Sounder wrote:You guys will like this.
Defaults make for more profits (big fees);
http://www.youtube.com/watch?v=vxyRFSYe ... re=related
I have been hearing about how we as in “We the people…” have to fix the banks so they can lend money again. Many options have been discussed and it looks like the President is strongly leaning toward a “Bad Bank” type of rescue where toxic securities will be dumped into a newly created institution. It’s a magical place where bad debt bets will disappear like tears in the rain, of course, with taxpayer help. This has never been done before on a scale this large, so no one really knows exactly what the consequences will be or if it will even work. NYU economics professor Nouriel Roubini predicts that the losses for the banking system could be 3.6 trillion and is “effectively insolvent.” Just about a year ago Roubini said the bank losses would be 2 trillion bucks. Fact is, no one knows for sure how much this may end up costing because the toxic securities (OTC derivatives) are very, very difficult to price. In many cases they could be worthless or worth a lot less then they can ever get on the open market. In a year from now the number could be 7 trillion in bank losses, who knows! The toxic asset picture is a moving target but, one thing is for sure, it will be many trillions in losses by the time it is finally cleared up.
My question is if the banking system is “insolvent” and it’s unknown how much this will cost then why is the “default option” not in play here? Famed investor Jim Rogers says the insolvent banks should be “allowed to fail.” Then the assets would go from the incompetent to the competent. There are hundreds of small and medium sized banks that did not invest in toxic securities and are financially sound. In short, the incompetent banks would be liquidated and competent banks would take over the assets that are left behind. Instead, the pundits of Wall Street are basically telling America,” You make us (the banks) whole first and then we will lend you your money back!” That is simply outrageous because we are rewarding the incompetent!!!!!!!
Remember, incompetent and foolhardy bankers are the cause of this “credit crisis” in the U.S. and the rest of the world. Letting those banks take the hit for their ill advised, reckless investments biased on greed will do many things. Here are just a few. Letting the reckless banks fail will limit taxpayer exposure and preserve our capital and our credit rating as a country. Bank failure will wash bad debt out of the system once and for all and protect the dollar from free fall. Finally, I think in the end it will be cheaper and more effective than what has and will be done in the future to “fix” the credit crisis.
In default, the incompetent banks, the bond holders and the share holders will get completely wiped out. Yes, there will be plenty of pain to go around but that is coming anyway. All the capital injections and bailouts and “Bad Banks” just put off judgment day and make things worse for the country. The idea that somehow we as a nation do not have to pay for our financial sins is a farce. The only people that should be protected with taxpayer money (even though it will cost trillions) are the depositors. Without depositors you do not have a banking system. Depositors are savers and that is what is needed for capital formation. We do not need anymore debt formation. Warren Buffet wasn’t able to get 10 percent interest for loaning billions to Goldman Sachs or GE because he had a good credit score. He got preferential treatment because he had capital (yes… cold hard cash) to invest. The way I see it, the less time we drag this problem out, the faster we can truly put it behind us. Right now the “default option” is voluntary, but if we get this wrong and do not really fix this problem, then default may be forced on a lot more people than just the incompetent bankers.
Bubble Economy 2.0: The Financial Recovery Plan from Hell
By Michael Hudson
Global Research, February 11, 2009
Martin Wolf started off his Financial Times column today (February 11) with the bold question: “Has Barack Obama’s presidency already failed?” The stock market had a similar opinion, plunging 382 points. Having promised “change,” Mr. Obama is giving us more Clinton-Bush via Robert Rubin’s protégé, Tim Geithner. Tuesday’s $2.5 trillion Financial Stabilization Plan to re-inflate the Bubble Economy is basically an extension of the Bush-Paulson giveaway – yet more Rubinomics for financial insiders in the emerging Wall Street trusts. The financial system is to be concentrated into a cartel of just a few giant conglomerates to act as the economy’s central planners and resource allocators. This makes banks the big winners in the game of “chicken” they’ve been playing with Washington, a shakedown holding the economy hostage. “Give us what we want or we’ll plunge the economy into financial crisis.” Washington has given them $9 trillion so far, with promises now of another $2 trillion– and still counting.
A true reform – one designed to undo the systemic market distortions that led to the real estate bubble – would have set out to reverse the Clinton-Rubin repeal of the Glass-Steagall Act so as to prevent the corrupting conflicts of interest that have resulted in vertical trusts such as Citibank and Bank of America/Countrywide/Merrill Lynch. By unleashing these conglomerate grupos (to use the term popularized under Pinochet with Chicago Boy direction – a dress rehearsal of the mass financial bankruptcies they caused in Chile by the end of the 1970s) The Clinton administration enabled banks to merge with junk mortgage companies, junk-money managers, fictitious property appraisal companies, and law-evasion firms all designed to package debts to investors who trusted them enough to let them rake off enough commissions and capital gains to make their managers the world’s highest-paid economic planners.
Today’s economic collapse is the direct result of their planning philosophy. It actually was taught as “wealth creation” and still is, as supposedly more productive than the public regulation and oversight so detested by Wall Street and its Chicago School aficionados. The financial powerhouses created by this “free market” philosophy span the entire FIRE sector – finance, insurance and real estate, “financializing” housing and commercial property markets in ways guaranteed to make money by creating and selling debt. Mr. Obama’s advisors are precisely those of the Clinton Administration who supported trustification of the FIRE sector. This is the broad deregulatory medium in which today’s bad-debt disaster has been able to spread so much more rapidly than at any time since the 1920s.
The commercial banks have used their credit-creating power not to expand the production of goods and services or raise living standards but simply to inflate prices for real estate (making fortunes for their brokerage, property appraisal and insurance affiliates), stocks and bonds (making more fortunes for their investment bank subsidiaries), fine arts (whose demand is now essentially for trophies, degrading the idea of art accordingly) and other assets already in place.
The resulting dot.com and real estate bubbles were not inevitable, not economically necessary. They were financially engineered by the political deregulatory power acquired by banks corrupting Congress through campaign contributions and public relations “think tanks” (more in the character of Orwellian doublethink tanks) to promote the perverse fiction that Wall Street can be and indeed is automatically self-regulating. This is a travesty of Adam Smith’s “Invisible Hand.” This hand is better thought of as covert. The myth of “free markets” is now supposed to consist of governments withdrawing from planning and taxing wealth, so as to leave resource allocation and the economic surplus to bankers rather than elected public representatives. This is what classically is called oligarchy, not democracy.
This centralization of planning, debt creation and revenue-extracting power is defended as the alternative to Hayek’s road to serfdom. But it is itself the road to debt peonage, a.k.a. the post-industrial economy or “Information Economy.” The latter term is another euphemistic travesty in view of the kind of information the banking system has promoted in the junk accounting crafted by their accounting firms and tax lawyers (off-balance-sheet entities registered on offshore tax-avoidance islands), the AAA applause provided as “information” to investors by the bond-rating cartel, and indeed the national income and product accounts that depict the FIRE sector as being part of the “real” economy, not as an institutional wrapping of special interests and government-sanctioned privilege acting in an extractive rather than a productive way.
“Thanks for the bonuses,” bankers in the United States and England testified this week before Congress and Parliament. “We’ll keep the money, but rest assured that we are truly sorry for having to ask you for another few trillion dollars. At least you should remember our theme song: We are still better managers than the government, and the bulwark against government bureaucratic resource allocation.” This is the ideological Big Lie sold by the Chicago School “free market” celebration of dismantling government power over finance, all defended by complex math rivaling that of nuclear physics that the financial sector is part of the “real” economy automatically producing a fair and equitable equilibrium.
This is not bad news for stockholders of more local and relatively healthy banks (healthy in the sense of avoiding negative equity). Their stocks soared and were by far the major gainers on Tuesday’s stock market, while Wall Street’s large Bad Banks plunged to new lows. Solvent local banks are the sort that were normal prior to repeal of Glass Steagall. They are to be bought by the large “troubled” banks, whose “toxic loans” reflect a basically toxic operating philosophy. In other words, small banks who have made loans carefully will be sucked into Citibank, Bank of America, JP Morgan Chase and Wells Fargo – the Big Four or Five where the junk mortgages, junk CDOs and junk derivatives are concentrated, and have used Treasury money from the past bailout to buy out smaller banks that were not infected with such reckless financial opportunism. Even the Wall Street Journal editorialized regarding the Obama Treasury’s new “Public-Private Investment Fund” to pump a trillion dollars into this mess: “Mr. Geithner would be wise to put someone strong land independent in charge of this fund – someone who can say no to Congress and has no ties to Citigroup, Robert Rubin or Wall Street.”
None of this can solve today’s financial problem. The debt overhead far exceeds the economy’s ability to pay. If the banks would indeed do what Pres. Obama’s appointees are begging them to do and lend more, the debt burden would become even heavier and buying access to housing even more costly. When the banks look back fondly on what Alan Greenspan called “wealth creation,” we can see today that the less euphemistic terminology would be “debt creation.” This is the objective of the new bank giveaway. It threatens to spread the distortions that the large banks have introduced until the entire system presumably looks like Citibank, long the number-one offender of “stretching the envelope,” its euphemism for breaking the law bit by bit and daring government regulators and prosecutors to try and stop it and thereby plunging the U.S. financial system into crisis. This is the shakedown that is being played out this week. And the Obama administration blinked – as these same regulators did when they were in charge of the Clinton administration’s bank policy. So much for the promised change!
The three-pronged Treasury program seems to be only Stage One of a two-stage “dream recovery plan” for Wall Street. Enough hints have trickled out for the past three months in Wall Street Journal op-eds to tip the hand for what may be in store. Watch for the magic phrase “equity kicker,” first heard in the S&L mortgage crisis of the 1980s. It refers to the banker’s share of capital gains, that is, asset price inflation in Bubble #2 that the Recovery Program hopes to sponsor.
The first question to ask about any Recovery Program is, “Recovery for whom?” The answer given on Tuesday is, “For the people who design the Program and their constituency” – in this case, the bank lobby. The second question is, “Just what is it they want to ‘recover’?” The answer is, the Bubble Economy. For the financial sector it was a golden age. Having enjoyed the Greenspan Bubble that made them so rich, its managers would love to create yet more wealth for themselves by indebting the “real” economy yet further while inflating prices all over again to make new capital gains.
The problem for today’s financial elites is that it is not possible to inflate another bubble from today’s debt levels, widespread negative equity, and still-high level of real estate, stock and bond prices. No amount of new capital will induce banks to provide credit to real estate already over-mortgaged or to individuals and corporations already over-indebted. Moody’s and other leading professional observers have forecast property prices to keep on plunging for at least the next year, which is as far as the eye can see in today’s unstable conditions. So the smartest money is still waiting like vultures in the wings – waiting for government guarantees that toxic loans will pay off. Another no-risk private profit to be subsidized by public-sector losses.
While the Obama administration’s financial planners wring their hands in public and say “We feel your pain” to debtors at large, they know that the past ten years have been a golden age for the banking system and the rest of Wall Street. Like feudal lord claiming the economic surplus for themselves while administering austerity for the population at large, the wealthiest 1% of the population has raised their appropriation of the nationwide returns to wealth – dividends, interest, rent and capital gains – from 37% of the total ten years ago to 57% five years ago and it seems nearly 70% today. This is the highest proportion since records have been kept. We are approaching Russian kleptocratic levels.
The officials drawn from Wall Street who now control of the Treasury and Federal Reserve repeat the right-wing Big Lie: Poor “subprime families” have brought the system down, exploiting the rich by trying to ape their betters and live beyond their means. Taking out subprime loans and not revealing their actual ability to pay, the NINJA poor (no income, no job, no audit) signed up to obtain “liars’ loans” as no-documentation Alt-A loans are called in the financial junk-paper trade.
I learned the reality a few years ago in London, talking to a commercial banker. “We’ve had an intellectual breakthrough,” he said. “It’s changed our credit philosophy.”
“What is it?” I asked, imagining that he was about to come out with yet a new magical mathematics formula?
“The poor are honest,” he said, accompanying his words with his jaw dropping open as if to say, “Who would have guessed?”
The meaning was clear enough. The poor pay their debts as a matter of honor, even at great personal sacrifice and what today’s neoliberal Chicago School language would call uneconomic behavior. Unlike Donald Trump, they are less likely to walk away from their homes when market prices sink below the mortgage level. This sociological gullibility does not make economic sense, but reflects a group morality that has made them rich pickings for predatory lenders such as Countrywide, Wachovia and Citibank. So it’s not the “lying poor.” It’s the banksters’ fault after all!
For this elite the Bubble Economy was a deliberate policy they would love to recover. The problem is how to start a new bubble to make yet another fortune? The alternative is not so bad – to keep the bonuses, capital gains and golden parachutes they have given themselves, and run. But perhaps they can improve in Bubble Economy #2.
The Treasury’s newest Financial Stability Plan (Bailout 2.0) is only the first step. It aims at putting in place enough new bank-lending capacity to start inflating prices on credit all over again. But a new bubble can’t be started from today’s asset-price levels. How can the $10 to $20 trillion capital-gain run-up of the Greenspan years been repeated in an economy that is “all loaned up”?
One thing Wall Street knows is that in order to make money, asset prices not only need to rise, they have to go down again. Without going down, after all, how can they rise up? Without a crucifixion for the economy, how can there be a resurrection? The more frenetic the price fibrillation, the easier it is for computerized buy-and-sell programs to make money on options and derivatives.
So here’s the situation as I see it. The first objective is to preserve the wealth of the creditor class – Wall Street, the banks and the other financial vehicles that enrich the wealthiest 1% and, to be fair within America’s emerging new financial oligarchy, the richest 10% of the population. Stage One involves buying out their bad loans at a price that saves them from taking a loss. The money will be depicted to voters as a “loan,” to be repaid by banks extracting enough new debt charges in the new rigged game the Treasury is setting up. The current loss will be shifted the onto “taxpayers” and made up by new debtors – in both cases labor, onto whose shoulders the tax burden has been shifted steadily, step by step since 1980.
An “aggregator” bank (sounds like “alligator,” from the swamps of toxic waste) will buy the bad debts and put them in a public agency. The government calls this the “bad” bank. (This is Geithner’s first point.) But it does good for Wall Street – by buying loans that have gone bad, along with loans and derivative guarantees and swaps that never were good in the first place. If the private sector refuses to buy these bad loans at prices the banks are asking for, why should the government pretend that these debt claims are worth more. Vulture funds are said to be offering about what they were when Lehman Brothers went bankrupt: about 22 cents on the dollar. The banks are asking for 75 cents on the dollar. What will the government offer?
Perhaps the worst alternative is that is now being promoted by the banks and vulture investors in tandem: the government will guarantee the price at which private investors buy toxic financial waste from the banks. A vulture fund would be happy enough to pay 75 cents on the dollar for worthless junk if the government were to provide a guarantee. The Treasury and Federal Reserve pretend that they simply would be “providing liquidity” to “frozen markets.” But the problem is not liquidity and it is not subjective “market psychology.” It is “solvency,” that is, a realistic awareness that toxic waste and bad derivatives gambles are junk. Mr. Geithner has not been able to come to terms with how to value this – without bringing the Obama administration down in a wave of populist protest – any more than Mr. Paulson was able to carry out his original Tarp proposal along these lines.
The hardest task for today’s banksters is to revive opportunities for creditors to make a new killing. (It’s the economy that’s being killed, of course.) This seems to be the aim of the Public/Private investment company that Mr. Geithner is establishing as the second element in his plan. The easiest free lunch is to ride the wave of a new bubble – a fresh wave of asset-price inflation to be introduced to “cure” the problem of debt deflation.
Here’s how I imagine the ploy might work. Suppose a hapless family has bought a home for $500,000, with a full 100% $500,000 adjustable-rate mortgage scheduled to reset this year at 8%. Suppose too that the current market price will fall to $250,000, a loss of 50% by yearend 2009. Sometime in mid 2010 would seem to be long enough for prices to decline by enough to make “recovery” possible – Bubble Economy 2.0. Without such a plunge, there will be no economy to “rescue,” no opportunity for Tim Geithner and Laurence Summers to “feel your pain” and pull out of their pocket the following package – a variant on the “cash for trash” swap, a public agency to acquire the $500,000 mortgage that is going bad, heading toward only a $250,000 market price.
The “bad bank” was not quite ready to be created this week, but the embryo is there. It will take the form of a public/private partnership (PPP) of the sort that Tony Blair made so notorious in Britain. And speaking of Mr. Blair, I am writing this from England, where almost every America-watcher I talk to has expressed amazement at Obama’s performance last week idealizing England’s counterpart to George Bush when it comes to unpopularity contests. Blair’s tenure in office was a horror story, not something to be congratulated for. He privatized the railroads and entering into the disastrous public/private partnership that doubled, tripled or quadrupled the cost of public projects by adding on a heavy financial overhead If Obama does not realize how he shocked Britain and much of Europe with his praise, then he is in danger of foisting a similar public/private financialized “partnership” on the United States
The new public/private institution will be financed with private funds – in fact, with the money now being given to re-capitalize America’s banks (headed by the Wall St. bank’s that have done so bad). Banks will use the Treasury money they have received by “borrowing” against their junk mortgages at or near par to buy shares in a new $5 trillion institution created along the lines of the unfortunate Fanny Mae and Freddie Mac. Its bonds will be guaranteed. (That’s the “public” part – “socializing” the risk.) The PPP institution will have the power to buy and renegotiate the mortgages that have passed into the hands of the government and other holders. This “Homeowner Rescue Trust” will use its private funding for the “socially responsible” purpose of “saving the taxpayer” and middle class homeowners by renegotiating the mortgage down from its original $500,000 to the new $250,000 market price.
Here’s the patter talk you can expect, with the usual Orwellian euphemisms. The Homeowners Rescue PPP will appear as a veritable Savior Bank resurrected from the wreckage of Bubble #1. Its clients will be families strapped by their mortgage debt and feeling more and more desperate as the price of their major asset plummets more deeply into Negative Equity territory. To them, the new PPP will say: “We’ve got a deal to save you. We’ll renegotiate your mortgage down to the current market price, $250,000, and we’ll also lower your interest rate to just 5.50%, the new rate. This will cut your monthly debt charges by nearly two thirds. Not only can you afford to stay in your home, you will escape from your negative equity.”
The family probably will say, “Great.” But they will have to make a concession. That’s where the new public/private partnership makes its killing. Funded with private money that will take the “risk” (and also reap the rewards), the Savior Bank will say to the family that agrees to renegotiate its mortgage: “Now that the government has absorbed a loss (in today’s travesty of “socializing” the financial system) while letting let you stay in your home, we need to recover the money that’s been lost. If we make you whole, we want to be made whole too. So when the time comes for you to sell your home or renegotiate your mortgage, our Homeowners Rescue PPP will receive the capital gain up to the original amount written off.”
In other words, if the homeowner sells the property for $400,000, the Homeowners Rescue PPP will get $150,000 of the capital gain. If the home sells for $500,000, the bank will get $250,000. And if it sells for more, thanks to some new clone of Alan Greenspan acting as bubblemeister, the capital gain will be split in some way. If the split is 50/50 and the home sells for $600,000, the owner will split the $100,000 further capital gain with the Homeowners Rescue PPP. It thus will make much more through its appropriation of capital gains (the new debt-fueled asset-price inflation being put in place) than it extracts in interest!
This would make Bubble 2.0 even richer for Wall Street than the Greenspan bubble! Last time around, it was the middle class that got the gains – even if new buyers had to enter a lifetime of debt peonage to buy higher-priced homes. It really was the bank that got the gains, of course, because mortgage interest charges absorbed the entire rental value and even the hoped-for price gain. But homeowners at least had a chance at the free ride, if they didn’t squander their money in refinancing their mortgages to “cash out” on their equity to support their living standards in a generation whose wage levels had stagnated since 1979. As Mr. Greenspan observed in testimony before Congress, a major reason why wages have not risen is that workers are afraid to strike or even to complain about being worked harder and harder for longer and longer hours (“raising productivity”), because they are one paycheck away from missing their mortgage payment – or, if renters, one paycheck or two away from homelessness.
This is the happy condition of normalcy that Wall Street’s financial planners would like to recover. This time around, they may not be obliged to make their gains in a way that also makes middle class homeowners rich. In the wake of Bubble Economy #1, today’s debt-strapped homeowners are willing to settle merely for a plan that leaves them in their homes! The Homeowners Rescue PPP can appropriate for its stockholder banks and other large investors the capital gains that have been the driving force of U.S. “wealth creation,” bubble-style. That is what the term “equity kicker” means.
This situation confronts the economy with a dilemma. The only policies deemed politically correct these days are those that make the situation worse: yet more government money in the hope that banks will create yet more credit/debt to raise house prices and make them even more unaffordable; credit/debt to inflate a new Bubble Economy #2.
Lobbyists for Wall Street’s enormous Bad Bank conglomerates are screaming that all real solutions to today’s debt problem and tax shift onto labor are politically incorrect, above all the time-honored debt write-downs to bring the debt burden within the ability to pay. That is what the market is supposed to do, after all, by bankruptcy in an anarchic collapse if not by more deliberate and targeted government policy. The Bad Banks, having demanded “free markets” all these years, fear a really free market when it threatens their bonuses and other takings. For Wall Street, free markets are “free” of public regulation against predatory lending; “free” of taxing the wealthy so as to shift the burden onto labor; “free” for the financial sector to wrap itself around the “real” economy like parasitic ivy around a tree to extract the surplus.
This is a travesty of freedom. As the putative neoliberal Adam Smith explained, “The government of an exclusive company of merchants, is, perhaps, the worst of all governments.” But worst of all is the “freedom” of today’s economic discussion from the wisdom of classical political economy and from historical experience regarding how societies through the ages have coped with the debt overhead.
How to save the economy from Wall Street
There is an alternative to ward all this off, and it is the classic definition of freedom from debt peonage and predatory credit. The only real solution to today’s debt overhang is a debt write-down. Until this occurs, debt service will crowd out spending on goods and services and there will be no recovery. Debt deflation will drag the economy down while assets are transferred further into the hands of the wealthiest 10 percent of the population, operating via the financial sector.
If Obama means what he says, he would use his office as a bully pulpit to urge repeal the present harsh creditor-oriented bankruptcy law sponsored by the banks and credit-card companies. He would campaign to restore the long-term trend of laws favoring debtors rather than creditors, and introduce legislation to restore the practice of writing down debts to reflect the debtor’s ability to pay, imposing market reality to debts that are far in excess of realistic valuations.
A second policy would be to restore the power of state attorneys general to bring financial fraud charges against the most egregious mortgage lenders – the prosecutions that the Bush Administration got thrown out of court by claiming that under an 1864 National Bank Act clause, the federal government had the right to override state prosecutions of national banks – and then appointing a non-prosecutor to this enforcement position.
On the basis of reinstated fraud charges, the government might claw back the bank bonuses, salaries and bank earnings that represented the profits from America’s greatest financial and real estate fraud in history. And to prevent repetition of the past decade’s experience, the Obama Administration might help popularize a new psychology of debt. The government could encourage “the poor” to act as “economically” as Donald Trumps or Angelo Mozilo’s would do, making it clear that debt write-downs are a right.
Also to ward off repetition of the Bubble Economy, the Treasury could impose the “Tobin tax” of 1% on purchases and options for stocks, bonds and foreign currency. Critics of this tax point out that it can be evaded by speculators trading offshore in the rights to securities held in U.S. accounts. But the government could simply refuse to provide deposit insurance and other support to institutions trading offshore, or simply could announce that trades in such “deposit receipts” for shares would not have legal standing. As for trades in derivatives, depository institutions – including conglomerates owning such banks – can simply be banned as inherently unsafe. If foreigners wish to speculate on financial horse races, let them.
Financial policy ultimately rests on tax policy. It is the ability to levy taxes, after all, that gives value to Treasury money (just as it is the inability to collect on debts that has depreciated the value of commercial bank deposits). It is easy enough for fiscal policy to prevent a new real estate bubble. Simply shift the tax system back to where it originally was, on the land’s site-rental value. The “free lunch” (what John Stuart Mill called the “unearned increment” of rising land prices, a gain that landlords made “in their sleep”) would serve as the tax base instead of burdening labor and industry with income taxes and sales taxes. This would achieve the kind of free market that Adam Smith, John Stuart Mill and Alfred Marshall described, and which the Progressive Era aimed to achieve with America’s first income tax in 1913. It would be a market free of the free lunch that Chicago Boys insist does not exist. But the recent Bubble Economy and today’s Bailout Sequel have been all about getting a free lunch.
A land tax would prevent housing prices from rising again. It is the most hated tax in America today, largely because of the disinformation campaign that has been mounted by the real estate interests and amplified by the banks that stand behind them. The reality is that taxing land appreciation rather than wages or corporate profits would save homeowners from having to take on so much debt in order to obtain housing. It would save the economy from seeing “wealth creation” take the form of the “unearned increment” being capitalized into higher bank loans with their associated carrying charges (interest and amortization).
The wealth tax originally fell mainly on real estate. The most immediate and politically feasible priority of the Obama Administration thus should be to repeal the Bush Administration’s drastic tax cuts for the top brackets and its moratorium on the estate tax. The aim should be to bring down the polarization between creditors and debtors that has concentrated over two-thirds of the returns to wealth in the richest 1% of the population.
If alternatives to the Bubble Economy such as these are not promoted, we will know that promises of change were mere rhetoric, Tony Blair style.
 Martin Wolf, “Why Obama’s new Tarp will fail to rescue the banks,” Financial Times, Feb. 11, 2009.
 “Geithner at the Improv,” Wall Street Journal editorial, February 11, 2009.
Disclaimer: The views expressed in this article are the sole responsibility of the author and do not necessarily reflect those of the Centre for Research on Globalization. The contents of this article are of sole responsibility of the author(s). The Centre for Research on Globalization will not be responsible or liable for any inaccurate or incorrect statements contained in this article.
February 17, 2009
Finance Capitalism Hits a Wall
The Oligarchs' Escape Plan
By MICHAEL HUDSON
The financial “wealth creation” game is over. Economies emerged from World War II relatively free of debt, but the 60-year global run-up has run its course. Finance capitalism is in a state of collapse, and marginal palliatives cannot revive it. The U.S. economy cannot “inflate its way out of debt,” because this would collapse the dollar and end its dreams of global empire by forcing foreign countries to go their own way. There is too little manufacturing to make the economy more “competitive,” given its high housing costs, transportation, debt and tax overhead. A quarter to a third of U.S. real estate has fallen into negative equity, so no banks will lend to them. The economy has hit a debt wall and is falling into negative equity, where it may remain for as far as the eye can see until there is a debt write-down.
Mr. Obama’s “recovery” plan, based on infrastructure spending, will make real estate fortunes for well-situated properties along the new public transport routes, but there is no sign of cities levying a windfall property tax to save their finances. Their mayors would rather keep the cities broke than to tax real estate and finance. The aim is to re-inflate property markets to enable owners to pay the banks, not to help the public sector break even. So state and local pension plans will remain underfunded while more corporate pension plans go broke.
One would think that politicians would be willing to do the math and realize that debts that can’t be paid, won’t be. But the debts are being kept on the books, continuing to extract interest to pay the creditors that have made the bad loans. The resulting debt deflation threatens to keep the economy in depression until a radical shift in policy occurs – a shift to save the “real” economy, not just the financial sector and the wealthiest 10 per cent of American families.
There is no sign that Mr. Obama’s economic advisors, Treasury officials and heads of the relevant Congressional committees recognize the need for a write-down. After all, they have been placed in their positions precisely because they do not understand that debt leveraging is a form of economic overhead, not real “wealth creation.” But their tunnel vision is what makes them “reliable” to Wall Street, which doesn’t like surprises. And the entire character of today’s financial crisis continues to be labeled “surprising” and “unexpected” by the press as each new surprisingly pessimistic statistic hits the news. It’s safe to be surprised; suspicious to have expected bad news and being a “premature doomsayer.” One must have faith in the system above all. And the system was the Greenspan Bubble. That is why “Ayn Rand Alan” was put in charge in the first place, after all.
So the government tries to recover the happy Bubble Economy years by getting debt growing again, hoping to re-inflate real estate and stock market prices. That was, after all, the Golden Age of finance capital’s world of using debt leverage to bid up the book-price of fictitious capital assets. Everyone loved it as long as it lasted. Voters thought they had a chance to become millionaires, and approved happily. And at least it made Wall Street richer than ever before – while almost doubling the share of wealth held by the wealthiest 1 per cent of America’s families. For Washington policy makers, they are synonymous with “the economy” – at least the economy for which national economic policy is being formulated these days.
The Obama-Geithner plan to restart the Bubble Economy’s debt growth so as to inflate asset prices by enough to pay off the debt overhang out of new “capital gains” cannot possibly work. But that is the only trick these ponies know. We have entered an era of asset-price deflation, not inflation. Economic data charts throughout the world have hit a wall and every trend has been plunging vertically downward since last autumn. U.S. consumer prices experienced their fastest plunge since the Great Depression of the 1930s, along with consumer “confidence,” international shipping, real estate and stock market prices, oil and the exchange rate for British sterling. The global economy is falling into depression, and cannot recover until debts are written down.
Instead of doing this, the government is doing just the opposite. It is proposing to take bad debts onto the public-sector balance sheet, printing new Treasury bonds give the banks – bonds whose interest charges will have to be paid by taxing labor and industry.
The oligarchy’s plans for a bailout (at least of its own financial position)
In periods of looming collapse, wealthy elites protect their funds. In times past they bought gold when currencies started to weaken. (Patriotism never has been a characteristic of cosmopolitan finance capital.) Since the 1950s the International Monetary Fund has made loans to support Third World exchange rates long enough to subsidize capital flight. In the United States over the past half-year, bankers and Wall Street investors have tapped the Treasury and Federal Reserve to support prices of their bad loans and financial gambles, buying out or guaranteeing $12 trillion of these junk debts. Protection for the U.S. financial elite thus takes the form of domestic public debt, not foreign currency.
It is all in vain as far as the real economy is concerned. When the Treasury gives banks newly printed government bonds in “cash for trash” swaps, it leaves today’s unpayably high private-sector debt in place. All that happens is that this debt is now owed to (or guaranteed by) the government, which will have to impose taxes to pay the interest charges.
The new twist is a variant on the IMF “stabilization” plans that lend money to central banks to support their currencies – for long enough to enable local oligarchs and foreign investors to move their savings and investments offshore at a good exchange rate. The currency then is permitted to collapse, enabling currency speculators to rake in enough gains to empty out the central bank’s reserves. Speculators view these central bank holdings as a target to be raided – the larger the better. The IMF will lend a central bank, say, $10 billion to “support the currency.” Domestic holders will flee the currency at a high exchange rate. Then, when the loan proceeds are depleted, the currency plunges. Wages are squeezed in the usual IMF austerity program, and the economy is forced to earn enough foreign exchange to pay back the IMF.
As a condition for getting this kind of IMF “support,” governments are told to run a budget surplus, cut back social spending, lower wages and raise taxes on labor so as to squeeze out enough exports to repay the IMF loans. But inasmuch as this kind “stabilization plan” cripples their domestic economy, they are obliged to sell off public infrastructure at distress prices – to foreign buyers who themselves borrow the money. The effect is to make such countries even more dependent on less “neoliberalized” economies.
Latvia is a poster child for this kind of disaster. Its recent agreement with Europe is a case in point. To help the Swedish banks withdraw their funds from the sinking ship, EU support is conditional on Latvia’s government agreeing to cut salaries in the private sector – and not to raise property taxes (currently almost zero).
The problem is that Latvia, like other post-Soviet economies, has scant domestic output to export. Industry throughout the former Soviet Union was torn up and scrapped in the 1990s. (Welcome to victorious finance capitalism, Western-style.) What they had was real estate and public infrastructure free of debt – and hence, available to be pledged as collateral for loans to finance their imports. Ever since its independence from Russia in 1991, Latvia has paid for its imported consumer goods and other purchases by borrowing mortgage credit in foreign currency from Scandinavian and other banks. The effect has been one of the world’s biggest property bubbles – in an economy with no means of breaking even except by loading down its real estate with more and more debt. In practice the loans took the form of mortgage borrowing from foreign banks to finance a real estate bubble – and their import dependency on foreign suppliers.
So instead of helping it and other post-Soviet nations develop self-reliant economies, the West has viewed them as economic oysters to be broken up to indebt them in order to extract interest charges and capital gains, leaving them empty shells. This policy crested on January 26, 2009, when Joaquin Almunia of the European Commission wrote a letter to Latvia’s Prime Minister spelling out the terms on which Europe will bail out the Swedish and other foreign banks operating in Latvia – at Latvia’s own expense:
Extended assistance is to be used to avoid a balance of payments crisis, which requires … restoring confidence in the banking sector [now entirely foreign owned], and bolstering the foreign reserves of the Bank of Latvia. This implies financing … outstanding government debt repayments (domestic and external). And if the banking sector were to experience adverse events, part of the assistance would be used for targeted capital infusions or appropriate short-term liquidity support. However, financial assistance is not meant to be used to originate new loans to businesses and households. …
… it is important not to raise ungrounded expectations among the general public and the social partners, and, equally, to counter misunderstandings that may arise in this respect. Worryingly, we have witnessed some recent evidence in Latvian public debate of calls for part of the financial assistance to be used inter alia for promoting export industries or to stimulate the economy through increased spending at large. It is important actively to stem these misperceptions.
Riots broke out last week, and protesters stormed the Latvian Treasury. Hardly surprising! There is no attempt to help Latvia develop the export capacity to cover its imports. After the domestic kleptocrats, foreign banks and investors have removed their funds from the economy, the Latvian lat will be permitted to depreciate. Foreign buyers then can come in and pick up local assets on the cheap once again.
The practice of European banks riding the crest of the post-Soviet real estate bubble is backfiring to wreck the European economies that have engaged in this predatory lending to neighboring economies as well. As one reporter has summarized:
In Poland 60 percent of mortgages are in Swiss francs. The zloty has just halved against the franc. Hungary, the Balkans, the Baltics, and Ukraine are all suffering variants of this story. As an act of collective folly – by lenders and borrowers – it matches America’s sub-prime debacle. There is a crucial difference, however. European banks are on the hook for both. US banks are not. Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks.
This was the West’s alternative to Stalinism. It did not help these countries emulate how Britain and America got rich by protectionist policies and publicly nurtured industrialization and infrastructure spending. Rather, the financial rape and industrial dismantling of the former Soviet economies was the most recent exercise in Western colonialism. At least U.S. investors were smart enough to stand clear and merely ride the stock market run-up before jumping ship.
But now, the government’s plan to “save” the economy is to “save the banks,” along similar lines to the West trying to save its banks from their adventure in the post-Soviet economies. This is the basic neoliberal economic plan, after all. The U.S. economy is about to be “post-Sovietized.”
The U.S. giveaway to banks, masquerading as “help for troubled homeowners”
The Obama bank bailout is arranged much like an IMF loan to support the exchange rate of foreign currency, but with the Treasury supporting financial asset prices for U.S. banks and other financial institutions. Instead of banks and oligarchs abandoning the dollar, the aim is to enable them to dump their bad mortgages and CDOs and get domestic Treasury bonds. Private-sector debt will be moved onto the U.S. Government balance sheet, where “taxpayers” will bear losses – mainly labor not Wall Street, inasmuch as the financial sector has been freed of income-tax liability by the “small print” in last fall’s Paulson-Bush bailout package. But at least the U.S. Government is handling the situation entirely in domestic dollars.
As in Third World austerity programs, the effect of keeping the debts in place at the “real” economy’s expense will be to shrink the domestic U.S. market – while providing opportunities for hedge funds to pick up depreciated assets cheaply as the federal government, states and cities sell them off. This is called letting the banks “earn their way out of debt.” It’s strangling the “real” economy, because not a dollar of the government’s response has been devoted to reducing the overall debt volume.
Take the much-vaunted $50 billion program designed to renegotiate mortgages downward for “troubled homeowners.” Upon closer examination it turns out that the real beneficiaries are the giant leading banks such as Citibank and Bank of America that have made the bad loans. The Treasury will take on the bad debt that banks are stuck with, and will permit mortgagees to renegotiate their monthly payment down to 38 per cent of their income. But rather than the banks taking the loss as they should do for over-lending, the Treasury itself will make up the difference – and pay it to the banks so that they will be able to get what they hoped to get. The hapless mortgage-burdened family stuck in their negative-equity home turns out to be merely a passive vehicle for the Treasury to pass debt relief on to the commercial banks.
Few news stories have made this clear, but the Financial Times spelled the details buried in small print. It added that the Treasury has not yet decided whether to write down the debt principal for the estimated 15 million families with negative equity (and perhaps 30 million by this time next year as property prices continue to plunge). No doubt a similar deal will be made: For every $100,000 of write-down in debt owed by over-mortgaged homeowners, the bank will receive $100,000 from the Treasury. Government debt will rise by $100,000, and the process will continue until the Treasury has transferred $50,000,000 to the banks that made the reckless loans.
There is enough for just 500,000 of these renegotiations of $100,000 each. It may seem like a big amount, but it’s only about 1/30th of the properties underwater. Hardly enough to make much of a dent, but the principle has been put in place for many further bailouts. It will take almost an infinity of them, as long as the Treasury tries to support the fiction that “the miracle of compound interest” can be sustained for long. The economy may be dead by the time saner economic understanding penetrates the public consciousness.
In the mean time, bad private-sector debt will be shifted onto the government’s balance sheet. Interest and amortization currently owed to the banks will be replaced by obligations to the U.S. Treasury. Taxes will be levied to make up the bad debts with which the government is stuck. The “real” economy will pay Wall Street – and will be paying for decades!
Calling the $12 trillion giveaway to bankers a “subprime crisis” makes it appear that bleeding-heart liberals got Fannie Mae and Freddie Mac into trouble by insisting that these public-private institutions make irresponsible loans to the poor. The party line is, “Blame the victim.” But we know this is false. The bulk of bad loans are concentrated in the largest banks. It was Countrywide and other banksters that led the irresponsible lending and brought heavy-handed pressure on Fannie Mae. Most of the nation’s smaller, local banks didn’t make such reckless loans. The big mortgage shops didn’t care about loan quality, because they were run by salesmen. The Treasury is paying off the gamblers and billionaires by supporting the value of bank loans, investments and derivative gambles, leaving the Treasury in debt.
It may be time to look once again at what Larry Summers and his Rubinomics gang did in Russia in the mid-1990s and to Third World countries during his tenure as World Bank economist to see what kind of future is being planned for the U.S. economy over the next few years. Throughout the Soviet Union the neoliberal model established “equilibrium” in a way that involved demographic collapse: shortening life spans, lower birth rates, alcoholism and drug abuse, psychological depression, suicides, bad health, unemployment and homelessness for the elderly (the neoliberal mode of Social Security reform).
Back in the 1970s, people speculated whether the US and Soviet economies were converging. Throughout the 20th century, of course, everyone expected government regulation, infrastructure investment and planning to increase. It looked like the spread of democratically elected governments would go hand in hand with people voting in their own economic interest to raise living standards, thereby closing the inequality gap.
This is not the kind of convergence that has occurred since 1991. Government power is being dismantled, living standards have stagnated and wealth is concentrating at the top of the economic pyramid. Economic planning and resource allocation has passed into the hands of Wall Street, whose alternative to Hayek’s “road to serfdom” is debt peonage for the economy at large. There does need to be a strong state, to be sure, to keep the financial and real estate rentier power in place. But the West’s alternative to the old Soviet bureaucracy is a financial planning. In place of a political overhead, we have a financial and real estate overhead.
Stalinist Russia and Maoist China achieved high technology without land-rent, monopoly rent and interest overhead. This purging of rentier income was the historical task of classical political economy, and it became that of socialism. The aim was to create a Clean Slate financially, bringing prices in line with technologically necessary costs of production. The aim was to provide everyone with the fruits of their labor rather than letting banks and landlords siphon off the economic surplus.
Ideas of economic efficiency and “wealth creation” today are an utterly different kind of liberalism and “free markets.” Commercial banks lend money not to increase production but to inflate asset prices. Some 70 per cent of bank loans are mortgage loans for real estate, and most of the rest is for corporate takeovers and raids, to finance stock buy-backs or simply to pay dividends. Asset-price inflation obliges people to go deeper into debt than ever before to obtain access to housing, education and medical care. The economy is being “financialized,” not industrialized. This has been the plan as much for the post-Soviet states as for North America, Western Europe and the Third World.
But we are far from having reached the end of the line. Celebrations that our present financialized economy represents the “end of history” are laughingly premature. Today’s policies look more like a dead end. But that does not mean that, like the Roman Empire, they won’t lead us down toward a new Dark Age. That’s what tends to happen when oligarchies do the planning.
Is America a Failed Economy?
It may be time to ask whether neoliberal pro-rentier economics has turned America and the West into a Failed Economy. Is there really no alternative? Have the neoliberals made the shift of planning from governments to the financial oligarchy irreversible?
Let’s first dispose of the “foundation myth” of the idea still guiding the United States and Europe. Free-market economists pretend that prices can be brought into line most efficiently with technologically necessary costs of production under capitalism, and indeed, under finance capitalism. The banks and stock market are supposed to allocate resources most efficiency. That at least is the dream of self-regulating markets. But today it looks like only a myth, public relations patter talk to get a generation of increasingly indebted voters not to act in their own self-interest.
Industrial capitalism always has been a hybrid, a symbiosis with its feudal legacy of absentee property ownership, oligarchic finance and public debts rather than the government acting as net creditor. The essence of feudalism was extractive, not productive. That is why it created industrial capitalism as state policy in the first place – if only to increase its war-making powers. But the question must now be raised as to whether only socialism can complete the historical task that classical political economy set out for itself – the ideal that futurists in the 19th and 20th centuries believed that an unpurified capitalism might still be able bring about without shedding its legacy of commercial banking indebting property and carving infrastructure out of the public domain.
Today it is easier to see that the Western economies cannot go on the way they have been. They have reached the point where the debts exceed the ability to pay. Instead of recognizing this fact and scaling debts back into line with the ability to pay, the Obama-Geithner plan is to bail out the big banks and hedge funds, keeping the volume of debt in place and indeed, growing once again through the “magic of compound interest.” The result can only be an increasingly extractive economy, until households, real estate and industrial companies, states and cities, and the national government itself is driven into debt peonage.
The alternative is a century and a half old, and emerged out of the ideals of the classical economic doctrines of Adam Smith, David Ricardo, John Stuart Mill, and the last great classical economist, Marx. Their common denominator was to view rent and interest are extractive, not productive. Classical political economy and its successor Progressive Era socialism sought to nationalize the land (or at least to fully tax its rent as the fiscal base). Governments were to create their own credit, not leave this function to wealthy elites via a bank monopoly on credit creation. So today’s neoliberalism paints a false picture of what the classical economists envisioned as free markets. They were markets free of economic rent and interest (and taxes to support an aristocracy or oligarchy). Socialism was to free economies from these overhead charges. Today’s Obama-Geithner rescue plan is just the reverse.
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, email@example.com
The American Spectator
The Public Policy
The TARP Trojan Horse
By Theodore H. Frank on 2.16.09 @ 6:06AM
In executing TARP, the Troubled Asset Relief Program, the Bush Treasury Department built off of the experience of costly mistakes the government made in the 1980s bailout of the savings and loan industry. But the lessons learned are the wrong ones, and the consequences could be dramatic.
To induce healthy thrifts to take over troubled thrifts, the Federal Savings and Loan Insurance Corporation offered a regulatory incentive: it would permit the institutions to count intangible "supervisory goodwill" towards their reserve requirements, and amortize that goodwill over forty years. This and other favorable accounting treatments would permit the acquirer to increase its leverage and thus, hypothetically, its profits. Without this incentive, the desired mergers never would have happened: a healthy thrift plus an insolvent thrift would have equaled another insolvent thrift under the old accounting regime.
Dozens of institutions made express agreements with the FSLIC and relied upon those promises. These deals saved the government money (at least in the short run) because the failing thrifts could continue operating and the government did not have to make good on deposit insurance.
Now, one can argue that the FSLIC's policy was unwise because it distorted economic incentives and encouraged healthy banks to make themselves less healthy. Recent events have shown the problem of overleveraging. And some businesses were rent-seeking, created simply to buy failing thrifts and take advantage of the favorable regulatory treatment. But the way Congress resolved that problem was to pull the rug out from under these deals retroactively.
FIRREA, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, abolished the old regulatory regime, including the FSLIC. More importantly for the thrifts, FIRREA established capital requirements that made the deals' accounting treatment impermissible.
Profitable thrifts that had relied upon the government's promises found themselves out of compliance with the new rules, and regulators seized and liquidated them.
Many of those thrifts sued the United States for breach of contract. And the Supreme Court quickly ruled unanimously in Winstar Corp. v. United States that the thrifts had a case. Yes, Congress could change the rules; the thrifts did not claim otherwise. But the government had the responsibility to make whole those who had contractual agreements when the new rules meant the government could no longer keep its promises.
The aftermath of Winstar was disappointing, however, for those investors. The Department of Justice litigated the suits to the hilt through three presidential administrations, and the thrifts received only a small fraction of the billions they lost for trusting the government.
There are many lessons that policymakers could take from this experience. One is to avoid addressing financial problems with short-term solutions that only forestall and magnify the eventual pain. (Yet TARP also involves accounting kludges.) Another is realizing the costs to the economy when the government reneges on a deal: aside from the fundamental unfairness of a broken promise, capricious policy makes it more expensive for the government to induce trust from investors in the future. The Winstar experience is no doubt interfering with the government's plans this time around.
But the government's conclusion from its Winstar experience is the wrong one: lawyer up in advance. TARP's "Securities Purchase Agreements" each contain a Trojan Horse clause, Section 5.3, stating that Treasury may "unilaterally amend" the agreement to comply with changes in federal statutes. In short, Congress has the power to retroactively amend the terms of the bailout, and stakeholders would have even less recourse than the Winstar plaintiffs.
The provision is a blank check. Congress could raise the dividend rate without warning; it could change the repayment schedule. Congress can wipe out shareholders or subordinate debt-holders overnight. Any of a raft of special interests could use Congress to demand that TARP participants engage in various forms of costly social engineering, ranging from meddling in corporate governance to abstinence from foreclosures to favorable treatment for Democratic constituencies.
This is already more than hypothetical. During December's Republic Windows and Doors sit-in, Illinois Governor Rod Blagojevich used the fact of the bailout to mau-mau Bank of America into paying over a million dollars to the lawbreaking union, even though banks have no legal obligation to their debtors' workers.
And the "stimulus" bill included strict regulation of executive pay for bailout recipients -- essentially insuring that the bailed out banks won't be able to compete in the marketplace for talent to replace the people who got them into the mess they are in.
David Baris of the American Association of Bank Directors pointed all this out in a November 3 letter to Treasury Secretary Paulson, but never received a response. Little wonder many banks are refusing to participate in TARP, and equity holders should be especially wary of the ones that do given the unbounded political risks.
This unnecessary uncertainty is almost certainly contributing to the financial paralysis that is preventing TARP from working. The Obama administration should ameliorate the damage by deleting Section 5.3 from the Securities Purchase Agreement.
Theodore H. Frank is a resident fellow at the American Enterprise Institute.
Ahi quanto a dir qual era è cosa dura / esta selva selvaggia e aspra e forte / che nel pensier rinova la paura!
by Noah Millman
Indeed, this dark forest is a hard thing to speak of. As readers of this blog may recall, I’ve spent the last several years working in an industry now credibly blamed for bringing on what is almost certainly the worst economic crisis since the Great Depression. Not only have I been working on Wall Street, but I work in structured finance. While I wasn’t at the epicenter of the crisis – I didn’t put together mortgage securitizations, and I don’t work for one of the big firms – I was certainly using some of the same financial technology, and trading the same products, as the businesses that were at the epicenter.
Given my eye-of-the-storm view of the matter, I thought it would be of interest to relate two stories from my long career in structured finance, one that may help explain why, if you asked me in 2004 or 2005, I would have staunchly defended structured finance technology as having real social benefit and why, by a couple of years later, it was clear to anyone looking honestly at the business that something had gone very wrong. I’ve chosen two stories that, as it happens, do not relate to mortgage securitization, for two reasons: first, because my world was primarily centered on corporate structured finance, so that’s what I know best, but, second, because I want to make it clear that both the promise and the peril of this financial technology extend well beyond the best-reported area of mortgage finance.
First, the promise.
Most of what I’ve worked on over the years is structuring and issuing synthetic corporate CDOs, and actively adjusting the composition of those asset pools over time. Our firm closed its first synthetic CDO in late 2001. To refresh everyone’s memory, late 2001 saw the terrorist attacks on New York and Washington, the collapse of Enron, and, following shortly thereafter in early 2002, the collapse of Worldcom. Enron and Worldcom were, at the time, the two biggest corporate frauds in history, and their collapse had far-reaching consequences.
Enron and Worldcom had invested huge amounts of mostly borrowed money in, respectively, a variety of commodity trading operations and broadband telecommunications infrastructure. Both firms appeared to be profitable, and numerous other firms – energy-generation utilities in the first case, telecom providers in the second – borrowed lots of money to invest in competing platforms, so as not to be left behind. When it became clear that both firms were frauds at heart, and that these activities were not profitable, it didn’t take long for people to figure out that there were a whole lot of other firms out there that were now in trouble. The market had already priced in a slowdown in telecom, for example, but it thought this slowdown was from a base of real profitability. If there had been no profit when times were good, then things were going to be much worse than originally anticipated now that times were bad.
Everyone knows what happened to the stock market in 2002. The corporate debt market situation was not as well-reported because it was of less interest to individual investors. But it was of enormous importance to the future of these companies, and to the world economy. Many of these companies had huge debt loads and substantial near-term refinancing needs. And it wasn’t clear they were going to get that refinancing, as investors were not eager to buy bonds from companies that might be the next Enron or Worldcom, and banks were not eager to lend more when they were increasing their provisions against their existing holdings. There was a real danger of a credit crunch, and a catastrophic series of bankruptcies that would cripple the banking sector for years.
Everyone also knows what the Fed did to respond to this threat: it dropped interest rates to what were once considered extremely low levels (the same thing the Fed did after the S&L debacle). Since banks borrow short via deposits and lend long, dropping the front end of the curve straightforwardly increases banks’ profitability which should (if banks are well-capitalized) make them more willing to risk capital by lending. And lend they did: most of the companies in question got new financing and, over the next two years, corporate America dramatically improved its balance sheets, paying down and/or extending out its debt, setting itself up for several years of extraordinary profit growth.
But, once again, what’s less reported is the role that structured finance played in facilitating bank lending. And it played a very important role. One reason banks were willing to lend again was that the credit derivatives marketplace made it possible for them to price and hedge their credit risk. Prior to the development of credit derivatives, it was extremely difficult for banks to get a clear picture of the price of credit. There was no market for corporate loans, and the corporate bond market is a clubby place where transparent pricing is available only for the most liquid issuers. But by 2002, the credit derivatives marketplace had matured to the point that banks could use it as one input into their decisionmaking process about when to lend.
And they could hedge their risk as well. Let’s say you were a utility that needed to roll over $1 billion in debt coming due in six months. The syndicate that lent you the money initially is ten banks, so that’s $100 million per bank on average. None of the banks want to take that much risk. At their previous level of security, they’d want to cut back to $25 million each; if they can get additional security, they’d consider going to $50 million each. How do you increase lending capacity? Well, if a bank can buy a credit default swap on $50 million, then it can lend $100 million, and hedge itself back to $50 million. And who would write that default swap? Maybe a hedge fund making a bet that credit would outperform equity (so-called “capital structure arbitrage”) and was therefore writing credit-default-swaps and shorting stock as a hedge. Maybe an insurance company taking advantage of wide spreads to take additional corporate credit exposure in its investment portfolio. Maybe a foreign bank that isn’t part of the lending syndicate for the utility looking to diversify geographically.
Or maybe the protection seller was a structured finance vehicle. This could be a vehicle set up by the bank itself – a balance-sheet CDO. This was an increasingly popular technology early in the decade, and it enabled banks to reduce concentrations to a wide variety of corporate credit risks all in one shot. Basically, the bank would take its portfolio of loans, and transfer a portion of these loans to a special-purpose vehicle via a credit default swap. Then the vehicle would issue various classes of debt, backed by government bonds and by the cashflow from this default swap, rated based on their relative level of seniority. The ratings agency process for rating this debt was based, as always with the agencies, on their historical data on corporate defaults and recoveries on defaulted assets in workout, and, given that corporate default data goes back to the 1920s, they’ve got a pretty decent data set to work off – moreover, this is the same data set that corporate bond investors such as insurance companies have long used in their own investment process, so market confidence in the ratings methodology was pretty high. If a bank set up such a vehicle, it could significantly expands its capacity to lend – it was effectively creating a synthetic syndicate for every loan it needed to hedge, a syndicate consisting not of other banks but of a much wider array of other investors, each investing at its preferred level of risk.
And apart from bank balance sheet CDOs, there were also “arbitrage” CDOs – investment vehicles structured around CDO technology. Equity investors in such vehicles were basically borrowing for term from the various classes of debt investor to purchase a portfolio of corporate risk, and could change the composition of that portfolio (subject to a variety of ratings agency restrictions) to capitalize on market moves of various kinds. By 2002, this CDO market had already become synthetic, which meant that a variety of investment banks could create such structures on the fly designed around the precise risks investors wished to access (in terms of the underlying portfolio and the degree of leverage in the structure). Again, because of the robustness and familiarity of the data set used by the agencies, market confidence in the ratings process was fairly high. Arbitrage vehicles of this sort made a material contribution to the liquidity of the corporate credit default swap market in the early 2000s, and thereby made it possible for banks to hedge their credit exposures to corporations to whom they extended credit, which in turn made it possible for them to expand their lending activities at precisely the moment when they were most nervous about doing so, and when the economy most needed them to do so.
Coming out of the experience of 2002, I can fairly say that I was a believer in the social value of credit derivatives and structured finance as part of the great machine of capitalism. I had seen this market and this technology play an important part in speeding the recovery from a fairly serious corporate borrowing binge that started with the internet bubble and ended with the collapse of Enron and Worldcom. Not the leading part – the Fed’s rate cuts were clearly much more important – but an important part nonetheless. Credit derivatives and structured finance were supposed to increase market transparency and liquidity, facilitate the more efficient pricing and distribution of credit risk, and hence smooth out the credit cycle. And that’s exactly what they appeared to have done.
Then, the peril.
Fast-forward to 2006. I could easily spend 10,000 words explaining all the ways in which the credit-derivatives and structured-products markets had grown, and changed. By this time, structured finance technology had facilitated a truly insane inflation of the housing market, and the extension of credit on absurd terms to borrowers who nobody could rationally expect to be able to pay. And credit derivatives made it possible for companies like AIG to leverage their AAA credit ratings to acquire enormous nominal amounts of purportedly loss-remote credit risk and leverage this risk hundreds of times without any regulatory body being aware of their activities, much less able to intervene to control them. Much of this has been well-reported in a variety of venues. I want to tell one anecdote from the corporate structured finance market (the market I know best) as a means of debunking what I think is a rather self-justifying explanations for how things went so wrong in the mortgage market.
It has been argued that, in a nutshell, the reason things went so wrong in the structured finance market is that “nobody” thought that the national housing market could suffer a meaningful year-on-year price decline. Local markets could decline, yes, and that national market could stagnate for a bit, as it had in past recessions. But a significant national decline in housing prices was inconceivable, and hence was not factored in to the ratings-agency models for mortgage securitizations. Rather, the agencies assumed historic default correlations between different geographies were predictive of future correlations, as well as that historic default rates were predictive of future default rates.
The argument against this is that the agencies should have known that the structured finance market they created by rating all this paper was, itself, changing the complexion of the underlying mortgages, and that this could change both default rates and default correlations (as, indeed, occurred). They should have factored this “reflexivity” (to use George Soros’ term) into their models, and made their ratings tougher. And there’s a great deal of truth to this, but I think this objection gives the agencies too much credit. After all, if all they got wrong was not paying attention to the tails of the distribution – the “black swan” problem – then they made the kind of error that happens all the time in finance; indeed, the kind of error that routinely creates bubbles. The thing about black swans is that you have no idea how likely they are, which makes it extremely difficult to build them into your models. There are always Cassandras out there saying the sky is about to fall, and eventually they will be right, but if you listen to them all the time you’ll never get out of bed.
The agencies got so much more wrong than that (for example, they didn’t rate the quality of servicers or originators of loans, which you would think would be important in assessing the credit quality of the mortgages in a securitization). But the thing they got most wrong was ignoring the quality of their own data set. The sub-prime mortgage market was still young when the agencies began rating securitizations dominated by such mortgages. And the structured finance market was in its infancy when the agencies began rating CDOs backed by asset-backed securities backed in turn by sub-prime mortgages. There is simply no way that the agencies had an adequate data set to justify rating these deals at all. And I can best illustrate the agencies’ disregard for the quality of their data sets by reference to a product unrelated to mortgages: the constant-proportion debt obligation, or CPDO.
This obscure little product was launched in late 2006 to great fanfare. And it was, indeed, an ingenious little fraud of a product. Here’s how it worked.
Some clever structurer noticed that, historically, investment-grade companies don’t default very often. Rather, they deteriorate for a while first, get downgraded to junk status, and eventually they default. That’s why the short-term ratings for relatively low-rated investment-grade companies may be reasonably high: even BBB companies are generally good for the next 90 days; if they weren’t, they wouldn’t be rated BBB. And this suggested the possibility of a trading strategy.
What if you bought a portfolio of investment-grade corporate debt and, every six months, purged it of the bonds that were downgraded to junk, replacing these with new investment-grade bonds. Obviously, you’d expect the downgraded bonds to underperform the remainder of the pool, so you’d have losses you need to make up, so assume you also sell out of a handful of bonds that have done well, and replace these with higher-yielding bonds that are still investment-grade, thus keeping your yield relatively constant. You’d still expect some losses if you wanted to keep your average rating relatively constant, though. So you need some excess yield to make up for these losses.
You find that yield by leveraging the portfolio. After all, it’s an investment-grade portfolio, very unlikely to default in the short term. You can borrow very cheaply short-term, invest in longer-term bonds, and earn the spread differential. If the bonds go against you, that’s OK, because you’re going to hold them to maturity and you’ll always be able to roll your short-term borrowing. And, if you can get a high enough degree of leverage, the excess in current yield from the differential between where you borrow and the yield on your portfolio should more than pay for the cost of rolling out of your losers every six months. And if you do that successfully, you’ve got a trading strategy that never loses principal, but has a surprisingly high expected yield. Sound good?
Well, it sounded great to the ratings agencies, who blessed this strategy by giving it a AAA rating.
How did they justify that AAA rating? By looking at the historic cost of rolling credit derivatives on indices of investment-grade corporate issuers, which generally have a high-BBB rating. These had been around for about three years when the first CPDOs were rated, and the roll had never cost more than 3 basis points. Factoring in that cost, at a leverage of 15-to-1, and using historic 6-month default rates for the portfolio (since the index would be rolled every six months), the proposed trading strategy would never lose money. Hence a AAA rating.
Let me reiterate that, just to drive the point home. The ratings agencies said: you can take a BBB-rated index, leverage it 15-to-1, and follow an entirely automatic trading strategy (no trader discretion, no forecasting of defaults or anything, just a formula-driven adjustment to the leverage ratio and an automatic roll of the index), and the result is rated AAA.
Needless to say, this worked out really well for all concerned. But that’s not really the point. The point is: the notion that you could grant a AAA based on a trading strategy for which there was at best three-years of data (three years that encompassed not a single recession, I’ll note) is mind-boggling. And, worse than that, nobody at the agencies apparently stood up and said, “wait a second: how can you turn a BBB into a AAA by leveraging it 15-to-1? That’s impossible!” Which, of course, it is.
I want to be very clear about something: we’re not talking about a CDO where the AAA investor is providing leverage, and there are subordinate investors below who bear the first risks of loss. This was a trading strategy; the investor in the AAA CPDO had first-loss risk with respect to a BBB portfolio. The trading strategy was just supposed to generate enough returns to create “virtual” subordination to justify the AAA.
When I first heard about this product, I thought: whichever agencies rated this thing have lost their minds. When people asked me whether it made sense as an investment, I said: it’s an outright fraud. You’re practically guaranteed to lose money. I never bought or sold one of these things myself, and neither did anyone else in our group. But the existence of such a ridiculous product should have been a wake-up call about just how divorced from reality the agencies were. And if they were out to lunch on something as straightforwardly absurd as the CPDO, how out to lunch were they on other products, ones that were far more significant to the markets and the economy, where the absurdity of their assumptions was less-obvious?
How did a market that, I thought, had really helped capitalism work in 2002 become the great destroyer of capitalism of the last two years? There were a lot of contributors to the catastrophe, but one indispensable one is that the ratings agencies monetized their sterling reputations in an extraordinary fashion, and nobody in regulatory apparatus of government saw that this was happening, and what it might portend. The success of 2002 depended on market confidence in the ratings agency process: that’s what made investors willing to buy the notes issued by structured finance vehicles that issued the credit protection that made it possible for banks to hedge. Without that confidence, the market would never have developed. And by 2006, the agencies understood just how much that confidence was worth.
The ratings agencies have an enormous amount of power: pension funds and insurance companies invest according to their rules; under Basel II, bank capital ratios are substantially determined by how the agencies rate their portfolios of loans; and, of course, the entire “shadow banking system” created by providers of super-senior credit protection (monoline insurers, bank-sponsored asset-backed conduits, AIG Financial Products, etc) was only possible because of the ratings agencies. By 2006, the entire financial system was extraordinarily leveraged to the opinions of these government-blessed non-governmental independent agencies, and these agencies were monetizing their market position by trashing their process.
Now, of course, the agencies have radically reversed course. They have completely changed their models, of course. But they’ve also begun to “follow the market”, incorporating credit derivatives swap and equity market pricing into their ratings for companies. If in 2006 the market had, to an alarming degree, delegated its risk-management to the ratings agencies, now the ratings agencies have delegated a great deal of their ratings process to the market. And so the market has lost any reason for confidence in the agencies in both directions: they cannot be trusted when the market is strong to assess the downside risks the market is ignoring, and they cannot be trusted when the market is weak to assess a company’s financial condition independently of the market panic.
This collapse of confidence is having a material impact on the ability of the credit markets to find their footing. I don’t want to minimize the impact of other factors – rates held too low for too long, Wall Street greed, an Administration with an ideological aversion to regulation – but I want to emphasize this one because of its unique contribution to this particular bubble and because I don’t see an obvious solution to it. The old model is permanently broken, and we have not yet come up with an alternative. Right now, we’re in the low-trust environment that is the reality when the libertarian fantasy of eliminating the market-distorting regulators actually comes to pass. The market is inevitably focused on a short time horizon, fickle and volatile by its very nature. We want major financial institutions – banks, insurers, etc. – to look beyond the market to longer term risk metrics. Without the agencies as an independent arbiter of what these might be, the market is all we have left. Trust is a very hard thing to rebuild, and structural changes – having the agencies be government-sponsored, or paid by investors rather than issuers – are insufficient solutions (government-sponsored entities are also capable of seeking to monetize their position – look at Fannie Mae – and investor-sponsored agencies would be subject to the same pressures to facilitate the business that investors want to do).
We are still in a dark wood wandering, the right road lost.
(By the way, “The Right Road Lost” would make a great name for a conservative blog, wouldn’t it?)
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Amazing post. The CPDO structure is (darkly) hilarious.
I’ve been in these kinds of business environments where intuition tells you the whole thing is going haywire, but things are moving so fast and you have so much skin in the game and the opportunity cost of stepping out of it for a while is so huge, that it’s hard to get perspective. Anybody who’s only read about it doesn’t, in my view, understand that decision environment. The only guideline I’ve ever found that mostly works is to always imagine that you own 100% of your business, will never sell it, and that you and your family will live on the dividends you will pay to shareholders out of free cash flow.
— Jim Manzi · Dec 23, 02:11 PM · #
This is a post I’ve been waiting for, Thanks.
— Matt Frost · Dec 23, 05:58 PM · #
Damn, I just got schooled!
There’s a lot of material here, and I’m looking forward to seeing it unpacked in the coming days so we can all understand a little better how we got here.
— Kevin · Dec 24, 01:43 AM · #
“What if you bought a portfolio of investment-grade corporate debt and, every six months, purged it of the bonds that were downgraded to junk, replacing these with new investment-grade bonds. Obviously, you’d expect the downgraded bonds to underperform the remainder of the pool, so you’d have losses you need to make up, so assume you also sell out of a handful of bonds that have done well, and replace these with higher-yielding bonds that are still investment-grade, thus keeping your yield relatively constant. You’d still expect some losses if you wanted to keep your average rating relatively constant, though. So you need some excess yield to make up for these losses.”
This isn’t the CPDOs I’m familiar with. The ones I deal with typically sell 50% Europe and 50% CDX index protection. Where you referring to something else?
— Noel · Dec 24, 09:06 AM · #
Noel: I’ve seen both US and US/Europe variants. But I was really trying to get the concept across mostly rather than match the terms of a particular contract precisely.
— Noah Millman · Dec 24, 09:25 AM · #
Truthfully I’ve only given this article a quick once-over; it’s dense and I suspect it would reward repeated readings.
But does it strike anyone else that what happened here is that the ratings agencies formalized the “greater fool” principle? That is to say, a risky financial product is no longer risky if you plan to sell it quickly?
— kingmob · Dec 24, 09:34 AM · #
This explanation is hugely appreciated, thanks for taking the time to write it. I’ve been trying to wrap my mind around the particulars of the financial crisis since it broke, and I have to say it’s not easy for someone like me who has no background in this kind of work.
— JG · Dec 24, 02:41 PM · #
This is really good, and you should write more like it. I’d read the 10K words on how the credit derivative market spun out of control.
A defense of the ratings agency deserves some order – if it was really them “monetizing their market position by trashing their process”, you’d expect to see a quality creep across all their ratings – corporate bonds BBs become BBB, etc. Perhaps that has happened, but I haven’t heard that argument in much detail.
I think it makes a lot more sense that they just dropped the ball on the models, and that the current techniques of modeling needed to do things (massive moral hazard on lenders, multiple counterparties, liquidity) they may not be able to do very well.
As for the CPDO, I think that it was an coding error on their part. A bug, not a feature. That is a scary thing – your model is fine but someone messes up a line of C++ code and suddenly you are getting the wrong values. That that line of code can destroy a large part of the economy is another odd feature of late capitalism.
From a lefty point of view, there’s a cool argument that the ratings agencies act as a de facto IMF on our cities – their power to determine debt quality of municipalities, and their efforts to push gentification-friendly neoliberal austerity measures on urban cores – have remade a lot of the sphere we live in, and that isn’t discussed much. They are getting sued on these measures – I’d hate to be the guy who has to defend Hartford being rated 2 notches less than a CDO!
Happy Holidays to the whole TAS crew!
— rortybomb · Dec 24, 03:18 PM · #
re. CPDOs, a coding error may have caused part of the problem, but using normal distribution for the underlying was, IMO, a bigger problem
http://www.noelwatson.com/blog/PermaLin ... ab805.aspx
— Noel · Dec 24, 04:12 PM · #
re: Levi processes; True story. I was with my girlfriend – an ethnomusicologist who doesn’t know the difference between a stock and a bond – at a bookstore, and picked up a copy of Øksendal “Applied Stochastic Control of Jump Diffusions”, and flipping to the portfolio theory stuff, I pointed at the series of equations and said “Don’t worry about the global economy, next time capitalism is going to do it with these equations instead of the old equations. We’ll add this n(t) part here.”
The look of shock and awe on her face was priceless. In part because she suspected the argument – “don’t worry about what seems to be a collapsing hegemonic order – we are fixing it with additional integral signs as we speak” – gets argued a lot.
— rortybomb · Dec 24, 04:38 PM · #
“Nel Mezzo del cammin di nostra vita mi ristrovai per una selva oscura, che la diritta via era smarrita”
I have never thought I could get this emotional on a technical subject. The Enron and WorldCom racontto was brilliant. The promise so reacheable, the fall so hard.
“Salimmo sú, el primo e io secondo, tanto ch’i’ vidi de le cose belle che porta ‘l ciel, per un pertugio tondo”
— PlanMaestro · Dec 25, 02:51 PM · #
You are more optimistic than me.
You see an illiquid system with problems that created a crisis in confidence, while I see those same problems having created an insolvent system, for which the current lack of confidence is justified.
— Matthew G. Saroff · Dec 25, 03:27 PM · #
Good article. You mention as one of the errors a lack of regulation, yet part of the problem seems to have been Basel II and its codification of trust in rating agencies.
So I wonder: what sort of regulation did you have in mind here? What rules were missing?
— Tom · Dec 25, 08:57 PM · #
Great article and a public service, thanks so much. I did find a little dense for even an informed non-finance guy to read. For example, this:
<i> And credit derivatives made it possible for companies like AIG to leverage their AAA credit ratings to acquire enormous nominal amounts of purportedly loss-remote credit risk and leverage this risk hundreds of times without any regulatory body being aware of their activities, </i>
does this mean that, for example, AIG used its AAA rating to write a like of insurance on other peoples debt, thus raising that debt to share AIG’s AAA rating, and then was able to borrow money using that insurance (I’m understanding credit default swaps as a form of insurance here) as collateral? Was it actually easy to use credit derivatives like CDSs as collateral for further credit? How did that work?
— MQ · Dec 26, 12:16 AM · #
My vague impression is that the ratings agencies first became corruptible in the 1970s when two things happened:
- They switched their basic business model from being paid by buyers of bonds to being paid by issuers of bonds. That incentive structure creates an obvious conflict of interest.
- The government started writing them into legislation, making them a legally-mandated quasi-cartel.
The perhaps surprising thing is that they didn’t get corrupted for several more decades. But, that long period of good behavior created an assumption on the part of the markets that just because they hadn’t allowed themselves to be corrupted by their incentive structure so far, they never would.
— Steve Sailer · Dec 26, 05:36 PM · #
The big question I have is:
Why was the world broken not by complicated novelties like the CPDO described above, but by a relatively venerable product — the mortgage-backed security, which is based on something that’s not esoteric at all: the home mortgage?
— Steve Sailer · Dec 26, 05:40 PM · #
And what about the intellectual bankruptcy of the business schools? Economists have been training financial gamesmen for decades, and this is the logical outcome of putting graduates of lectures without sense or connection with reality in charge of designing new instruments.
And of course these interaction of this with the rampant grade inflation that is threatening to drown our school systems cannot be overlooked.
— John Toradze · Dec 28, 10:58 PM · #
Great article. Thanks.
— Dan · Dec 29, 02:12 PM · #
Very nice Blog! Blog is very good!
— spódnice · Jan 6, 06:32 AM · #
Commenting is closed for this article.
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The PORTAL Alliance Could Be the Destruction of Our Economy and We Don’t Even Know What It Is
February 12th, 2009 | Category: Investing, Politics
Bailout, Rescue Plan, Stimulus Package, Toxic Assets, Subprime Mortgage Crisis and Bad Banks are just a few of the buzz words the financial media has filtered to the American public over the last year. On a daily basis CNBC, CNN, FOXNews, and many other media outlets continue to tell us about the “unprecedented” financial times in which we are living and what may have caused this disaster. There is something that they left out that may very well be a huge part of the entire financial disaster: the PORTAL Alliance.
The PORTAL Alliance is “an open, industry-wide platform for the offering, trading and centralization of information in privately placed 144A Securities.” The founding members of the PORTAL Alliance include:
Bank of America - BAC - down 86.65%
Barclays Capital - BCS - down 84.31%
Citi - C - down 89.89%
Credit Suisse - CS - down 53.42%
Deutsche Bank - DB - down 75.87%
Goldman Sachs - GS - down 54.77%
JP Morgan - JPM - down 38.1%
Merril Lynch - bought out by BAC
Morgan Stanley - MS - down 57.57%
UBS - UBS - down 73.03%
Wachovia Securities - WB - down 86.37%
Does anyone else find this list to be the who’s who of financial fall outs on Wall Street? What makes this even more interesting is the fact that this “open platform of trading” was created in November of 2007. To help illustrate how poorly this group of institutions has performed over the period of time since the inception of the PORTAL Alliance, the stock performance of each security is listed.
NASDAQ’s Chief Executive Bob Greifeld made the statement “We’ll have great growth stats in the years to come with respect to the volume of trading.” Well, Bob, little did you know that the opposite would happen. Is it possible that creating this alliance to trade $100 million investable assets amongst themselves is a large part of this economic crisis? Why has there been no media coverage on this topic?
We will dive deeper into this subject in the days ahead…
Will The Last Honest Bank Please Stand Up?
Government Bailout Up To $8,500,000,000,000. Didn’t See That One Coming!
NASDAQ in February of 2000
""We're near the cliff's edge, very close to capitulation, the mood is very gloomy," said Jean-Claude Petit, head of equities at Barclays Wealth Managers France.
"I not sure that governments and central banks are realising what's really going on," he said.
What's "really going on" is that our entire financial system has turned into a gigantic clown car. There hasn't been any recognition that the fundamental problem over the last two decades has been fraudulent lending - giving money to people on loan that the lender knows full well has no real chance of being able to pay it back.
The FX dislocations that we've seen over the last few days have perplexed me and in addition been cause for great alarm. This is not without foundation. After much study I think I've figured out what's going on - we are witnessing the capital flight that I feared might happen in some of my Tickers from last year.
These moves are hedge funds and others that are leaving The United States with their money. It is flowing out of the United States.
Nor is this limited to hedge funds - it has become essentially impossible to sell Fannie and Freddie paper overseas now too:
"Feb. 20 (Bloomberg) -- Asian investors won’t buy debt and mortgage-backed securities from Fannie Mae and Freddie Mac until they carry explicit U.S. guarantees, similar to those given on bonds issued by Bank of America Corp. or Citigroup Inc.
The risks are too great without a pledge that the U.S. will repay the debt no matter what, according to Hideo Shimomura, chief fund investor in Tokyo for Mitsubishi UFJ Asset Management Co., and other bondholders and analysts in Japan, China and South Korea interviewed by Bloomberg. Overseas resistance may hamper U.S. efforts to hold down home-loan rates and rebuild the nation’s largest mortgage-finance companies.
The problem is that we can't guarantee these securities. If we attempt it we will literally double the outstanding debt of the United States overnight. This will in turn destroy the bond market, spiking yields higher, which in turn will crush what's left of the credit markets (including and especially housing.)
Policy-makers must understand: This is a confidence problem and they are responsible for it. The people pulling the levers of power, including Bernanke, the OTS, OCC, President Obama and Geithner (and their predecessors, have intentionally and systematically obscured the facts and looked the other way while various people within Wall Street repeatedly misrepresented the quality of the securities they were peddling and, in many cases, the health of their firms. Do I really need to go back and cite "The economy is fundamentally sound" or "I'm going to burn the shorts" again? None of these people have been held to account for their falsehoods by our government and as a consequence the market is doing the job that government refuses to do, with the result being a market collapse.
We as Americans and in fact investors all over the world have suffered trillions of dollars in harm, a consequence that accrued to us as a direct and proximate consequence of the intentional and willful acts of these government officials and "captains of Wall Street."
Now the people with the money are quite literally leaving. They're finished with the liars and games and are taking their ball and going home, voting with their wallets. The damage being done to our capital markets is reaching critical levels and threatens to stoke a positive feedback loop that is nearly impossible to stop.
Should our policymakers not step up and put a stop to the lies and fraud in the immediate future the other actions they are taking will mean exactly nothing. A "mini-crash" of another 20-30% down in the S&P 500 (which would take us into the 600s) will destroy another 2-3 million American jobs and bankrupt hundreds of midsize and large companies, along with tens of thousands of small firms. An all-on market panic, which is looking increasingly likely and may initiate as soon as today, will result in the bankruptcy of 30% or more of the S&P 500 and an unemployment rate that will exceed 15% within the next twelve months on "official statistics", and U-6 numbers above 25% - rivaling The Great Depression.
There is no more time for game-playing. Our policy-makers were not elected to protect the malefactors and fraudsters; they were elected to protect the people.
Confidence has been lost across the board. If our government does not act decisively and quickly to restore confidence, forcing the fraud into the open and prosecuting those involved, along with setting forth a concrete path of action specifically addressing the issue of "nationalization" (in any of its various forms of dress) for financial institutions capital flight will accelerate, our financial institutions stock prices will continue on their trip to zero and our markets will crash.
chiggerbit wrote:What's your take on Geithner, Jack?
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