunpoint. These free-marketers closed down every economics department in Chile, every social science department outside of the Catholic University where the Chicago Boys held sway. Operation Condor arrested, exiled or murdered tens of thousands of academics, intellectuals, labor leaders and artists. Only by totalitarian control over the academic curriculum and public media backed by an active secret police and army could "free markets" neoliberal style be imposed. The resulting privatization at gunpoint became an exercise in what Marx called "primitive accumulation" - seizure of the public domain by political elites backed by force. It is a free market William-the-Conqueror or Yeltsin-kleptocrat style, with property parceled out to the companions of the political or military leader.
"The neoliberal ideal of free markets is basically that of a bank robber or embezzler, wishing for a world without police."
All this was just the opposite of the kind of free markets that Adam Smith had in mind when he warned that businessmen rarely get together but to plot ways to fix markets to their advantage. This is not a problem that troubled Mr. Greenspan or the editorial writers of the New York Times and Washington Post. There really is no kinship between their neoliberal ideals and those of the Enlightenment political philosophers. For them to promote an idea of free markets as ones "free" for political insiders to pry away the public domain for themselves is to lower an intellectual Iron Curtain on the history of economic thought.
The classical economists and American Progressives envisioned markets free of economic rent and interest - free of rentier overhead charges and monopoly price gouging, free of land-rent, interest paid to bankers and wealthy financial institutions, and free of taxes to support an oligarchy. Governments were to base their tax systems on collecting the "free lunch" of economic rent, headed by that of favorable locations supplied by nature and given market value by public investment in transportation and other infrastructure, not by the efforts of landlords themselves.
The argument between Progressive Era reformers, socialists, anarchists and individualists thus turned on the political strategy of how best to free markets from debt and rent. Where they differed was on the best political means to achieve it, above all the role of the state. There was broad agreement that the state was controlled by vested interests inherited from feudal Europe's military conquests and the world that was colonized by European military force. The political question at the turn of the 20th century was whether peaceful democratic reform could overcome the political and even military resistance wielded by the Old Regime using violence to retain its "rights." The ensuing political revolutions were grounded in the Enlightenment, in the legal philosophy of men such as John Locke, political economists such as Adam Smith, John Stuart Mill and Marx. Power was to be used to free markets from the predatory property and financial systems inherited from feudalism. Markets were to be free of privilege and free lunches, so that people would obtain income and wealth only by their own labor and enterprise. This was the essence of the labor theory of value and its complement, the concept of economic rent as the excess of market price over socially necessary cost-value.
Although we now know that markets and prices, rent and interest, contractual formalities and nearly all the elements of economic enterprise originated in the "mixed economies" of Mesopotamia in the fourth millennium BC and continued throughout the mixed public/private economies of classical antiquity, the discussion was so politically polarized that the idea of a mixed economy with checks and balances received scant attention a century ago.
"Power was to be used to free markets from the predatory property and financial systems inherited from feudalism."
Individualists believed that shrinking central governments would shrink the control mechanism by which the vested interests extracted wealth without work or enterprise of their own. Socialists saw that a strong government was needed to protect society from the attempts of property and finance to use their gains to monopolize economic and political power. Both ends of the political spectrum aimed at the same objective - to bring prices down to actual costs of production. The common aim was to maximize economic efficiency so as to pass on the fruits of the Industrial and Agricultural Revolutions to the population at large. This required blocking the rentier class of interlopers from grabbing the public domain and controlling the allocation of resources. Socialists did not believe this could be done without taking the state's political and legal power into their own hands. Marxists believed that a revolution was necessary to reclaim property rent for the public domain, and to enable governments to create their own credit rather than borrow at interest from commercial bankers and wealthy bondholders. The aim was not to create a bureaucracy but to free society from the surviving absentee ownership power of the vested property and financial interests.
All this history of economic thought has been as thoroughly expunged from today's academic curriculum as it has from popular discussion. Few people remember the great debate at the turn of the 20th century: Would the world progress fairly quickly from Progressive Era reforms to outright socialism - public ownership of basic economic infrastructure, natural monopolies (including the banking system) and the land itself (and to Marxists, of industrial capital as well)? Or, could the liberal reformers of the day - individualists, land taxers, classical economists in the tradition of Mill, and American institutionalists such as Simon Patten - retain capitalism's basic structure and private property ownership? If they could do so, they recognized that it would have to be in the context of regulating markets and introducing progressive taxation of wealth and income. This was the alternative to outright "state" ownership. Today's extreme "free market" idea is a dumbed-down caricature of this position.
"A ‘free market' was an active political creation and required regulatory vigilance."
All sides viewed the government as society's "brain," its forward planning organ. Given the complexity of modern technology, humanity would shape its own evolution. Instead of evolution occurring by "primitive accumulation," it could be planned deliberately. Individualists countered that no human planner was sufficiently imaginative to manage the complexity of markets, but endorsed the need to strip away all forms of unearned income - economic rent and the rise in land prices that Mill called the "unearned increment." This involved government regulation to shape markets. A "free market" was an active political creation and required regulatory vigilance.
As public relations advocates for the vested interests and special rentier privilege, today's "neoliberal" advocates of "free" markets seek to maximize economic rent - the free lunch of price in excess of cost-value, not to free markets from rentier charges. So misleading a pedigree only could be achieved by outright suppression of knowledge of what Locke, Smith and Mill really wrote. Attempts to regulate "free markets" and limit monopoly pricing and privilege are conflated with "socialism," even with Soviet-style bureaucracy. The aim is to deter the analysis of what a "free market" really is: a market free of unnecessary costs: monopoly rents, property rents and financial charges for credit that governments can create freely.
Political reform to bring market prices in line with socially necessary cost-value was the great economic issue of the 19th century. The labor theory of intrinsic cost-value found its counterpart in the theory of economic rent: land rent, monopoly price gouging, interest and other returns to special privilege that increased market prices purely by institutional property claims. The discussion goes all the way back to the medieval churchmen defining Just Price. The doctrine originally was applied to the proper fees that bankers could charge, and later was extended to land rent, then to the monopolies that governments created and sold off to creditors in an attempt to extricate themselves from debt.
Reformists and more radical socialists alike sought to free capitalism of its egregious inequities, above all its legacy from Europe's Dark Age of military conquest when invading warlords seized lands and imposed an absentee landlord class to receive the rental income, which was used to finance wars of further land acquisition. As matters turned out, hopes that industrial capitalism could reform itself along progressive lines to purge itself of its legacy from feudalism have come crashing down. World War I hit the global economy like a comet, pushing it into a new trajectory and catalyzing its evolution into an unanticipated form of finance capitalism.
"Instead of industrial capitalism increasing capital formation we are seeing finance capitalism strip capital."
It was unanticipated largely because most reformers spent so much effort advocating progressive policies that they neglected what Thorstein Veblen called the vested interests. Their Counter-Enlightenment is creating a world that would have been deemed a dystopia a century ago - something so pessimistic that no futurist dared depict a world run by venal and corrupt bankers, protecting as their prime customers the monopolies, real estate speculators and hedge funds whose economic rent, financial gambling and asset-price inflation is turned into a flow of interest in today's rentier economy. Instead of industrial capitalism increasing capital formation we are seeing finance capitalism strip capital, and instead of the promised world of leisure we are being drawn into one of debt peonage.
The financial travesty of democracy
The financial sector has redefined democracy by making claims that the Federal Reserve must be "independent" from democratically elected representatives, in order to act as the bank lobbyist in Washington. This makes the financial sector exempt from the democratic political process, despite the fact that today's economic planning is now centralized in the banking system. The result is a regime of insider dealings and oligarchy - rule by the wealthy few.
The economic fallacy at work is that bank credit is a veritable factor of production, an almost Physiocratic source of fertility without which growth could not occur. The reality is that the monopoly right to create interest-bearing bank credit is a free transfer from society to a privileged elite. The moral is that when we see a "factor of production" that has no actual labor-cost of production, it is simply an institutional privilege.
So this brings us to the most recent debate about "nationalizing" or "socializing" the banks. The Troubled Asset Relief Program (TARP) so far has been used for the following uses that I think can be truly deemed anti-social, not "socialist" in any form.
By the end of last year, $20 billion was used to pay bonuses and salaries to financial mismanagers, despite the plunge of their banks into negative equity. And to protect their interests, these banks continued to pay lobbying fees to persuade legislators to give them yet more special privileges.
"Do we really want to let banks 'pay back taxpayers' by engaging in yet more predatory financial practices."
While Citibank and other major institutions threatened to bring the financial system crashing down by being "too big to fail," over $100 billion of TARP funds was used to make them even bigger. Already teetering banks bought affiliates that had grown by making irresponsible and outright fraudulent loans. Bank of America bought Angelo Mozilo's Countrywide Financial and Merrill Lynch, while JP Morgan Chase bought Bear Stearns and other big banks bought WaMu and Wachovia.
Today's policy is to "rescue" these giant bank conglomerates by enabling them to "earn" their way out of debt - by selling yet more debt to an already over-indebted U.S. economy. The hope is to re-inflate real estate and other asset prices. But do we really want to let banks "pay back taxpayers" by engaging in yet more predatory financial practices vis-à-vis the economy at large? It threatens to maximize the margin of market price over direct costs of production, by building in higher financial charges. This is just the opposite policy from trying to bring prices for housing and infrastructure in line with technologically necessary costs. It certainly is not a policy to make the U.S. economy more globally competitive.
The Treasury's plan to "socialize" the banks, insurance companies and other financial institutions is simply to step in and take bad loans off their books, shifting the loss onto the public sector. This is the antithesis of true nationalization or "socialization" of the financial system. The banks and insurance companies quickly got over their initial knee-jerk fear that a government bailout would occur on terms that would wipe out their bad management, along with the stockholders and bondholders who backed this bad management. The Treasury has assured these mismanagers that "socialism" for them is a free gift. The primacy of finance over the rest of the economy will be affirmed, leaving management in place and giving stockholders a chance to recover by earning more from the economy at large, with yet more tax favoritism. (This means yet heavier taxes shifted onto consumers, raising their living costs accordingly.)
"The Treasury has assured these mismanagers that ‘socialism' for them is a free gift."
The bulk of wealth under capitalism - as under feudalism -always has come primarily from the public domain, headed by the land and formerly public utilities, capped most recently by the Treasury's debt-creating power. In effect, the Treasury creates a new asset ($11 trillion of new Treasury bonds and guarantees, e.g. the $5.2 trillion to Fannie and Freddie). Interest on these bonds is to be paid by new levies on labor, not on property. This is what is supposed to re-inflate housing, stock and bond prices - the money freed from property and corporate taxes will be available to be capitalized into yet new loans.
So the revenue hitherto paid as business taxes will still be paid - in the form of interest - while the former taxes will still be collected, but from labor. The fiscal-financial burden thus will be doubled. This is not a program to make the economy more competitive or raise living standards for most people. It is a program to polarize the U.S. economy even further between finance, insurance and real estate (FIRE) at the top and labor at the bottom.
Neoliberal denunciations of public regulation and taxation as "socialism" is really an attack on classical political economy - the "original" liberalism whose ideal was to free society from the parasitic legacy of feudalism. A truly socialized Treasury policy would be for banks to lend for productive purposes that contribute to real economic growth, not merely to increase overhead and inflate asset prices by enough to extract interest charges. Fiscal policy would aim to minimize rather than maximizing the price of home ownership and doing business, by basing the tax system on collecting the rent that is now being paid out as interest. Shifting the tax burden off wages and profits onto rent and interest was the core of classical political economy in the 18th and 19th centuries, as well as the Progressive Era and Social Democratic reform movements in the United States and Europe prior to World War I. But this doctrine and its reform program has been buried by the rhetorical smokescreen organized by financial lobbyists seeking to muddy the ideological waters sufficiently to mute popular opposition to today's power grab by finance capital and monopoly capital. Their alternative to true nationalization and socialization of finance is debt peonage, oligarchy and neo-feudalism. They have called this program "free markets."
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com
Wednesday, December 10, 2008
The truth behind the Citigroup nationalization
http://onlinejournal.com/artman/publish/article_4062.shtml
The truth behind the Citigroup nationalization
By F. William Engdahl
Online Journal Contributing Writer
Nov 27, 2008
On Friday, November 21, the world came within a hair’s breadth of the most colossal financial collapse in history, according to bankers on the inside of events with whom we have contact.
The trigger was the bank which only two years ago was America’s largest, Citigroup. The size of the US government de facto nationalization of the $2 trillion banking institution is an indication of shocks yet to come in other major US and perhaps European banks thought to be ‘too big to fail.’
The clumsy way in which US Treasury Secretary Henry Paulson, himself not a banker but a Wall Street ‘investment banker,’ whose experience has been in the quite different world of buying and selling stocks or bonds or underwriting and selling same, has handled the unfolding crisis has been worse than incompetent. It has made a grave situation into a globally alarming one.
‘Spitting into the wind’
A case in point is the secretive manner in which Paulson has used the $700 billion in taxpayer funds voted him by a pliable Congress in September. Early on, Paulson put $125 billion into the nine largest banks, including $10 billion for his old firm, Goldman Sachs. However, if we compare the value of the equity share that $125 billion bought with the market price of those banks’ stock, US taxpayers have paid $125 billion for bank stock that a private investor could have bought for $62.5 billion, according to a detailed analysis from Ron W. Bloom, economist with the United Steelworkers union, whose members as well as pension fund face devastating losses were GM to fail.
That means half of the public’s money was a gift to Paulson’s Wall Street cronies. Now, only weeks later, the Treasury is forced to intervene to de facto nationalize Citigroup. It won’t be the last.
Paulson demanded, and got from a pliable US Congress, Democrats as well as Republicans, sole discretion over how and where he can invest the $700 billion, to date with no effective oversight. It amounts to the Treasury secretary in effect ‘spitting into the wind’ in terms of resolving the fundamental crisis.
It should be clear to any serious analyst by now that the September decision by Paulson to defer to rigid financial ideology and let the fourth largest US investment bank, Lehman Brothers fail, was the proximate trigger for the present global crisis. Lehman Brothers’ surprise collapse triggered the current global crisis of confidence. It was simply not clear to the rest of the banking world which US financial institution bank might be saved and which not, after the government had earlier saved the far smaller Bear Stearns, while letting the larger, far more strategic Lehman Brothers fail.
Some Citigroup details
The most alarming aspect of the crisis is the fact that we are in an inter-regnum period when the next president has been elected but cannot act on the situation until after January 20, 2009, when he is sworn in.
Consider the details of the latest Citigroup government de facto nationalization (for ideological reasons Paulson and the Bush administration hysterically avoid admitting they are in the process of nationalizing key banks). Citigroup has more than $2 trillion of assets, dwarfing companies such as American International Group Inc. that got some $150 billion in US taxpayer funds in the past two months. Ironically, only eight weeks before, the government had designated Citigroup to take over the failing Wachovia Bank. Normally, authorities have an ailing bank absorbed by a stronger one. In this instance the opposite seems to have been the case. Now it is clear that the Citigroup was in deeper trouble than Wachovia. In a matter of hours in the week before the US government nationalization was announced, the stock value of Citibank plunged to $3.77 in New York, giving the company a market value of about $21 billion. The market value of Citigroup stock in December 2006 had been $247 billion. Two days before the bank’s nationalization, the CEO, Vikram Pandit, had announced a huge 52,000 job slashing plan. It did nothing to stop the slide.
The scale of the hidden losses of perhaps the 20 largest US banks is so enormous that if not before, the first presidential decree of President Barack Obama will likely have to be declaration of a US ‘Bank Holiday’ and the full nationalization of the major banks, taking on the toxic assets and losses until the economy can again function with credit flowing to industry once more.
Citigroup and the government have identified a pool of about $306 billion in troubled assets. Citigroup will absorb the first $29 billion in losses. After that, remaining losses will be split between Citigroup and the government, with the bank absorbing 10 percent and the government absorbing 90 percent. The US Treasury Department will use its $700 billion TARP or Troubled Asset Recovery Program bailout fund, to assume up to $5 billion of losses. If necessary, the government’s Federal Deposit Insurance Corporation (FDIC) will bear the next $10 billion of losses. Beyond that, the Federal Reserve will guarantee any additional losses. The measures are without precedent in US financial history. It’s by no means certain they will salvage the dollar system.
The situation is so intertwined, with six US major banks holding the vast bulk of worldwide financial derivatives exposure, that the failure of a single major US financial institution could result in losses to the OTC derivatives market of $300-$400 billion, a new IMF working paper finds. What’s more, since such a failure would likely cause cascading failures of other institutions. total global financial system losses could exceed another $1,500 billion according to an IMF study by Singh and Segoviano.
The madness over a Detroit GM rescue deal
The health of Citigroup is not the only gripping crisis that must be dealt with. At this point, political and ideological bickering in the US Congress has so far prevented a simple emergency $25 billion loan extension to General Motors and others of the US Big Three automakers -- Ford and Chrysler. The absurd spectacle of US congressmen attacking the chairmen of the Big Three for flying to the emergency congressional hearings on a rescue loan in their private company jets, while largely ignoring the issue of consequences to the economy of a GM failure underscores the utter lack of touch with reality that has overwhelmed Washington in recent years.
For GM to go into bankruptcy risks a disaster of colossal proportions. Although Lehman Brothers, the biggest bankruptcy in US history, appears to have had an orderly settlement of its credit defaults swaps, the disruption occurred beforehand, as protection writers had to post additional collateral prior to settlement. That was a major factor in the dramatic global market selloff in October. GM is bigger by far, meaning bigger collateral damage, and this would take place when the financial system is even weaker than when Lehman failed.
In addition, a second, and potentially far more damaging issue, has been largely ignored. The advocates of letting GM go bankrupt argue that it can go into Chapter 11 just like other big companies that get themselves in trouble. That may not happen however, and a Chapter 7 or liquidation of GM that would then result would be a tectonic event.
The problem is that under Chapter 11, it takes time for the company to get the protection of a bankruptcy court. Until that time, which may be weeks or months, the company would need urgently ‘bridge financing’ to continue operating. This is known as ‘Debtor-in-Possession’ or DIP financing. DIP is essential for most Chapter 11 bankruptcies, as it takes time to get the plan of reorganization approved by creditors and the courts. Most companies, like GM today, go to bankruptcy court when they are at the end of their liquidity.
DIP is specifically for companies in, or on the verge of bankruptcy, and the debt is generally senior to other outstanding creditor claims. So it is actually very low risk, as the amount spent is usually not large, relatively speaking. But DIP lending is being severely curtailed right now, just when it is most needed, as healthier banks drastically curtail loans in the severe credit crunch situation.
Without access to DIP bridge financing, GM would be forced into a partial, or even a full liquidation. The ramifications are horrendous. Aside from loss of 125,000 US jobs at GM itself, GM is critical to keeping many US auto suppliers in business. If GM failed, soon most, possibly even all, of the US and even foreign auto suppliers will go under. Those parts suppliers are important to other automakers. Many foreign car factories would be forced to close due to loss of suppliers. Some analysts put 2009 job losses from a GM failure as high as 2.5 million jobs due to the follow-on effects. If the impact of that 2.5 million job loss is seen in terms of the overall losses to the economy of non-auto jobs such as services, home foreclosures caused and such, some estimate total impact would be more than 15 million jobs.
So far in the face of this staggering prospect, the members of the US Congress have chosen to focus on the fact the GM chief, Rick Wagoner, flew in his private company jet to Washington. The congressional charade conjures up the image of Nero playing his fiddle as Rome goes up in flames. It should not be surprising that at the recent EU-Asian Summit in Beijing, Chinese officials floated the idea of trading between the EU and Asian nations such as China in euros, renminbi, yen or other national currencies other than the dollar. The Citigroup bailout and GM debacle has confirmed the death of the post-1944 Bretton Woods Dollar System.
The truth behind Citigroup bailout
What neither Paulson nor anyone in Washington is willing to reveal is the truth behind the Citigroup bailout. By his and the Republican Bush administration’s adamant earlier refusal to take an initial resolute action to immediately nationalize the nine or so largest troubled banks, he has created the present debacle. By refusing, on ideological grounds, to instead reorganize the banks’ assets into some form of ‘good bank’ and ‘bad bank,’ similar to what the government of Sweden did with what it called Securum, during its banking crisis in the early 1990s, Paulson and company have created a global financial structure on the brink.
A Securum or similar temporary nationalization would have allowed the healthy banks to continue lending to the real economy so the economy could continue operating, while the state merely sat on the undervalued real estate assets of the Swedish banks for some months until the recovering economy made the assets again marketable to the private sector. Instead, Paulson and his ‘crony capitalists’ in Washington have turned a bad situation into a globally catastrophic one.
His apparent realization of the error of his initial refusal to nationalize came too late. When Paulson reversed policy on September 19 and presented the nine largest banks with an ultimatum to accept partial government equity ownership, abandoning his original bizarre plan to merely buy up the toxic waste asset-backed securities of the banks with his $700 billion TARP taxpayer money, he never revealed why.
Under the original Paulson Plan, as Dimitri B. Papadimitriou and L. Randall Wray of the Jerome Levy Institute at Bard College in New York point out, Paulson sought to create a situation in which the US ‘Treasury would become an owner of troubled financial institutions in exchange for a capital injection -- but without exercising any ownership rights, such as replacing the management that created the mess. The bailout would be used as an opportunity to consolidate control of the nation’s financial system in the hands of a few large [Wall Street] banks, with government funds subsidizing purchases of troubled banks by “healthy” ones.’
Paulson soon realized the scale of crisis, largely triggered by his inept handling of the Lehman Brothers case, had created an impossible situation. Were Paulson to use the $700 billion to buy up toxic waste ABS from the select banks at today’s market price, the $700 billion would be far too little to take an estimated $2 trillion ($2,000 billion) in Asset Backed Securities off the books of the banks.
The Levy Economics Institute economists state, ‘It is probable that many and perhaps most financial institutions are insolvent today -- with a black hole of negative net worth that would swallow Paulson’s entire $700 billion in one gulp.’
That reality is the real reason Paulson was forced to abandon his original ‘crony bailout’ TARP plan and opt to use some of his money to buy equity shares in the nine largest banks.
That scheme as well is ‘dead on arrival,’ as the latest Citigroup nationalization scheme underscores. The dilemma Paulson has created with his inept handling of the crisis is simple: If the US government paid the true value for these nearly worthless assets, the banks would have to write down huge losses, and, as Levy economists put it, ‘announce to the world that they are insolvent.’ On the other hand, if Paulson raised the toxic waste purchase price high enough to protect the banks from losses, $700 billion ‘will buy only a tiny fraction of the ‘troubled’ assets.’ That is what the latest nationalization of Citigroup is about.
It is only the beginning. The 2009 year will be one of titanic shocks and changes to the global order of a scale perhaps not experienced in the past five centuries. This is why we should speak of the end of the American Century and its Dollar System.
How destructive that process will be to the citizens of the United States who are the prime victims of Paulson’s crony capitalists, as well as to the rest of the world, depends now on the urgency and resoluteness with which heads of national governments in Germany, the EU, China, Russia and the rest of the non-US world react. It is no time for ideological sentimentality and nostalgia of the postwar old order. That collapsed this past September along with Lehman Brothers and the Republican presidency. Waiting for a ‘miracle’ from an Obama presidency is no longer an option for the rest of the world.
F. William Engdahl is author of the book, ‘A Century of War: Anglo-American Oil Politics and the New World Order.’ He is completing work on a new book, ‘Power of Money: The Rise and Decline of the American Century’ due to be released in late Spring 2009. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
The truth behind the Citigroup nationalization
By F. William Engdahl
Online Journal Contributing Writer
Nov 27, 2008
On Friday, November 21, the world came within a hair’s breadth of the most colossal financial collapse in history, according to bankers on the inside of events with whom we have contact.
The trigger was the bank which only two years ago was America’s largest, Citigroup. The size of the US government de facto nationalization of the $2 trillion banking institution is an indication of shocks yet to come in other major US and perhaps European banks thought to be ‘too big to fail.’
The clumsy way in which US Treasury Secretary Henry Paulson, himself not a banker but a Wall Street ‘investment banker,’ whose experience has been in the quite different world of buying and selling stocks or bonds or underwriting and selling same, has handled the unfolding crisis has been worse than incompetent. It has made a grave situation into a globally alarming one.
‘Spitting into the wind’
A case in point is the secretive manner in which Paulson has used the $700 billion in taxpayer funds voted him by a pliable Congress in September. Early on, Paulson put $125 billion into the nine largest banks, including $10 billion for his old firm, Goldman Sachs. However, if we compare the value of the equity share that $125 billion bought with the market price of those banks’ stock, US taxpayers have paid $125 billion for bank stock that a private investor could have bought for $62.5 billion, according to a detailed analysis from Ron W. Bloom, economist with the United Steelworkers union, whose members as well as pension fund face devastating losses were GM to fail.
That means half of the public’s money was a gift to Paulson’s Wall Street cronies. Now, only weeks later, the Treasury is forced to intervene to de facto nationalize Citigroup. It won’t be the last.
Paulson demanded, and got from a pliable US Congress, Democrats as well as Republicans, sole discretion over how and where he can invest the $700 billion, to date with no effective oversight. It amounts to the Treasury secretary in effect ‘spitting into the wind’ in terms of resolving the fundamental crisis.
It should be clear to any serious analyst by now that the September decision by Paulson to defer to rigid financial ideology and let the fourth largest US investment bank, Lehman Brothers fail, was the proximate trigger for the present global crisis. Lehman Brothers’ surprise collapse triggered the current global crisis of confidence. It was simply not clear to the rest of the banking world which US financial institution bank might be saved and which not, after the government had earlier saved the far smaller Bear Stearns, while letting the larger, far more strategic Lehman Brothers fail.
Some Citigroup details
The most alarming aspect of the crisis is the fact that we are in an inter-regnum period when the next president has been elected but cannot act on the situation until after January 20, 2009, when he is sworn in.
Consider the details of the latest Citigroup government de facto nationalization (for ideological reasons Paulson and the Bush administration hysterically avoid admitting they are in the process of nationalizing key banks). Citigroup has more than $2 trillion of assets, dwarfing companies such as American International Group Inc. that got some $150 billion in US taxpayer funds in the past two months. Ironically, only eight weeks before, the government had designated Citigroup to take over the failing Wachovia Bank. Normally, authorities have an ailing bank absorbed by a stronger one. In this instance the opposite seems to have been the case. Now it is clear that the Citigroup was in deeper trouble than Wachovia. In a matter of hours in the week before the US government nationalization was announced, the stock value of Citibank plunged to $3.77 in New York, giving the company a market value of about $21 billion. The market value of Citigroup stock in December 2006 had been $247 billion. Two days before the bank’s nationalization, the CEO, Vikram Pandit, had announced a huge 52,000 job slashing plan. It did nothing to stop the slide.
The scale of the hidden losses of perhaps the 20 largest US banks is so enormous that if not before, the first presidential decree of President Barack Obama will likely have to be declaration of a US ‘Bank Holiday’ and the full nationalization of the major banks, taking on the toxic assets and losses until the economy can again function with credit flowing to industry once more.
Citigroup and the government have identified a pool of about $306 billion in troubled assets. Citigroup will absorb the first $29 billion in losses. After that, remaining losses will be split between Citigroup and the government, with the bank absorbing 10 percent and the government absorbing 90 percent. The US Treasury Department will use its $700 billion TARP or Troubled Asset Recovery Program bailout fund, to assume up to $5 billion of losses. If necessary, the government’s Federal Deposit Insurance Corporation (FDIC) will bear the next $10 billion of losses. Beyond that, the Federal Reserve will guarantee any additional losses. The measures are without precedent in US financial history. It’s by no means certain they will salvage the dollar system.
The situation is so intertwined, with six US major banks holding the vast bulk of worldwide financial derivatives exposure, that the failure of a single major US financial institution could result in losses to the OTC derivatives market of $300-$400 billion, a new IMF working paper finds. What’s more, since such a failure would likely cause cascading failures of other institutions. total global financial system losses could exceed another $1,500 billion according to an IMF study by Singh and Segoviano.
The madness over a Detroit GM rescue deal
The health of Citigroup is not the only gripping crisis that must be dealt with. At this point, political and ideological bickering in the US Congress has so far prevented a simple emergency $25 billion loan extension to General Motors and others of the US Big Three automakers -- Ford and Chrysler. The absurd spectacle of US congressmen attacking the chairmen of the Big Three for flying to the emergency congressional hearings on a rescue loan in their private company jets, while largely ignoring the issue of consequences to the economy of a GM failure underscores the utter lack of touch with reality that has overwhelmed Washington in recent years.
For GM to go into bankruptcy risks a disaster of colossal proportions. Although Lehman Brothers, the biggest bankruptcy in US history, appears to have had an orderly settlement of its credit defaults swaps, the disruption occurred beforehand, as protection writers had to post additional collateral prior to settlement. That was a major factor in the dramatic global market selloff in October. GM is bigger by far, meaning bigger collateral damage, and this would take place when the financial system is even weaker than when Lehman failed.
In addition, a second, and potentially far more damaging issue, has been largely ignored. The advocates of letting GM go bankrupt argue that it can go into Chapter 11 just like other big companies that get themselves in trouble. That may not happen however, and a Chapter 7 or liquidation of GM that would then result would be a tectonic event.
The problem is that under Chapter 11, it takes time for the company to get the protection of a bankruptcy court. Until that time, which may be weeks or months, the company would need urgently ‘bridge financing’ to continue operating. This is known as ‘Debtor-in-Possession’ or DIP financing. DIP is essential for most Chapter 11 bankruptcies, as it takes time to get the plan of reorganization approved by creditors and the courts. Most companies, like GM today, go to bankruptcy court when they are at the end of their liquidity.
DIP is specifically for companies in, or on the verge of bankruptcy, and the debt is generally senior to other outstanding creditor claims. So it is actually very low risk, as the amount spent is usually not large, relatively speaking. But DIP lending is being severely curtailed right now, just when it is most needed, as healthier banks drastically curtail loans in the severe credit crunch situation.
Without access to DIP bridge financing, GM would be forced into a partial, or even a full liquidation. The ramifications are horrendous. Aside from loss of 125,000 US jobs at GM itself, GM is critical to keeping many US auto suppliers in business. If GM failed, soon most, possibly even all, of the US and even foreign auto suppliers will go under. Those parts suppliers are important to other automakers. Many foreign car factories would be forced to close due to loss of suppliers. Some analysts put 2009 job losses from a GM failure as high as 2.5 million jobs due to the follow-on effects. If the impact of that 2.5 million job loss is seen in terms of the overall losses to the economy of non-auto jobs such as services, home foreclosures caused and such, some estimate total impact would be more than 15 million jobs.
So far in the face of this staggering prospect, the members of the US Congress have chosen to focus on the fact the GM chief, Rick Wagoner, flew in his private company jet to Washington. The congressional charade conjures up the image of Nero playing his fiddle as Rome goes up in flames. It should not be surprising that at the recent EU-Asian Summit in Beijing, Chinese officials floated the idea of trading between the EU and Asian nations such as China in euros, renminbi, yen or other national currencies other than the dollar. The Citigroup bailout and GM debacle has confirmed the death of the post-1944 Bretton Woods Dollar System.
The truth behind Citigroup bailout
What neither Paulson nor anyone in Washington is willing to reveal is the truth behind the Citigroup bailout. By his and the Republican Bush administration’s adamant earlier refusal to take an initial resolute action to immediately nationalize the nine or so largest troubled banks, he has created the present debacle. By refusing, on ideological grounds, to instead reorganize the banks’ assets into some form of ‘good bank’ and ‘bad bank,’ similar to what the government of Sweden did with what it called Securum, during its banking crisis in the early 1990s, Paulson and company have created a global financial structure on the brink.
A Securum or similar temporary nationalization would have allowed the healthy banks to continue lending to the real economy so the economy could continue operating, while the state merely sat on the undervalued real estate assets of the Swedish banks for some months until the recovering economy made the assets again marketable to the private sector. Instead, Paulson and his ‘crony capitalists’ in Washington have turned a bad situation into a globally catastrophic one.
His apparent realization of the error of his initial refusal to nationalize came too late. When Paulson reversed policy on September 19 and presented the nine largest banks with an ultimatum to accept partial government equity ownership, abandoning his original bizarre plan to merely buy up the toxic waste asset-backed securities of the banks with his $700 billion TARP taxpayer money, he never revealed why.
Under the original Paulson Plan, as Dimitri B. Papadimitriou and L. Randall Wray of the Jerome Levy Institute at Bard College in New York point out, Paulson sought to create a situation in which the US ‘Treasury would become an owner of troubled financial institutions in exchange for a capital injection -- but without exercising any ownership rights, such as replacing the management that created the mess. The bailout would be used as an opportunity to consolidate control of the nation’s financial system in the hands of a few large [Wall Street] banks, with government funds subsidizing purchases of troubled banks by “healthy” ones.’
Paulson soon realized the scale of crisis, largely triggered by his inept handling of the Lehman Brothers case, had created an impossible situation. Were Paulson to use the $700 billion to buy up toxic waste ABS from the select banks at today’s market price, the $700 billion would be far too little to take an estimated $2 trillion ($2,000 billion) in Asset Backed Securities off the books of the banks.
The Levy Economics Institute economists state, ‘It is probable that many and perhaps most financial institutions are insolvent today -- with a black hole of negative net worth that would swallow Paulson’s entire $700 billion in one gulp.’
That reality is the real reason Paulson was forced to abandon his original ‘crony bailout’ TARP plan and opt to use some of his money to buy equity shares in the nine largest banks.
That scheme as well is ‘dead on arrival,’ as the latest Citigroup nationalization scheme underscores. The dilemma Paulson has created with his inept handling of the crisis is simple: If the US government paid the true value for these nearly worthless assets, the banks would have to write down huge losses, and, as Levy economists put it, ‘announce to the world that they are insolvent.’ On the other hand, if Paulson raised the toxic waste purchase price high enough to protect the banks from losses, $700 billion ‘will buy only a tiny fraction of the ‘troubled’ assets.’ That is what the latest nationalization of Citigroup is about.
It is only the beginning. The 2009 year will be one of titanic shocks and changes to the global order of a scale perhaps not experienced in the past five centuries. This is why we should speak of the end of the American Century and its Dollar System.
How destructive that process will be to the citizens of the United States who are the prime victims of Paulson’s crony capitalists, as well as to the rest of the world, depends now on the urgency and resoluteness with which heads of national governments in Germany, the EU, China, Russia and the rest of the non-US world react. It is no time for ideological sentimentality and nostalgia of the postwar old order. That collapsed this past September along with Lehman Brothers and the Republican presidency. Waiting for a ‘miracle’ from an Obama presidency is no longer an option for the rest of the world.
F. William Engdahl is author of the book, ‘A Century of War: Anglo-American Oil Politics and the New World Order.’ He is completing work on a new book, ‘Power of Money: The Rise and Decline of the American Century’ due to be released in late Spring 2009. He may be contacted through his website, www.engdahl.oilgeopolitics.net.
Thursday, November 6, 2008
Wall Street’s Great Heist of 2008
http://wsws.org/articles/2008/nov2008/pers-n01.shtml
Wall Street’s Great Heist of 2008
1st November 2008
The Wall Street Journal published a front-page article Friday reporting that the nine biggest US banks, which have received a combined $125 billion in taxpayer funds as part of the $700 billion bailout authored by Treasury Secretary Henry Paulson and passed by the Democratic Congress, owed their executives more than $40 billion for recent years’ compensation and pensions as of the end of 2007.
This means that nearly a third of the public funds given to these banks will ultimately be used to increase the private fortunes of a handful of multimillionaire Wall Street executives.
This revelation, the result of an analysis of the banks’ corporate reports by the American financial elite’s own chief organ, provides a stark exposure of the social interests that are being served by the government bailout. More generally, it provides an instructive insight into class relations in America.
It has already been widely reported that the banks are refusing to use their government windfalls to resume lending to other banks, businesses and consumers—the ostensible purpose of the cash injections—and are, instead, hoarding the money for the purpose of acquiring smaller and weaker banks. The so-called economic rescue plan is, in fact, a plan to effect a rapid consolidation of the US banking system, resulting in the domination of the economy by a few mega-banks, which will be free to set interest rates and lending standards as they see fit.
Far from opposing this development, Treasury Secretary Paulson and the Federal Reserve Board are encouraging it. They deliberately designed the bailout to place no restrictions on how the banks use their taxpayer money and then enacted changes in the tax code to give banks acquiring other banks a huge tax break. (See: “The ‘dirty little secret’ of the US bank bailout”)
As the Journal explains, the minimal restrictions on future executive compensation stipulated in the bailout bill do not affect deferred payments to executives accumulated over previous years. Since such deferred payment accounts are commonplace in the banking industry and are the preferred means by which top executives build up nest eggs in the hundreds of millions of dollars, those who are primarily responsible for the financial disaster and, in many cases, the ruin of their own companies, will emerge from the crisis richer than ever.
As the Journal puts it: “The deferred-compensation programs for executives are like 401(k) plans on steroids.” At some of the banks that have received government handouts, the newspaper notes, the total amounts previously incurred and owed to their executives exceed what they owe in pensions to their entire work forces.
The newspaper notes that at Goldman Sachs, formerly headed by Paulson, “the $11.8 billion obligation primarily for deferred executive compensation dwarfed the liability for its broad-based pension plan for all employees. That was just $399 million.”
Goldman received $10 billion of the $125 billion doled out to the biggest banks. JPMorgan Chase, which was granted $25 billion, owes its top officers $8.5 billion. Citigroup, another $25 billion recipient, owes $5 billion, and Morgan Stanley, which got $10 billion in taxpayer money, is in debt to its top executives to the tune of $10 to $12 billion.
A separate article in the same issue of the Journal amplifies this picture of parasitism and criminality. Headlined “Securities Firms Tackle Pay Issue,” it deals with discussions among the top executives of Wall Street firms such as Goldman Sachs, Morgan Stanley and Merrill Lynch over the advisability of paring down their traditional multimillion-dollar year-end bonuses in the face of growing public outrage.
The article notes that since the start of 2002, Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns have paid a total of $312 billion in compensation and benefits. It estimates that these firms have also paid out $187 billion in bonuses, for a grand total of $499 billion. Much of this staggering sum—more than five-and-a-half times the total income of the firms—has gone to the top echelon of executives.
The latter three firms have either disappeared or are in the process of being taken over. Bear Stearns was bought out by JPMorgan Chase last March in a deal subsidized by the government in the amount of $29 billion; Lehman Brothers filed for bankruptcy in September, and Merrill Lynch has agreed to sell itself to Bank of America in a government-brokered agreement.
While the bank executives were awarding themselves tens of millions in salaries and bonuses, their companies were being run into the ground. Since the start of 2007, for example, Merrill Lynch has had net losses of nearly $20 billion, or virtually all of the profits it made from 2003 to 2006. CEO John Thain took in $83 million in 2007. Now, thousands of Merrill employees are being laid off to cut $7 billion in costs as part of the takeover by Bank of America.
The events of the past two months have brought into sharper focus the naked power exercised by the American financial aristocracy over society and the state. All of the various schemes devised in response to the near-collapse of the financial system have had one thing in common: they proceed from the need to uphold the interests of the most powerful banks and the richest of the rich.
The combination of impotence, servility and duplicity of Congress and its Democratic leadership is being mercilessly exposed. Charles Schumer, the Democratic chairman of the Joint Economic Committee, said this week in regard to the banks’ refusal to use the government money to extend new loans, “There’s not much we can do other than jawbone.”
Christopher Dodd, the Democratic chairman of the Senate Banking Committee, blustered, “The intent here certainly wasn’t for healthy banks to buy healthy banks—it’s infuriating.”
Dodd, it would seem, is shocked to learn that the bailout plan he adamantly supported is being used to serve the narrow self-interest of the bankers. Even if one makes the implausible assumption that this veteran of Washington politics and favorite of Wall Street is not being disingenuous, that does not alter the fact of his utter prostration before the real power brokers in America.
Nothing is permissible that impinges on the basic prerogatives of the financial oligarchy, no matter the cost to the American people. On critical matters regarding the class interests of the ruling elite, the people have no say.
There is a ruling class in America. The administration, Congress, the courts—all of the agencies of the state—are, behind the trappings of democracy, instruments of its domination.
Barry Grey
Wall Street’s Great Heist of 2008
1st November 2008
The Wall Street Journal published a front-page article Friday reporting that the nine biggest US banks, which have received a combined $125 billion in taxpayer funds as part of the $700 billion bailout authored by Treasury Secretary Henry Paulson and passed by the Democratic Congress, owed their executives more than $40 billion for recent years’ compensation and pensions as of the end of 2007.
This means that nearly a third of the public funds given to these banks will ultimately be used to increase the private fortunes of a handful of multimillionaire Wall Street executives.
This revelation, the result of an analysis of the banks’ corporate reports by the American financial elite’s own chief organ, provides a stark exposure of the social interests that are being served by the government bailout. More generally, it provides an instructive insight into class relations in America.
It has already been widely reported that the banks are refusing to use their government windfalls to resume lending to other banks, businesses and consumers—the ostensible purpose of the cash injections—and are, instead, hoarding the money for the purpose of acquiring smaller and weaker banks. The so-called economic rescue plan is, in fact, a plan to effect a rapid consolidation of the US banking system, resulting in the domination of the economy by a few mega-banks, which will be free to set interest rates and lending standards as they see fit.
Far from opposing this development, Treasury Secretary Paulson and the Federal Reserve Board are encouraging it. They deliberately designed the bailout to place no restrictions on how the banks use their taxpayer money and then enacted changes in the tax code to give banks acquiring other banks a huge tax break. (See: “The ‘dirty little secret’ of the US bank bailout”)
As the Journal explains, the minimal restrictions on future executive compensation stipulated in the bailout bill do not affect deferred payments to executives accumulated over previous years. Since such deferred payment accounts are commonplace in the banking industry and are the preferred means by which top executives build up nest eggs in the hundreds of millions of dollars, those who are primarily responsible for the financial disaster and, in many cases, the ruin of their own companies, will emerge from the crisis richer than ever.
As the Journal puts it: “The deferred-compensation programs for executives are like 401(k) plans on steroids.” At some of the banks that have received government handouts, the newspaper notes, the total amounts previously incurred and owed to their executives exceed what they owe in pensions to their entire work forces.
The newspaper notes that at Goldman Sachs, formerly headed by Paulson, “the $11.8 billion obligation primarily for deferred executive compensation dwarfed the liability for its broad-based pension plan for all employees. That was just $399 million.”
Goldman received $10 billion of the $125 billion doled out to the biggest banks. JPMorgan Chase, which was granted $25 billion, owes its top officers $8.5 billion. Citigroup, another $25 billion recipient, owes $5 billion, and Morgan Stanley, which got $10 billion in taxpayer money, is in debt to its top executives to the tune of $10 to $12 billion.
A separate article in the same issue of the Journal amplifies this picture of parasitism and criminality. Headlined “Securities Firms Tackle Pay Issue,” it deals with discussions among the top executives of Wall Street firms such as Goldman Sachs, Morgan Stanley and Merrill Lynch over the advisability of paring down their traditional multimillion-dollar year-end bonuses in the face of growing public outrage.
The article notes that since the start of 2002, Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns have paid a total of $312 billion in compensation and benefits. It estimates that these firms have also paid out $187 billion in bonuses, for a grand total of $499 billion. Much of this staggering sum—more than five-and-a-half times the total income of the firms—has gone to the top echelon of executives.
The latter three firms have either disappeared or are in the process of being taken over. Bear Stearns was bought out by JPMorgan Chase last March in a deal subsidized by the government in the amount of $29 billion; Lehman Brothers filed for bankruptcy in September, and Merrill Lynch has agreed to sell itself to Bank of America in a government-brokered agreement.
While the bank executives were awarding themselves tens of millions in salaries and bonuses, their companies were being run into the ground. Since the start of 2007, for example, Merrill Lynch has had net losses of nearly $20 billion, or virtually all of the profits it made from 2003 to 2006. CEO John Thain took in $83 million in 2007. Now, thousands of Merrill employees are being laid off to cut $7 billion in costs as part of the takeover by Bank of America.
The events of the past two months have brought into sharper focus the naked power exercised by the American financial aristocracy over society and the state. All of the various schemes devised in response to the near-collapse of the financial system have had one thing in common: they proceed from the need to uphold the interests of the most powerful banks and the richest of the rich.
The combination of impotence, servility and duplicity of Congress and its Democratic leadership is being mercilessly exposed. Charles Schumer, the Democratic chairman of the Joint Economic Committee, said this week in regard to the banks’ refusal to use the government money to extend new loans, “There’s not much we can do other than jawbone.”
Christopher Dodd, the Democratic chairman of the Senate Banking Committee, blustered, “The intent here certainly wasn’t for healthy banks to buy healthy banks—it’s infuriating.”
Dodd, it would seem, is shocked to learn that the bailout plan he adamantly supported is being used to serve the narrow self-interest of the bankers. Even if one makes the implausible assumption that this veteran of Washington politics and favorite of Wall Street is not being disingenuous, that does not alter the fact of his utter prostration before the real power brokers in America.
Nothing is permissible that impinges on the basic prerogatives of the financial oligarchy, no matter the cost to the American people. On critical matters regarding the class interests of the ruling elite, the people have no say.
There is a ruling class in America. The administration, Congress, the courts—all of the agencies of the state—are, behind the trappings of democracy, instruments of its domination.
Barry Grey
Thursday, October 30, 2008
So When Will Banks Give Loans?
http://www.nytimes.com/2008/10/25/business/25nocera.html
October 25, 2008
Talking Business
So When Will Banks Give Loans?
By JOE NOCERA
“Chase recently received $25 billion in federal funding. What effect will that have on the business side and will it change our strategic lending policy?”
It was Oct. 17, just four days after JPMorgan Chase’s chief executive, Jamie Dimon, agreed to take a $25 billion capital injection courtesy of the United States government, when a JPMorgan employee asked that question. It came toward the end of an employee-only conference call that had been largely devoted to meshing certain divisions of JPMorgan with its new acquisition, Washington Mutual.
Which, of course, it also got thanks to the federal government. Christmas came early at JPMorgan Chase.
The JPMorgan executive who was moderating the employee conference call didn’t hesitate to answer a question that was pretty politically sensitive given the events of the previous few weeks.
Given the way, that is, that Treasury Secretary Henry M. Paulson Jr. had decided to use the first installment of the $700 billion bailout money to recapitalize banks instead of buying up their toxic securities, which he had then sold to Congress and the American people as the best and fastest way to get the banks to start making loans again, and help prevent this recession from getting much, much worse.
In point of fact, the dirty little secret of the banking industry is that it has no intention of using the money to make new loans. But this executive was the first insider who’s been indiscreet enough to say it within earshot of a journalist.
(He didn’t mean to, of course, but I obtained the call-in number and listened to a recording.)
“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase,” he began. “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”
Read that answer as many times as you want — you are not going to find a single word in there about making loans to help the American economy. On the contrary: at another point in the conference call, the same executive (who I’m not naming because he didn’t know I would be listening in) explained that “loan dollars are down significantly.” He added, “We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side.” In other words JPMorgan has no intention of turning on the lending spigot.
It is starting to appear as if one of Treasury’s key rationales for the recapitalization program — namely, that it will cause banks to start lending again — is a fig leaf, Treasury’s version of the weapons of mass destruction.
In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation. As Mark Landler reported in The New York Times earlier this week, “the government wants not only to stabilize the industry, but also to reshape it.” Now they tell us.
Indeed, Mr. Landler’s story noted that Treasury would even funnel some of the bailout money to help banks buy other banks. And, in an almost unnoticed move, it recently put in place a new tax break, worth billions to the banking industry, that has only one purpose: to encourage bank mergers. As a tax expert, Robert Willens, put it: “It couldn’t be clearer if they had taken out an ad.”
Friday delivered the first piece of evidence that this is, indeed, the plan. PNC announced that it was purchasing National City, an acquisition that will be greatly aided by the new tax break, which will allow it to immediately deduct any losses on National City’s books.
As part of the deal, it is also tapping the bailout fund for $7.7 billion, giving the government preferred stock in return. At least some of that $7.7 billion would have gone to NatCity if the government had deemed it worth saving. In other words, the government is giving PNC money that might otherwise have gone to NatCity as a reward for taking over NatCity.
I don’t know about you, but I’m starting to feel as if we’ve been sold a bill of goods.
•
The markets had another brutal day Friday. The Asian markets got crushed. Germany and England were down more than 5 percent. In the hours before the United States markets opened, all the signals suggested it was going to be the worst day yet in the crisis. The Dow dropped more than 400 points at the opening, but thankfully it never got any worse.
There are lots of reasons the markets remain unstable — fears of a global recession, companies offering poor profit projections for the rest of the year, and the continuing uncertainties brought on by the credit crisis. But another reason, I now believe, is that investors no longer trust Treasury. First it says it has to have $700 billion to buy back toxic mortgage-backed securities. Then, as Mr. Paulson divulged to The Times this week, it turns out that even before the bill passed the House, he told his staff to start drawing up a plan for capital injections. Fearing Congress’s reaction, he didn’t tell the Hill about his change of heart.
Now, he’s shifted gears again, and is directing Treasury to use the money to force bank acquisitions. Sneaking in the tax break isn’t exactly confidence-inspiring, either. (And let’s not even get into the less-than-credible, after-the-fact rationalizations for letting Lehman default, which stands as the single worst mistake the government has made in the crisis.)
On Thursday, at a hearing of the Senate Banking Committee, the chairman, Christopher J. Dodd, a Connecticut Democrat, pushed Neel Kashkari, the young Treasury official who is Mr. Paulson’s point man on the bailout plan, on the subject of banks’ continuing reluctance to make loans. How, Senator Dodd asked, was Treasury going to ensure that banks used their new government capital to make loans — “besides rhetorically begging them?”
“We share your view,” Mr. Kashkari replied. “We want our banks to be lending in our communities.”
Senator Dodd: “Are you insisting upon it?”
Mr. Kashkari: “We are insisting upon it in all our actions.”
But they are doing no such thing. Unlike the British government, which is mandating lending requirements in return for capital injections, our government seems afraid to do anything except plead. And those pleas, in this environment, are falling on deaf ears.
Yes, there are times when a troubled bank needs to be acquired by a stronger bank. Given that the federal government insures deposits, it has an abiding interest in seeing that such mergers take place as smoothly as possible. Nobody is saying those kinds of deals shouldn’t take place.
But Citigroup, at this point, probably falls into the category of troubled bank, and nobody seems to be arguing that it should be taken over. It is in the “too big to fail” category, and the government will ensure that it gets back on its feet, no matter how much money it takes. One reason Mr. Paulson forced all of the nine biggest banks to take government money was to mask the fact that some of them are much weaker than others.
We have long been a country that has treasured its diversity of banks; up until the 1980s, in fact, there were no national banks at all. If Treasury is using the bailout bill to turn the banking system into the oligopoly of giant national institutions, it is hard to see how that will help anybody. Except, of course, the giant banks that are declared the winners by Treasury.
JPMorgan is going to be one of the winners — and deservedly so.
Mr. Dimon managed the company so well during the housing bubble that it is saddled with very few of the problems that have crippled competitors like Citi. The government handed it Bear Stearns and Washington Mutual because it was strong enough to swallow both institutions without so much as a burp.
Of all the banking executives in that room with Mr. Paulson a few weeks ago, none needed the government’s money less than Mr. Dimon. A company spokesman told me, “We accepted the money for the good of the entire financial system.” He added that JP Morgan would use the money “to do good for customers and shareholders. We are disciplined to try to make loans that people can repay.”
Nobody is saying it should make loans that people can’t repay. What I am saying is that Mr. Dimon took the $25 billion on the condition that his institution would start making loans. There are plenty of small and medium-size businesses that are choking because they have no access to capital — and are perfectly capable of repaying the money. How about a loan program for them, Mr. Dimon?
Late Thursday afternoon, I caught up with Senator Dodd, and asked him what he was going to do if the loan situation didn’t improve. “All I can tell you is that we are going to have the bankers up here, probably in another couple of weeks and we are going to have a very blunt conversation,” he replied.
He continued: “If it turns out that they are hoarding, you’ll have a revolution on your hands. People will be so livid and furious that their tax money is going to line their pockets instead of doing the right thing. There will be hell to pay.”
Let’s hope so.
October 25, 2008
Talking Business
So When Will Banks Give Loans?
By JOE NOCERA
“Chase recently received $25 billion in federal funding. What effect will that have on the business side and will it change our strategic lending policy?”
It was Oct. 17, just four days after JPMorgan Chase’s chief executive, Jamie Dimon, agreed to take a $25 billion capital injection courtesy of the United States government, when a JPMorgan employee asked that question. It came toward the end of an employee-only conference call that had been largely devoted to meshing certain divisions of JPMorgan with its new acquisition, Washington Mutual.
Which, of course, it also got thanks to the federal government. Christmas came early at JPMorgan Chase.
The JPMorgan executive who was moderating the employee conference call didn’t hesitate to answer a question that was pretty politically sensitive given the events of the previous few weeks.
Given the way, that is, that Treasury Secretary Henry M. Paulson Jr. had decided to use the first installment of the $700 billion bailout money to recapitalize banks instead of buying up their toxic securities, which he had then sold to Congress and the American people as the best and fastest way to get the banks to start making loans again, and help prevent this recession from getting much, much worse.
In point of fact, the dirty little secret of the banking industry is that it has no intention of using the money to make new loans. But this executive was the first insider who’s been indiscreet enough to say it within earshot of a journalist.
(He didn’t mean to, of course, but I obtained the call-in number and listened to a recording.)
“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase,” he began. “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”
Read that answer as many times as you want — you are not going to find a single word in there about making loans to help the American economy. On the contrary: at another point in the conference call, the same executive (who I’m not naming because he didn’t know I would be listening in) explained that “loan dollars are down significantly.” He added, “We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side.” In other words JPMorgan has no intention of turning on the lending spigot.
It is starting to appear as if one of Treasury’s key rationales for the recapitalization program — namely, that it will cause banks to start lending again — is a fig leaf, Treasury’s version of the weapons of mass destruction.
In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation. As Mark Landler reported in The New York Times earlier this week, “the government wants not only to stabilize the industry, but also to reshape it.” Now they tell us.
Indeed, Mr. Landler’s story noted that Treasury would even funnel some of the bailout money to help banks buy other banks. And, in an almost unnoticed move, it recently put in place a new tax break, worth billions to the banking industry, that has only one purpose: to encourage bank mergers. As a tax expert, Robert Willens, put it: “It couldn’t be clearer if they had taken out an ad.”
Friday delivered the first piece of evidence that this is, indeed, the plan. PNC announced that it was purchasing National City, an acquisition that will be greatly aided by the new tax break, which will allow it to immediately deduct any losses on National City’s books.
As part of the deal, it is also tapping the bailout fund for $7.7 billion, giving the government preferred stock in return. At least some of that $7.7 billion would have gone to NatCity if the government had deemed it worth saving. In other words, the government is giving PNC money that might otherwise have gone to NatCity as a reward for taking over NatCity.
I don’t know about you, but I’m starting to feel as if we’ve been sold a bill of goods.
•
The markets had another brutal day Friday. The Asian markets got crushed. Germany and England were down more than 5 percent. In the hours before the United States markets opened, all the signals suggested it was going to be the worst day yet in the crisis. The Dow dropped more than 400 points at the opening, but thankfully it never got any worse.
There are lots of reasons the markets remain unstable — fears of a global recession, companies offering poor profit projections for the rest of the year, and the continuing uncertainties brought on by the credit crisis. But another reason, I now believe, is that investors no longer trust Treasury. First it says it has to have $700 billion to buy back toxic mortgage-backed securities. Then, as Mr. Paulson divulged to The Times this week, it turns out that even before the bill passed the House, he told his staff to start drawing up a plan for capital injections. Fearing Congress’s reaction, he didn’t tell the Hill about his change of heart.
Now, he’s shifted gears again, and is directing Treasury to use the money to force bank acquisitions. Sneaking in the tax break isn’t exactly confidence-inspiring, either. (And let’s not even get into the less-than-credible, after-the-fact rationalizations for letting Lehman default, which stands as the single worst mistake the government has made in the crisis.)
On Thursday, at a hearing of the Senate Banking Committee, the chairman, Christopher J. Dodd, a Connecticut Democrat, pushed Neel Kashkari, the young Treasury official who is Mr. Paulson’s point man on the bailout plan, on the subject of banks’ continuing reluctance to make loans. How, Senator Dodd asked, was Treasury going to ensure that banks used their new government capital to make loans — “besides rhetorically begging them?”
“We share your view,” Mr. Kashkari replied. “We want our banks to be lending in our communities.”
Senator Dodd: “Are you insisting upon it?”
Mr. Kashkari: “We are insisting upon it in all our actions.”
But they are doing no such thing. Unlike the British government, which is mandating lending requirements in return for capital injections, our government seems afraid to do anything except plead. And those pleas, in this environment, are falling on deaf ears.
Yes, there are times when a troubled bank needs to be acquired by a stronger bank. Given that the federal government insures deposits, it has an abiding interest in seeing that such mergers take place as smoothly as possible. Nobody is saying those kinds of deals shouldn’t take place.
But Citigroup, at this point, probably falls into the category of troubled bank, and nobody seems to be arguing that it should be taken over. It is in the “too big to fail” category, and the government will ensure that it gets back on its feet, no matter how much money it takes. One reason Mr. Paulson forced all of the nine biggest banks to take government money was to mask the fact that some of them are much weaker than others.
We have long been a country that has treasured its diversity of banks; up until the 1980s, in fact, there were no national banks at all. If Treasury is using the bailout bill to turn the banking system into the oligopoly of giant national institutions, it is hard to see how that will help anybody. Except, of course, the giant banks that are declared the winners by Treasury.
JPMorgan is going to be one of the winners — and deservedly so.
Mr. Dimon managed the company so well during the housing bubble that it is saddled with very few of the problems that have crippled competitors like Citi. The government handed it Bear Stearns and Washington Mutual because it was strong enough to swallow both institutions without so much as a burp.
Of all the banking executives in that room with Mr. Paulson a few weeks ago, none needed the government’s money less than Mr. Dimon. A company spokesman told me, “We accepted the money for the good of the entire financial system.” He added that JP Morgan would use the money “to do good for customers and shareholders. We are disciplined to try to make loans that people can repay.”
Nobody is saying it should make loans that people can’t repay. What I am saying is that Mr. Dimon took the $25 billion on the condition that his institution would start making loans. There are plenty of small and medium-size businesses that are choking because they have no access to capital — and are perfectly capable of repaying the money. How about a loan program for them, Mr. Dimon?
Late Thursday afternoon, I caught up with Senator Dodd, and asked him what he was going to do if the loan situation didn’t improve. “All I can tell you is that we are going to have the bankers up here, probably in another couple of weeks and we are going to have a very blunt conversation,” he replied.
He continued: “If it turns out that they are hoarding, you’ll have a revolution on your hands. People will be so livid and furious that their tax money is going to line their pockets instead of doing the right thing. There will be hell to pay.”
Let’s hope so.
The “dirty little secret” of the US bank bailout
http://wsws.org/articles/2008/oct2008/pers-o27.shtml
The “dirty little secret” of the US bank bailout
27 October 2008
In an unusually frank article published in Saturday's New York Times, the newspaper's economic columnist, Joe Nocera, reveals what he calls "the dirty little secret of the banking industry"--namely, that "it has no intention of using the [government bailout] money to make new loans."
As Nocera explains, the plan announced October 13 by Treasury Secretary Henry Paulson to hand over $250 billion in taxpayer money to the biggest banks, in exchange for non-voting stock, was never really intended to get them to resume lending to businesses and consumers--the ostensible purpose of the bailout. Its essential aim was to engineer a rapid consolidation of the American banking system by subsidizing a wave of takeovers of smaller financial firms by the most powerful banks.
Nocera cites an employee-only conference call held October 17 by a top executive of JPMorgan Chase, the beneficiary of $25 billion in public funds. Nocera explains that he obtained the call-in number and was able to listen to a recording of the proceedings, unbeknownst to the executive, whom he declines to name.
Asked by one of the participants whether the $25 billion in federal funding will "change our strategic lending policy," the executive replies: "What we do think, it will help us to be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling."
Referring to JPMorgan's recent government-backed acquisition of two large competitors, the executive continues: "And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way, and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop."
As Nocera notes: "Read that answer as many times as you want--you are not going to find a single word in there about making loans to help the American economy."
Later in the conference call the same executive states, "We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side."
"It is starting to appear," the Times columnist writes, "as if one of the Treasury's key rationales for the recapitalization program--namely, that it will cause banks to start lending again--is a fig leaf.... In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation."
Early this month, he explains, "in a nearly unnoticed move," Paulson, the former CEO of Goldman Sachs, put in place a new tax break worth billions of dollars that is designed to encourage bank mergers. It allows the acquiring bank to immediately deduct any losses on the books of the acquired bank.
Paulson and other Treasury officials have made public statements calling on the banks that receive public funds to use them to increase their lending activities. That, however, is for public consumption. The bailout program imposes no lending requirements on the banks in return for government cash.
Already, the credit crisis has been used to engineer the takeover of Bear Stearns and Washington Mutual by JPMorgan, Merrill Lynch by Bank of America, Wachovia by Wells Fargo and, last Friday, National City by PNC.
What the Wall Street Journal on Saturday called the "strong-arm sale" of National City provides a taste of what is to come. The Treasury Department sealed the fate of the Cleveland-based bank by deciding not to include it among the regional banks that will receive government handouts. It then gave Pittsburgh-based PNC $7.7 billion from the bailout fund to help defray the costs of a takeover of National City. PNC will also benefit greatly from the tax write-off on mergers enacted by Treasury.
All of the claims that were made to justify the bank bailout have been exposed as lies. President Bush, Federal Reserve Chairman Ben Bernanke and Paulson were joined by the Democratic congressional leadership and Barack Obama in warning that the bailout had to be passed, and passed immediately, despite massive popular opposition. Those who opposed the plan were denounced for jeopardizing the well being of the American people.
In a nationally televised speech delivered September 24, in advance of the congressional vote on the bailout plan, Bush said it would "help American consumers and businessmen get credit to meet their daily needs and create jobs." If the bailout was not passed, he warned, "More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account.... More businesses would close their doors, and millions of Americans could lose their jobs ... ultimately, our country could experience a long and painful recession."
One month later, the bailout has been enacted, and all of the dire developments--banks and businesses disappearing, the stock market plunging, unemployment skyrocketing--which the American people were told it would prevent are unfolding with accelerating speed.
While Obama talks about the need for all Americans to "come together" in a spirit of "shared sacrifice"--meaning drastic cuts in Medicare, Medicaid, Social Security and other social programs--and the cost of the bailout is cited to justify fiscal austerity, the bankers proceed to ruthlessly prosecute their class interests.
As the World Socialist Web Site warned when it was first proposed in mid-September, the "economic rescue" plan has been revealed to be a scheme to plunder society for the benefit of the financial aristocracy. The American ruling elite, utilizing its domination of the state and the two-party political system, is exploiting a crisis of its own making to carry through an economic agenda, long in preparation, that could not be imposed under normal conditions.
The result will be greater economic hardship for ordinary Americans. The big banks will have even greater market power to set interest rates and control access to credit for workers, students and small businesses.
While no serious measures are being proposed, either by the Bush administration, the Republican presidential candidate or his Democratic opponent, to prevent a social catastrophe from overtaking working people, the government is organizing a restructuring of the financial system that will enable a handful of mega-banks to increase their power over society.
Barry Grey
The “dirty little secret” of the US bank bailout
27 October 2008
In an unusually frank article published in Saturday's New York Times, the newspaper's economic columnist, Joe Nocera, reveals what he calls "the dirty little secret of the banking industry"--namely, that "it has no intention of using the [government bailout] money to make new loans."
As Nocera explains, the plan announced October 13 by Treasury Secretary Henry Paulson to hand over $250 billion in taxpayer money to the biggest banks, in exchange for non-voting stock, was never really intended to get them to resume lending to businesses and consumers--the ostensible purpose of the bailout. Its essential aim was to engineer a rapid consolidation of the American banking system by subsidizing a wave of takeovers of smaller financial firms by the most powerful banks.
Nocera cites an employee-only conference call held October 17 by a top executive of JPMorgan Chase, the beneficiary of $25 billion in public funds. Nocera explains that he obtained the call-in number and was able to listen to a recording of the proceedings, unbeknownst to the executive, whom he declines to name.
Asked by one of the participants whether the $25 billion in federal funding will "change our strategic lending policy," the executive replies: "What we do think, it will help us to be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling."
Referring to JPMorgan's recent government-backed acquisition of two large competitors, the executive continues: "And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way, and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop."
As Nocera notes: "Read that answer as many times as you want--you are not going to find a single word in there about making loans to help the American economy."
Later in the conference call the same executive states, "We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side."
"It is starting to appear," the Times columnist writes, "as if one of the Treasury's key rationales for the recapitalization program--namely, that it will cause banks to start lending again--is a fig leaf.... In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation."
Early this month, he explains, "in a nearly unnoticed move," Paulson, the former CEO of Goldman Sachs, put in place a new tax break worth billions of dollars that is designed to encourage bank mergers. It allows the acquiring bank to immediately deduct any losses on the books of the acquired bank.
Paulson and other Treasury officials have made public statements calling on the banks that receive public funds to use them to increase their lending activities. That, however, is for public consumption. The bailout program imposes no lending requirements on the banks in return for government cash.
Already, the credit crisis has been used to engineer the takeover of Bear Stearns and Washington Mutual by JPMorgan, Merrill Lynch by Bank of America, Wachovia by Wells Fargo and, last Friday, National City by PNC.
What the Wall Street Journal on Saturday called the "strong-arm sale" of National City provides a taste of what is to come. The Treasury Department sealed the fate of the Cleveland-based bank by deciding not to include it among the regional banks that will receive government handouts. It then gave Pittsburgh-based PNC $7.7 billion from the bailout fund to help defray the costs of a takeover of National City. PNC will also benefit greatly from the tax write-off on mergers enacted by Treasury.
All of the claims that were made to justify the bank bailout have been exposed as lies. President Bush, Federal Reserve Chairman Ben Bernanke and Paulson were joined by the Democratic congressional leadership and Barack Obama in warning that the bailout had to be passed, and passed immediately, despite massive popular opposition. Those who opposed the plan were denounced for jeopardizing the well being of the American people.
In a nationally televised speech delivered September 24, in advance of the congressional vote on the bailout plan, Bush said it would "help American consumers and businessmen get credit to meet their daily needs and create jobs." If the bailout was not passed, he warned, "More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account.... More businesses would close their doors, and millions of Americans could lose their jobs ... ultimately, our country could experience a long and painful recession."
One month later, the bailout has been enacted, and all of the dire developments--banks and businesses disappearing, the stock market plunging, unemployment skyrocketing--which the American people were told it would prevent are unfolding with accelerating speed.
While Obama talks about the need for all Americans to "come together" in a spirit of "shared sacrifice"--meaning drastic cuts in Medicare, Medicaid, Social Security and other social programs--and the cost of the bailout is cited to justify fiscal austerity, the bankers proceed to ruthlessly prosecute their class interests.
As the World Socialist Web Site warned when it was first proposed in mid-September, the "economic rescue" plan has been revealed to be a scheme to plunder society for the benefit of the financial aristocracy. The American ruling elite, utilizing its domination of the state and the two-party political system, is exploiting a crisis of its own making to carry through an economic agenda, long in preparation, that could not be imposed under normal conditions.
The result will be greater economic hardship for ordinary Americans. The big banks will have even greater market power to set interest rates and control access to credit for workers, students and small businesses.
While no serious measures are being proposed, either by the Bush administration, the Republican presidential candidate or his Democratic opponent, to prevent a social catastrophe from overtaking working people, the government is organizing a restructuring of the financial system that will enable a handful of mega-banks to increase their power over society.
Barry Grey
Wednesday, October 8, 2008
Buffett backs Treasury plan
http://www.chron.com/disp/story.mpl/business/6021508.html
Buffett backs Treasury plan
Billionaire says market meltdown is 'an economic Pearl Harbor'
By ERIK HOLM Bloomberg News
Sept. 24, 2008
Billionaire Warren Buffett, calling turmoil in the markets an "economic Pearl Harbor," said his $5 billion investment in Goldman Sachs Group is an endorsement of the Treasury's $700 billion bank rescue plan.
"I am betting on the Congress doing the right thing for the American public and passing this bill," Buffett said on cable channel CNBC Wednesday. "I certainly have a vote of confidence in Goldman and vote of confidence in Congress."
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke are pushing Congress to quickly approve the proposal to remove illiquid assets from the banking system. Buffett is buying a stake in New York-based Goldman after three of the investment bank's biggest competitors collapsed or were forced into emergency sales.
"I think the Treasury will pay back the $700 billion and make a considerable amount of money," Buffett said, adding that if he had $700 billion on the government's terms to buy distressed assets, he would. "Unfortunately, I'm tapped out."
74
Goldman's shares rose $4.95, or 4 percent, to $130 at 4 p.m. in New York Stock Exchange composite trading after the agreement with Buffett's Berkshire Hathaway was announced late Tuesday.
The perpetual preferred shares will pay 10 percent interest, and Buffett will get the right to buy $5 billion in common stock in the next five years at $115 a share.
Buffett, 78, has frequently scolded Wall Street for shoddy accounting and risky investments.
He invested in the most profitable U.S. investment bank a week after Lehman Brothers Holdings went bankrupt and Merrill Lynch & Co. sold itself to Bank of America Corp. Bear Stearns Cos. in March was absorbed by JPMorgan Chase & Co.
"It's not like Pearl Harbor where you could look at what happened with your own eyes and decide you had to do something that day," Buffett said on the cable channel. "This is sort of an economic Pearl Harbor we're going through."
The Goldman investment puts Berkshire back in an industry Buffett has mostly shunned since 1997, when Salomon Bros. was sold to Travelers Group. Buffett helped the firm fend off an unwanted takeover in 1987, only to see the New York securities firm trail every U.S. stock index for the next decade.
Buffett backs Treasury plan
Billionaire says market meltdown is 'an economic Pearl Harbor'
By ERIK HOLM Bloomberg News
Sept. 24, 2008
Billionaire Warren Buffett, calling turmoil in the markets an "economic Pearl Harbor," said his $5 billion investment in Goldman Sachs Group is an endorsement of the Treasury's $700 billion bank rescue plan.
"I am betting on the Congress doing the right thing for the American public and passing this bill," Buffett said on cable channel CNBC Wednesday. "I certainly have a vote of confidence in Goldman and vote of confidence in Congress."
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke are pushing Congress to quickly approve the proposal to remove illiquid assets from the banking system. Buffett is buying a stake in New York-based Goldman after three of the investment bank's biggest competitors collapsed or were forced into emergency sales.
"I think the Treasury will pay back the $700 billion and make a considerable amount of money," Buffett said, adding that if he had $700 billion on the government's terms to buy distressed assets, he would. "Unfortunately, I'm tapped out."
74
Goldman's shares rose $4.95, or 4 percent, to $130 at 4 p.m. in New York Stock Exchange composite trading after the agreement with Buffett's Berkshire Hathaway was announced late Tuesday.
The perpetual preferred shares will pay 10 percent interest, and Buffett will get the right to buy $5 billion in common stock in the next five years at $115 a share.
Buffett, 78, has frequently scolded Wall Street for shoddy accounting and risky investments.
He invested in the most profitable U.S. investment bank a week after Lehman Brothers Holdings went bankrupt and Merrill Lynch & Co. sold itself to Bank of America Corp. Bear Stearns Cos. in March was absorbed by JPMorgan Chase & Co.
"It's not like Pearl Harbor where you could look at what happened with your own eyes and decide you had to do something that day," Buffett said on the cable channel. "This is sort of an economic Pearl Harbor we're going through."
The Goldman investment puts Berkshire back in an industry Buffett has mostly shunned since 1997, when Salomon Bros. was sold to Travelers Group. Buffett helped the firm fend off an unwanted takeover in 1987, only to see the New York securities firm trail every U.S. stock index for the next decade.
Thursday, September 25, 2008
Last major investment banks change status
http://news.yahoo.com/s/ap/bank_change
Last major investment banks change status
By MARTIN CRUTSINGER
Mon Sep 22, 2008
It was the end of an era on Wall Street as the Federal Reserve granted permission for the last two major investment banks — Goldman Sachs and Morgan Stanley — to become bank holding companies in order to stay in business.
The Fed announced late Sunday evening that it had approved the request, which will allow Goldman and Morgan Stanley to create commercial banks that can take deposits, bolstering the resources of both institutions.
The change is the latest seismic shift on Wall Street as the financial system tries to cope with mounting problems that began more than a year ago with the subprime mortgage crisis.
The Fed had originally said Sunday night that the change in status from investment banks to bank holding companies would not take place for five days, pending review on antitrust grounds. The Fed announced Monday, however, that after discussions with the Justice Department, the status change for both institutions could take place immediately.
After weekend meetings where the Treasury Department, Fed and congressional staff ironed out the program's details, Sen. Christopher Dodd said Monday it's equally important to act responsibly as it is to move quickly on the legislation needed to stabilize the country's troubled financial markets.
Dodd, chairman of the Senate Banking committee, said on CBS's "The Early Show" that many members of Congress believe a legislative relief package also should be tailored to protect taxpayers in the best way possible.
Democrats in Congress said they will add provisions in the bailout measure to protect people in danger of losing their homes and measures to cap executive compensation at firms who get to unload their bad mortgages debt onto the government.
But the proposal is still expected to win quick congressional passage because both parties are concerned about the adverse reaction in financial markets should the measure look like it is being delayed.
The Fed's board of governors granted the investment banks' requests by unanimous vote during a late Sunday meeting in Washington.
The change of status means both companies will come under the direct regulation of the Fed, which oversees the nation's bank holding companies. The banking subsidiaries of the two institutions will face the stricter regulations that commercial banks are required to meet. Previously, the primary regulator for Goldman and Morgan Stanley was the Securities and Exchange Commission.
Shares of both institutions had come under pressure ever since the bankruptcy filing last week by investment bank Lehman Brothers and the forced sale of investment bank Merrill Lynch to Bank of America.
Three people familiar with the matter said Monday that Japan's largest brokerage Nomura Holdings is buying Lehman's Asian assets. Britains Barclay's Bank received bankruptcy court approval early Saturday morning to purchase Lehman's North American brokerage operations.
Shares of Morgan Stanley rose 3.5 percent on word of a possible investment by a Japanese bank while Goldman's fell 3.6 percent in afternoon trading on Monday. Overall, U.S. stocks pulled back Monday. In early afternoon trading, the Dow fell 245.71, or 2.16 percent, to 11,142.73. Broader stock indicators also declined.
Investors feared that the last remaining independent investment banks would not be able to survive in their current form, especially after hedge funds saw some of their funds at Lehman Brothers frozen as part of its bankruptcy. There had been speculation that both institutions would be acquired by commercial banks, whose ability to take deposits would give them a stable source of funding.
In the surprise announcement late Sunday, the central bank said Goldman and Morgan Stanley would be allowed during a transition period to get short-term loans from the Federal Reserve Bank of New York against various types of collateral.
The decision means that Goldman and Morgan Stanley will be able not only to set up commercial bank subsidiaries to take deposits, giving them a major resource base, but they will also have the same access as other commercial banks to the Fed's emergency loan program.
After the collapse of Bear Stearns and its forced sale to JP Morgan Chase last March, the Fed used powers it had been granted during the Great Depression to extend its emergency loans to investment banks as well as commercial banks. However, that extension was granted on a temporary basis.
Last major investment banks change status
By MARTIN CRUTSINGER
Mon Sep 22, 2008
It was the end of an era on Wall Street as the Federal Reserve granted permission for the last two major investment banks — Goldman Sachs and Morgan Stanley — to become bank holding companies in order to stay in business.
The Fed announced late Sunday evening that it had approved the request, which will allow Goldman and Morgan Stanley to create commercial banks that can take deposits, bolstering the resources of both institutions.
The change is the latest seismic shift on Wall Street as the financial system tries to cope with mounting problems that began more than a year ago with the subprime mortgage crisis.
The Fed had originally said Sunday night that the change in status from investment banks to bank holding companies would not take place for five days, pending review on antitrust grounds. The Fed announced Monday, however, that after discussions with the Justice Department, the status change for both institutions could take place immediately.
After weekend meetings where the Treasury Department, Fed and congressional staff ironed out the program's details, Sen. Christopher Dodd said Monday it's equally important to act responsibly as it is to move quickly on the legislation needed to stabilize the country's troubled financial markets.
Dodd, chairman of the Senate Banking committee, said on CBS's "The Early Show" that many members of Congress believe a legislative relief package also should be tailored to protect taxpayers in the best way possible.
Democrats in Congress said they will add provisions in the bailout measure to protect people in danger of losing their homes and measures to cap executive compensation at firms who get to unload their bad mortgages debt onto the government.
But the proposal is still expected to win quick congressional passage because both parties are concerned about the adverse reaction in financial markets should the measure look like it is being delayed.
The Fed's board of governors granted the investment banks' requests by unanimous vote during a late Sunday meeting in Washington.
The change of status means both companies will come under the direct regulation of the Fed, which oversees the nation's bank holding companies. The banking subsidiaries of the two institutions will face the stricter regulations that commercial banks are required to meet. Previously, the primary regulator for Goldman and Morgan Stanley was the Securities and Exchange Commission.
Shares of both institutions had come under pressure ever since the bankruptcy filing last week by investment bank Lehman Brothers and the forced sale of investment bank Merrill Lynch to Bank of America.
Three people familiar with the matter said Monday that Japan's largest brokerage Nomura Holdings is buying Lehman's Asian assets. Britains Barclay's Bank received bankruptcy court approval early Saturday morning to purchase Lehman's North American brokerage operations.
Shares of Morgan Stanley rose 3.5 percent on word of a possible investment by a Japanese bank while Goldman's fell 3.6 percent in afternoon trading on Monday. Overall, U.S. stocks pulled back Monday. In early afternoon trading, the Dow fell 245.71, or 2.16 percent, to 11,142.73. Broader stock indicators also declined.
Investors feared that the last remaining independent investment banks would not be able to survive in their current form, especially after hedge funds saw some of their funds at Lehman Brothers frozen as part of its bankruptcy. There had been speculation that both institutions would be acquired by commercial banks, whose ability to take deposits would give them a stable source of funding.
In the surprise announcement late Sunday, the central bank said Goldman and Morgan Stanley would be allowed during a transition period to get short-term loans from the Federal Reserve Bank of New York against various types of collateral.
The decision means that Goldman and Morgan Stanley will be able not only to set up commercial bank subsidiaries to take deposits, giving them a major resource base, but they will also have the same access as other commercial banks to the Fed's emergency loan program.
After the collapse of Bear Stearns and its forced sale to JP Morgan Chase last March, the Fed used powers it had been granted during the Great Depression to extend its emergency loans to investment banks as well as commercial banks. However, that extension was granted on a temporary basis.
IT’S THE DERIVATIVES, STUPID!
http://www.webofdebt.com/articles/its_the_derivatives.php
IT’S THE DERIVATIVES, STUPID!
WHY FANNIE, FREDDIE AND AIG ALL HAD TO BE BAILED OUT
Ellen Brown, September 18, 2008
“I can calculate the movement of the stars, but not the madness of men.”
– Sir Isaac Newton, after losing a fortune in the South Sea bubble
Something extraordinary is going on with these government bailouts. In March 2008, the Federal Reserve extended a $55 billion loan to JPMorgan to “rescue” investment bank Bear Stearns from bankruptcy, a highly controversial move that tested the limits of the Federal Reserve Act. On September 7, 2008, the U.S. government seized private mortgage giants Fannie Mae and Freddie Mac and imposed a conservatorship, a form of bankruptcy; but rather than let the bankruptcy court sort out the assets among the claimants, the Treasury extended an unlimited credit line to the insolvent corporations and said it would exercise its authority to buy their stock, effectively nationalizing them. Now the Federal Reserve has announced that it is giving an $85 billion loan to American International Group (AIG), the world’s largest insurance company, in exchange for a nearly 80% stake in the insurer . . . .
The Fed is buying an insurance company? Where exactly is that covered in the Federal Reserve Act? The Associated Press calls it a “government takeover,” but this is not your ordinary “nationalization” like the purchase of Fannie/Freddie stock by the U.S. Treasury. The Federal Reserve has the power to print the national money supply, but it is not actually a part of the U.S. government. It is a private banking corporation owned by a consortium of private banks. The banking industry just bought the world’s largest insurance company, and they used federal money to do it. Yahoo Finance reported on September 17:
“The Treasury is setting up a temporary financing program at the Fed’s request. The program will auction Treasury bills to raise cash for the Fed’s use. The initiative aims to help the Fed manage its balance sheet following its efforts to enhance its liquidity facilities over the previous few quarters.”
Treasury bills are the I.O.U.s of the federal government. We the taxpayers are on the hook for the Fed’s “enhanced liquidity facilities,” meaning the loans it has been making to everyone in sight, bank or non-bank, exercising obscure provisions in the Federal Reserve Act that may or may not say they can do it. What’s going on here? Why not let the free market work? Bankruptcy courts know how to sort out assets and reorganize companies so they can operate again. Why the extraordinary measures for Fannie, Freddie and AIG?
The answer may have less to do with saving the insurance business, the housing market, or the Chinese investors clamoring for a bailout than with the greatest Ponzi scheme in history, one that is holding up the entire private global banking system. What had to be saved at all costs was not housing or the dollar but the financial derivatives industry; and the precipice from which it had to be saved was an “event of default” that could have collapsed a quadrillion dollar derivatives bubble, a collapse that could take the entire global banking system down with it.
The Anatomy of a Bubble
Until recently, most people had never even heard of derivatives; but in terms of money traded, these investments represent the biggest financial market in the world. Derivatives are financial instruments that have no intrinsic value but derive their value from something else. Basically, they are just bets. You can “hedge your bet” that something you own will go up by placing a side bet that it will go down. “Hedge funds” hedge bets in the derivatives market. Bets can be placed on anything, from the price of tea in China to the movements of specific markets.
“The point everyone misses,” wrote economist Robert Chapman a decade ago, “is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing.”1 They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services. In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling. But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve “risk management.” Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked. But the cost was an increase in risk to the financial system as a whole.2
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars.3 How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don’t have, and that is where the huge increase in risk comes in.
Credit default swaps (CDS) are the most widely traded form of credit derivative. CDS are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the “protection buyer” gets a large payoff from the “protection seller” if the company defaults within a certain period of time, while the “protection seller” collects periodic payments from the “protection buyer” for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes. In one blogger’s example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money – free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.
And there’s the catch: what if the hedge fund doesn’t have the $100 million? The fund’s corporate shell or limited partnership is put into bankruptcy; but both parties are claiming the derivative as an asset on their books, which they now have to write down. Players who have “hedged their bets” by betting both ways cannot collect on their winning bets; and that means they cannot afford to pay their losing bets, causing other players to also default on their bets.
The dominos go down in a cascade of cross-defaults that infects the whole banking industry and jeopardizes the global pyramid scheme. The potential for this sort of nuclear reaction was what prompted billionaire investor Warren Buffett to call derivatives “weapons of financial mass destruction.” It is also why the banking system cannot let a major derivatives player go down, and it is the banking system that calls the shots. The Federal Reserve is literally owned by a conglomerate of banks; and Hank Paulson, who heads the U.S. Treasury, entered that position through the revolving door of investment bank Goldman Sachs, where he was formerly CEO.
The Best Game in Town
In an article on FinancialSense.com on September 9, Daniel Amerman maintains that the government’s takeover of Fannie Mae and Freddie Mac was not actually a bailout of the mortgage giants. It was a bailout of the financial derivatives industry, which was faced with a $1.4 trillion “event of default” that could have bankrupted Wall Street and much of the rest of the financial world. To explain the enormous risk involved, Amerman posits a scenario in which the mortgage giants are not bailed out by the government. When they default on the $5 trillion in bonds and mortgage-backed securities they own or guarantee, settlements are immediately triggered on $1.4 trillion in credit default swaps entered into by major financial firms, which have promised to make good on Fannie/Freddie defaulted bonds in return for very lucrative fee income and multi-million dollar bonuses. The value of the vulnerable bonds plummets by 70%, causing $1 trillion (70% of $1.4 trillion) to be due to the “protection buyers.” This is more money, however, than the already-strapped financial institutions have to spare. The CDS sellers are highly leveraged themselves, which means they depend on huge day-to-day lines of credit just to stay afloat. When their creditors see the trillion dollar hit coming, they pull their financing, leaving the strapped institutions with massive portfolios of illiquid assets. The dreaded cascade of cross-defaults begins, until nearly every major investment bank and commercial bank is unable to meet its obligations. This triggers another massive round of CDS events, going to $10 trillion, then $20 trillion. The financial centers become insolvent, the markets have to be shut down, and when they open months later, the stock market has been crushed. The federal government and the financiers pulling its strings naturally feel compelled to step in to prevent such a disaster, even though this rewards the profligate speculators at the expense of the Fannie/Freddie shareholders who will get wiped out. Amerman concludes:
“[I]t’s the best game in town. Take a huge amount of risk, be paid exceedingly well for it and if you screw up -- you have absolute proof that the government will come in and bail you out at the expense of the rest of the population (who did not share in your profits in the first place).”4
Desperate Measures for Desperate Times
It was the best game in town until September 14, when Treasury Secretary Paulson, Fed Chairman Ben Bernanke, and New York Fed Head Tim Geithner closed the bailout window to Lehman Brothers, a 158-year-old Wall Street investment firm and major derivatives player. Why? “There is no political will for a federal bailout,” said Geithner. Bailing out Fannie and Freddie had created a furor of protest, and the taxpayers could not afford to underwrite the whole quadrillion dollar derivatives bubble. The line had to be drawn somewhere, and this was apparently it.
Or was the Fed just saving its ammunition for AIG? Recent downgrades in AIG’s ratings meant that the counterparties to its massive derivatives contracts could force it to come up with $10.5 billion in additional capital reserves immediately or file for bankruptcy. Treasury Secretary Paulson resisted advancing taxpayer money; but on Monday, September 15, stock trading was ugly, with the S & P 500 registering the largest one-day percent drop since September 11, 2001. Alan Kohler wrote in the Australian Business Spectator:
“[I]t’s unlikely to be a slow-motion train wreck this time. With Lehman in liquidation, and Washington Mutual and AIG on the brink, the credit market would likely shut down entirely and interbank lending would cease.”5
Kohler quoted the September 14 newsletter of Professor Nouriel Roubini, who has a popular website called Global EconoMonitor. Roubini warned:
“What we are facing now is the beginning of the unravelling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank-like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank.”
The risk posed to the system was evidently too great. On September 16, while Barclay’s Bank was offering to buy the banking divisions of Lehman Brothers, the Federal Reserve agreed to bail out AIG in return for 80% of its stock. Why the Federal Reserve instead of the U.S. Treasury? Perhaps because the Treasury would take too much heat for putting yet more taxpayer money on the line. The Federal Reserve could do it quietly through its “Open Market Operations,” the ruse by which it “monetizes” government debt, turning Treasury bills (government I.O.U.s) into dollars. The taxpayers would still have to pick up the tab, but the Federal Reserve would not have to get approval from Congress first.
Time for a 21st Century New Deal?
Another hole has been plugged in a very leaky boat, keeping it afloat another day; but how long can these stopgap measures be sustained? Professor Roubini maintains:
“The step by step, ad hoc and non-holistic approach of Fed and Treasury to crisis management has been a failure. . . . [P]lugging and filling one hole at [a] time is useless when the entire system of levies is collapsing in the perfect financial storm of the century. A much more radical, holistic and systemic approach to crisis management is now necessary.”6
We may soon hear that “the credit market is frozen” – that there is no money to keep homeowners in their homes, workers gainfully employed, or infrastructure maintained. But this is not true. The underlying source of all money is government credit – our own public credit. We don’t need to borrow it from the Chinese or the Saudis or private banks. The government can issue its own credit – the “full faith and credit of the United States.” That was the model followed by the Pennsylvania colonists in the eighteenth century, and it worked brilliantly well. Before the provincial government came up with this plan, the Pennsylvania economy was languishing. There was little gold to conduct trade, and the British bankers were charging 8% interest to borrow what was available. The government solved the credit problem by issuing and lending its own paper scrip. A publicly-owned bank lent the money to farmers at 5% interest. The money was returned to the government, preventing inflation; and the interest paid the government’s expenses, replacing taxes. During the period the system was in place, the economy flourished, prices remained stable, and the Pennsylvania colonists paid no taxes at all. (For more on this, see E. Brown, “Sustainable Energy Development: How Costs Can Be Cut in Half,” webofdebt.com/articles, November 5, 2007.)
Today’s credit crisis is very similar to that facing Herbert Hoover and Franklin Roosevelt in the 1930s. In 1932, President Hoover set up the Reconstruction Finance Corporation (RFC) as a federally-owned bank that would bail out commercial banks by extending loans to them, much as the privately-owned Federal Reserve is doing today. But like today, Hoover’s ploy failed. The banks did not need more loans; they were already drowning in debt. They needed customers with money to spend and invest. President Roosevelt used Hoover’s new government-owned lending facility to extend loans where they were needed most – for housing, agriculture and industry. Many new federal agencies were set up and funded by the RFC, including the HOLC (Home Owners Loan Corporation) and Fannie Mae (the Federal National Mortgage Association, which was then a government-owned agency). In the 1940s, the RFC went into overdrive funding the infrastructure necessary for the U.S. to participate in World War II, setting the country up with the infrastructure it needed to become the world’s industrial leader after the war.
The RFC was a government-owned bank that sidestepped the privately-owned Federal Reserve; but unlike the Pennsylvania provincial government, which originated the money it lent, the RFC had to borrow the money first. The RFC was funded by issuing government bonds and relending the proceeds. Then as now, new money entered the money supply chiefly in the form of private bank loans. In a “fractional reserve” banking system, banks are allowed to lend their “reserves” many times over, effectively multiplying the amount of money in circulation. Today a system of public banks might be set up on the model of the RFC to fund productive endeavors – industry, agriculture, housing, energy -- but we could go a step further than the RFC and give the new public banks the power to create credit themselves, just as the Pennsylvania government did and as private banks do now. At the rate banks are going into FDIC receivership, the federal government will soon own a string of banks, which it might as well put to productive use. Establishing a new RFC might be an easier move politically than trying to nationalize the Federal Reserve, but that is what should properly, logically be done. If we the taxpayers are putting up the money for the Fed to own the world’s largest insurance company, we should own the Fed.
Proposals for reforming the banking system are not even on the radar screen of Prime Time politics today; but the current system is collapsing at train-wreck speed, and the “change” called for in Washington may soon be taking a direction undreamt of a few years ago. We need to stop funding the culprits who brought us this debacle at our expense. We need a public banking system that makes a cost-effective credit mechanism available for homeowners, manufacturing, renewable energy, and infrastructure; and the first step to making it cost-effective is to strip out the swarms of gamblers, fraudsters and profiteers now gaming the system.
Ellen Brown, J.D., developed her research skills as an attorney practicing civil litigation in Los Angeles. In Web of Debt, her latest book, she turns those skills to an analysis of the Federal Reserve and “the money trust.” She shows how this private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her eleven books include the bestselling Nature’s Pharmacy, co-authored with Dr. Lynne Walker, and Forbidden Medicine.
--------------------------------------------------------------------------------
1 Quoted in James Wesley, “Derivatives – The Mystery Man Who’ll Break the Global Bank at Monte Carlo,” SurvivalBlog.com (September 2006).
2 “Killer Derivatives, Zombie CDOs and Basel Too?”, Institutional Risk Analytics (August 14, 2007).
3 Kevin DeMeritt, “$1.14 Quadrillion in Derivatives – What Goes Up . . . ,” Gold-Eagle.com (June 16, 2008).
4 Daniel Amerman, “The Hidden Bailout of $1.4 Trillion in Fannie/Freddie Credit-Default Swaps,” FinancialSense.com (September 10, 2008).
5 Alan Kohler, “Lehman End-game,” Business Spectator (Australia) (September 15, 2008).
6 Ibid.
IT’S THE DERIVATIVES, STUPID!
WHY FANNIE, FREDDIE AND AIG ALL HAD TO BE BAILED OUT
Ellen Brown, September 18, 2008
“I can calculate the movement of the stars, but not the madness of men.”
– Sir Isaac Newton, after losing a fortune in the South Sea bubble
Something extraordinary is going on with these government bailouts. In March 2008, the Federal Reserve extended a $55 billion loan to JPMorgan to “rescue” investment bank Bear Stearns from bankruptcy, a highly controversial move that tested the limits of the Federal Reserve Act. On September 7, 2008, the U.S. government seized private mortgage giants Fannie Mae and Freddie Mac and imposed a conservatorship, a form of bankruptcy; but rather than let the bankruptcy court sort out the assets among the claimants, the Treasury extended an unlimited credit line to the insolvent corporations and said it would exercise its authority to buy their stock, effectively nationalizing them. Now the Federal Reserve has announced that it is giving an $85 billion loan to American International Group (AIG), the world’s largest insurance company, in exchange for a nearly 80% stake in the insurer . . . .
The Fed is buying an insurance company? Where exactly is that covered in the Federal Reserve Act? The Associated Press calls it a “government takeover,” but this is not your ordinary “nationalization” like the purchase of Fannie/Freddie stock by the U.S. Treasury. The Federal Reserve has the power to print the national money supply, but it is not actually a part of the U.S. government. It is a private banking corporation owned by a consortium of private banks. The banking industry just bought the world’s largest insurance company, and they used federal money to do it. Yahoo Finance reported on September 17:
“The Treasury is setting up a temporary financing program at the Fed’s request. The program will auction Treasury bills to raise cash for the Fed’s use. The initiative aims to help the Fed manage its balance sheet following its efforts to enhance its liquidity facilities over the previous few quarters.”
Treasury bills are the I.O.U.s of the federal government. We the taxpayers are on the hook for the Fed’s “enhanced liquidity facilities,” meaning the loans it has been making to everyone in sight, bank or non-bank, exercising obscure provisions in the Federal Reserve Act that may or may not say they can do it. What’s going on here? Why not let the free market work? Bankruptcy courts know how to sort out assets and reorganize companies so they can operate again. Why the extraordinary measures for Fannie, Freddie and AIG?
The answer may have less to do with saving the insurance business, the housing market, or the Chinese investors clamoring for a bailout than with the greatest Ponzi scheme in history, one that is holding up the entire private global banking system. What had to be saved at all costs was not housing or the dollar but the financial derivatives industry; and the precipice from which it had to be saved was an “event of default” that could have collapsed a quadrillion dollar derivatives bubble, a collapse that could take the entire global banking system down with it.
The Anatomy of a Bubble
Until recently, most people had never even heard of derivatives; but in terms of money traded, these investments represent the biggest financial market in the world. Derivatives are financial instruments that have no intrinsic value but derive their value from something else. Basically, they are just bets. You can “hedge your bet” that something you own will go up by placing a side bet that it will go down. “Hedge funds” hedge bets in the derivatives market. Bets can be placed on anything, from the price of tea in China to the movements of specific markets.
“The point everyone misses,” wrote economist Robert Chapman a decade ago, “is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing.”1 They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services. In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling. But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve “risk management.” Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked. But the cost was an increase in risk to the financial system as a whole.2
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars.3 How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don’t have, and that is where the huge increase in risk comes in.
Credit default swaps (CDS) are the most widely traded form of credit derivative. CDS are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the “protection buyer” gets a large payoff from the “protection seller” if the company defaults within a certain period of time, while the “protection seller” collects periodic payments from the “protection buyer” for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes. In one blogger’s example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money – free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.
And there’s the catch: what if the hedge fund doesn’t have the $100 million? The fund’s corporate shell or limited partnership is put into bankruptcy; but both parties are claiming the derivative as an asset on their books, which they now have to write down. Players who have “hedged their bets” by betting both ways cannot collect on their winning bets; and that means they cannot afford to pay their losing bets, causing other players to also default on their bets.
The dominos go down in a cascade of cross-defaults that infects the whole banking industry and jeopardizes the global pyramid scheme. The potential for this sort of nuclear reaction was what prompted billionaire investor Warren Buffett to call derivatives “weapons of financial mass destruction.” It is also why the banking system cannot let a major derivatives player go down, and it is the banking system that calls the shots. The Federal Reserve is literally owned by a conglomerate of banks; and Hank Paulson, who heads the U.S. Treasury, entered that position through the revolving door of investment bank Goldman Sachs, where he was formerly CEO.
The Best Game in Town
In an article on FinancialSense.com on September 9, Daniel Amerman maintains that the government’s takeover of Fannie Mae and Freddie Mac was not actually a bailout of the mortgage giants. It was a bailout of the financial derivatives industry, which was faced with a $1.4 trillion “event of default” that could have bankrupted Wall Street and much of the rest of the financial world. To explain the enormous risk involved, Amerman posits a scenario in which the mortgage giants are not bailed out by the government. When they default on the $5 trillion in bonds and mortgage-backed securities they own or guarantee, settlements are immediately triggered on $1.4 trillion in credit default swaps entered into by major financial firms, which have promised to make good on Fannie/Freddie defaulted bonds in return for very lucrative fee income and multi-million dollar bonuses. The value of the vulnerable bonds plummets by 70%, causing $1 trillion (70% of $1.4 trillion) to be due to the “protection buyers.” This is more money, however, than the already-strapped financial institutions have to spare. The CDS sellers are highly leveraged themselves, which means they depend on huge day-to-day lines of credit just to stay afloat. When their creditors see the trillion dollar hit coming, they pull their financing, leaving the strapped institutions with massive portfolios of illiquid assets. The dreaded cascade of cross-defaults begins, until nearly every major investment bank and commercial bank is unable to meet its obligations. This triggers another massive round of CDS events, going to $10 trillion, then $20 trillion. The financial centers become insolvent, the markets have to be shut down, and when they open months later, the stock market has been crushed. The federal government and the financiers pulling its strings naturally feel compelled to step in to prevent such a disaster, even though this rewards the profligate speculators at the expense of the Fannie/Freddie shareholders who will get wiped out. Amerman concludes:
“[I]t’s the best game in town. Take a huge amount of risk, be paid exceedingly well for it and if you screw up -- you have absolute proof that the government will come in and bail you out at the expense of the rest of the population (who did not share in your profits in the first place).”4
Desperate Measures for Desperate Times
It was the best game in town until September 14, when Treasury Secretary Paulson, Fed Chairman Ben Bernanke, and New York Fed Head Tim Geithner closed the bailout window to Lehman Brothers, a 158-year-old Wall Street investment firm and major derivatives player. Why? “There is no political will for a federal bailout,” said Geithner. Bailing out Fannie and Freddie had created a furor of protest, and the taxpayers could not afford to underwrite the whole quadrillion dollar derivatives bubble. The line had to be drawn somewhere, and this was apparently it.
Or was the Fed just saving its ammunition for AIG? Recent downgrades in AIG’s ratings meant that the counterparties to its massive derivatives contracts could force it to come up with $10.5 billion in additional capital reserves immediately or file for bankruptcy. Treasury Secretary Paulson resisted advancing taxpayer money; but on Monday, September 15, stock trading was ugly, with the S & P 500 registering the largest one-day percent drop since September 11, 2001. Alan Kohler wrote in the Australian Business Spectator:
“[I]t’s unlikely to be a slow-motion train wreck this time. With Lehman in liquidation, and Washington Mutual and AIG on the brink, the credit market would likely shut down entirely and interbank lending would cease.”5
Kohler quoted the September 14 newsletter of Professor Nouriel Roubini, who has a popular website called Global EconoMonitor. Roubini warned:
“What we are facing now is the beginning of the unravelling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank-like runs; but unlike banks they are not properly regulated and supervised, they don’t have access to deposit insurance and don’t have access to the lender of last resort support of the central bank.”
The risk posed to the system was evidently too great. On September 16, while Barclay’s Bank was offering to buy the banking divisions of Lehman Brothers, the Federal Reserve agreed to bail out AIG in return for 80% of its stock. Why the Federal Reserve instead of the U.S. Treasury? Perhaps because the Treasury would take too much heat for putting yet more taxpayer money on the line. The Federal Reserve could do it quietly through its “Open Market Operations,” the ruse by which it “monetizes” government debt, turning Treasury bills (government I.O.U.s) into dollars. The taxpayers would still have to pick up the tab, but the Federal Reserve would not have to get approval from Congress first.
Time for a 21st Century New Deal?
Another hole has been plugged in a very leaky boat, keeping it afloat another day; but how long can these stopgap measures be sustained? Professor Roubini maintains:
“The step by step, ad hoc and non-holistic approach of Fed and Treasury to crisis management has been a failure. . . . [P]lugging and filling one hole at [a] time is useless when the entire system of levies is collapsing in the perfect financial storm of the century. A much more radical, holistic and systemic approach to crisis management is now necessary.”6
We may soon hear that “the credit market is frozen” – that there is no money to keep homeowners in their homes, workers gainfully employed, or infrastructure maintained. But this is not true. The underlying source of all money is government credit – our own public credit. We don’t need to borrow it from the Chinese or the Saudis or private banks. The government can issue its own credit – the “full faith and credit of the United States.” That was the model followed by the Pennsylvania colonists in the eighteenth century, and it worked brilliantly well. Before the provincial government came up with this plan, the Pennsylvania economy was languishing. There was little gold to conduct trade, and the British bankers were charging 8% interest to borrow what was available. The government solved the credit problem by issuing and lending its own paper scrip. A publicly-owned bank lent the money to farmers at 5% interest. The money was returned to the government, preventing inflation; and the interest paid the government’s expenses, replacing taxes. During the period the system was in place, the economy flourished, prices remained stable, and the Pennsylvania colonists paid no taxes at all. (For more on this, see E. Brown, “Sustainable Energy Development: How Costs Can Be Cut in Half,” webofdebt.com/articles, November 5, 2007.)
Today’s credit crisis is very similar to that facing Herbert Hoover and Franklin Roosevelt in the 1930s. In 1932, President Hoover set up the Reconstruction Finance Corporation (RFC) as a federally-owned bank that would bail out commercial banks by extending loans to them, much as the privately-owned Federal Reserve is doing today. But like today, Hoover’s ploy failed. The banks did not need more loans; they were already drowning in debt. They needed customers with money to spend and invest. President Roosevelt used Hoover’s new government-owned lending facility to extend loans where they were needed most – for housing, agriculture and industry. Many new federal agencies were set up and funded by the RFC, including the HOLC (Home Owners Loan Corporation) and Fannie Mae (the Federal National Mortgage Association, which was then a government-owned agency). In the 1940s, the RFC went into overdrive funding the infrastructure necessary for the U.S. to participate in World War II, setting the country up with the infrastructure it needed to become the world’s industrial leader after the war.
The RFC was a government-owned bank that sidestepped the privately-owned Federal Reserve; but unlike the Pennsylvania provincial government, which originated the money it lent, the RFC had to borrow the money first. The RFC was funded by issuing government bonds and relending the proceeds. Then as now, new money entered the money supply chiefly in the form of private bank loans. In a “fractional reserve” banking system, banks are allowed to lend their “reserves” many times over, effectively multiplying the amount of money in circulation. Today a system of public banks might be set up on the model of the RFC to fund productive endeavors – industry, agriculture, housing, energy -- but we could go a step further than the RFC and give the new public banks the power to create credit themselves, just as the Pennsylvania government did and as private banks do now. At the rate banks are going into FDIC receivership, the federal government will soon own a string of banks, which it might as well put to productive use. Establishing a new RFC might be an easier move politically than trying to nationalize the Federal Reserve, but that is what should properly, logically be done. If we the taxpayers are putting up the money for the Fed to own the world’s largest insurance company, we should own the Fed.
Proposals for reforming the banking system are not even on the radar screen of Prime Time politics today; but the current system is collapsing at train-wreck speed, and the “change” called for in Washington may soon be taking a direction undreamt of a few years ago. We need to stop funding the culprits who brought us this debacle at our expense. We need a public banking system that makes a cost-effective credit mechanism available for homeowners, manufacturing, renewable energy, and infrastructure; and the first step to making it cost-effective is to strip out the swarms of gamblers, fraudsters and profiteers now gaming the system.
Ellen Brown, J.D., developed her research skills as an attorney practicing civil litigation in Los Angeles. In Web of Debt, her latest book, she turns those skills to an analysis of the Federal Reserve and “the money trust.” She shows how this private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her eleven books include the bestselling Nature’s Pharmacy, co-authored with Dr. Lynne Walker, and Forbidden Medicine.
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1 Quoted in James Wesley, “Derivatives – The Mystery Man Who’ll Break the Global Bank at Monte Carlo,” SurvivalBlog.com (September 2006).
2 “Killer Derivatives, Zombie CDOs and Basel Too?”, Institutional Risk Analytics (August 14, 2007).
3 Kevin DeMeritt, “$1.14 Quadrillion in Derivatives – What Goes Up . . . ,” Gold-Eagle.com (June 16, 2008).
4 Daniel Amerman, “The Hidden Bailout of $1.4 Trillion in Fannie/Freddie Credit-Default Swaps,” FinancialSense.com (September 10, 2008).
5 Alan Kohler, “Lehman End-game,” Business Spectator (Australia) (September 15, 2008).
6 Ibid.
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