2008 Global Crisis of Credit: Collapse of Confidence
The seismic rupture and transformative collapse of the financial system appears to be global, but there is no overarching, multi-national, global architecture of governance to deal with it, so we see various attempts to coordinate actions among nations. Financial globalization has lurched way ahead of any effective global regulatory structure. Crashed markets and confidence have spread around the world like a virus, and humans everywhere seem shocked, confused ab out how this happened and what to do about it. Trillions of dollars of worldwide wealth have been wiped out as if an atomic bomb had been detonated. I think of the words from Hindu scripture that J. Robert Oppenheimer uttered on July 16. 1945, as he witnessed the test explosion of the 19-kiloton plutonium bomb at Trinity, New Mexico: “Now I am become death, the destroyer of worlds.”
The shadow banking system of unregulated private equity, hedge funds, money markets and investment banks, which traded in the currency of hyper-leveraged, off-balance-sheet accounting, is collapsing.
Credit Default Swaps Scheme—Is it Theft?
The credit default swaps are insurance policies sold to protect debt against the risk of the debt not being paid off, vehicles through which financial engineers innovated nothing more than jacking billions of dollars out of the taxpayers. Is it fraud when the swappers kept insuring debts with the same risk money over and over and there were never enough funds in reserve to pay off the risks? The swappers sold ”insurance” that they knew they could never pay up because they held insufficient reserves for the leverage, while giving $500 million bonuses to traders at the swap desks.
The Boards of the investment banks and trading floors, whose job it is to oversee risk and soundness, see billions of dollars more than they ever made before but do not ask what is being risked. Their job and fiduciary duty is to look at/moderate risk to be sure that the firm is sound to survive for the long term and is not taking on too much risk. Is it stealing to sell insurance on something you could never afford to pay for if defaulted? When financial wizardry creates chimera in place of the wealth that institutions count and are built upon, and it threatens the whole financial system, is it theft and conspiracy to defraud? The American people know there is a scam and that is why they opposed the bailout. They know that the hoodwinking financial engineers of Wall Street manipulated hundreds of billions of dollars of risk off of their balance sheets and onto the taxpayers’ balance sheets while disappearing the hundreds of billions of dollars of bonuses into their own pockets, leaving behind with deft sleight of hand mere illusions of wealth in the form of worthless IOUs.
Remember that great scene in Casablanca when Claude Raines as Captain Renault is forced to close down Rick’s Café Americain? When Rick asks him why, he declares, "I'm shocked, shocked to find that gambling is going on here!" Without missing a beat, a waiter walks up to Raines, hands him a bunch of chits, and says, "Your winnings, sir," to which Raines graciously replies, "Oh, thank you."
The Social Engineering
Mortgage brokers didn’t care if borrowers were strong enough to repay, because they sold off the mortgages to Fannie Mae & Freddie Mac, the government supported enterprises (GSEs), who sold them to Wall Street, who repackaged and sold the toxic paper around the world. The ratings companies who rated the bonds were paid by the Wall Street bond insurers. Then the bad loans were bundled as collateral to borrow even more money----leverage on leverage.
The subprime mortgage debacle is really a scandal of Washington & New York. Going back to Clinton’s policy in the 1990s that everyone should own a home, and continuing through Bush’s “ownership society,” Congress has pursued the reckless and corrupted policy of affordable housing that got people into mortgages they cannot afford to keep. With the refusal of Congress to exercise oversight, many others (including McCain) issued alarmist warnings concerning the risky sub-prime mortgages and over-leveraged balance sheets of the GSEs. By then, though, long before they were taken under conservatorship, the question had become, did Fannie & Freddie control Congress, or did Congress control them? The ardent supporters of “affordable housing” for “poor people,” such as Barney Frank, Chris Dodd, Charles Schumer, and later Barack Obama, were bathed in campaign contributions by the GSEs. When the accounting scandals broke in 2004 everyone saw that Fannie & Freddie were cooking the books, and their CEOs pocketing huge multi-billion dollar bonuses, it was obvious that Fannie & Freddie were skeetering into insolvency, but Frank, Schumer, and other Congressional members resisted reform, and their political support protected Fannie & Freddie while they spread around political contribution to buy off our elected representatives. The ultimate collapse of the sub- prime housing market engineered by Congress and the GSEs triggered the cascading credit crisis and ultimate global loss of confidence in the credit markets---by then, the bad mortgages had been bundled, sliced, diced, re-aggregated, then sold to a world hungry for yield, served up garnished with a dollop of fake credit swap insurance against default! How can the world not be furious with the United States? Who could ever trust us again as leader of the world, financial or otherwise? Too smart by half.
Credit Markets in Distress—Geoeconomics
(The following in part incorporating comments by Jeffrey Sachs, Sebastian Mallaby, Fred Bergsten & George Soros):
America, as the center of the globalized financial market, had gotten into the habit of consuming 6 to 7 percent more than we are producing. We were sucking up the savings of the world--China and other nations buying Ame rican bonds. That game is finished, and it means a serious process of financial readjustment for America, a painful deleveraging of our balance sheets. Now, we will have to save more, and live within our means. The housing bubble has detonated the entire financial system built of super leverage & financial engineering, where credit was substituted for actual wealth. That Ponzi-scheme construct works only as long as everyone believes in it and has trust, and when confidence collapses, when everyone sees that the emperor has no clothes---the false construct vaporizes. The credit markets are in distress, a financial crisis with wide geopolitical or geoeconomic effects. We are witnessing the de-Americanization of the global financial system and loss of America as the center of finance.
In many ways, this brings home the decline in America's position in the world, because we have over-consumed. The Chinese have produced a lot more than they consume, so they built up reserves. We built up debts; they built up assets. We have exported our wealth abroad, to the oil-producing countries, and exported our jobs and industrial base as well. So, there has been a tremendous power shift. The flow of wealth that had kept this country strong is now a river of debt. The irony is not lost that we outsourced in order to squeeze more corporate profits, yet it left us poorer.
We've gone beyond simply a problem that reflects a busted property market, the fact that banks have holes on their books. We've even gone beyond the effects of deleveraging, which were bound to be inescapable. We've gotten into a complete, blind panic of confidence, where no one will lend to anybody.
The Closure of Lehman Brothers
The Fed made a bad mistake in how it handled the Lehman Brothers closure, by not protecting the short term paper. By allowing it to go worthless, it broke the money market, which broke the confidence in the system. Now banks won’t lend to each other because confidence has dried up. This is the big tactical blunder the Fed made in this crisis. Even if they had let Lehman go under, they could have protected the short-term money market paper, which they didn't do. The shareholders could have lost; the owners of longer term debt to Lehman could have lost. But by let ting the short-term paper go bad, that broke the money markets, and that in turn created the panic. And that was a tactical blunder of tremendous significance.
Since then, they've been scrambling with everything they can think of, lending in every which way. The bailout plan emerged two days after the Lehman mistake. And so, they're trying still to calm what is now an outright panic.
The Coming Recession
Even if the Fed succeeds in calming the markets, that won't stop a recession. It won't solve the bank recapitalization problem. It won't solve the problem of households that are at the limit of debt and can't repay their mortgages. The structural imbalances are real, and will mean that the U.S. economy goes through a significant recession and a lot of pain as it restructures. Many businesses will fail and jobs will be lost. But what is most important right now is to stop the panic, because that's seizing up day-to-day economic operations.
The era of big tax cuts, whether for stimulus or other things, are over. We're going to have to grow up and understand that we need taxes to pay for basic government services. We've been neglecting that for a long time. We've been in fiscal unreality even before the crisis. Now the crisis is going to make all of this more dramatic. We'll have large budget deficits. We're not going to let our roads, bridges, infrastructure collapse. We're not going to let our energy grid collapse. We're not going to let our schools and health care completely collapse. We're going to have to pay for those things. That's the difference. And the way you pay for it, basically, is higher taxes.
We've been trying to run a government on about 17 percent of national income in taxation ever since the Reagan era came in. It's been a myth all the way along. We've been borrowing heavy amounts all through the period. You can't squeeze government when you take into account Social Security and Medicare, Medicaid, military, the interest on the debt. When you see all the other things that we care about, the quality of our lives, all squeezed into a tiny little amount, which is what has happened for almost 30 years now, we've run out of that game.
So, this is not only a financial crisis, it's the end of the Reagan era. It' s time to grow up again and understand that we're going to have to pay taxes and that from there, we're going to have to use those revenues for the things that count: health, education, infrastructure, energy. This is not an invitation to ignore our future, it's an invitation to start thinking seriously about it again.
External Finances
The other element to add to the unsustainability of our current situation is that the foreigners have actually been paying, at the margin, most of the increase in our national borrowing. We've been borrowing half-a-trillion dollars or more per year from the rest of the world for the last five to 10 years. That means the United States is now the world's largest debtor country.
Part of the pressure on the government here and the Federal Reserve to deal with our financial crisis has been the fear that our foreign creditors would bail out of the dollar, start dumping dollars. Fortunately, they have not done that. But we have to retain their confidence even more than we have to retain confidence at home, because we put ourselves in the position of being in hock to the world. That can't go on. We can't increase that further. We can't put ourselves more in debt to the rest of the world and lose control over our own destiny. So, for that reason, as well, we've got to get real, get our fiscal house in order.
The United States government goes out to the market and externally finances-- asks foreigners to buy--about $4 billion of IOUs every day. If foreigners buying these assets. don't have faith in the credibility of American Treasury bonds or other financial assets (private debt issued by Wall Street on behalf of companies, including a lot of securitised mortgage assets) they will stop buying U.S. debt. In the past, foreigners have bought this debt because they believed in the institutions on Wall Street. They believed in the credibility and transparency of American financial regulation. Now that that credibility has been exploded, will the foreigners continue to finance American borrowing needs? We are vulnerable when we rely on governments, who have made a political decision to lend America money, that those same governments could make a new political decision to stop lending America money. We have risked putting ourselves into a position where we have a foreign policy liability. If China, which holds a lot of American debt, decided to sell it or to switch the debt into some other dollar instrument - for example, the equity market -- it could disrupt our capital market, inflict a lot of pain on us.
Even if the Fed succeeds in calming the markets, that won't stop a recession. It won't solve the bank recapitalization problem. It won't solve the problem of households that are at the limit of debt and can't repay their mortgages. The structural imbalances are real, and will mean that the U.S. economy goes through a significant recession and a lot of pain as it restructures. But what is most important right now is to stop the panic, because that's seizing up day-to-day economic operations.
The End of Reaganomics
McCain is going to lose the presidential election because he stands for a philosophy that is broken and that has brought this country down to its economic knees. I have admired McCain for his years of principled and tough courage, and feel sorry for him because he does not get that his era has crashed with the financial system; he fights on instead of packing it in. He will lose because the age of Reaganomics is over; it is exhausted. The no-regulation, low-taxes practice has broken the back of our economy. Reagan, Margaret Thatcher, the apocryphal idea of the magic of the marketplace; when they came to power in 1980, this belief became the dominant creed, and then led to the globalization of markets, the deregulation of markets and the increased use of leverage and all the financial engineering. Around the world, unfettered markets upheaved, devoured & monetized a huge amount of the Earth’s resources, produced an overwhelming quantity of unneeded products and trash, and did not promote the greater good. Way too much junk wasted diminishing and precious fossil fuels. In the United States, we produced nothing, but put our trust in the reprobate money changers of Wall Street who manipulated balance sheets and hollowed out the economy, bankrupting the financial system while pocketing huge profits, free-market style. A low point in shameful human behaviour for sure.
Now, we have to again get serious about reconstructing normal government that pays its way and a normal financial sector that is properly regulated. The threat we face right now is in the world of geoeconomics, not geopolitics ---how to get through this financial meltdown, how to handle the multiple economic challenges before us, how to steer America in a world where other countries are gaining economic power and resources and confidence.
Our blunders with excessive leverage causing a meltdown in global financial markets will have transformative consequences for United States: The loss of Untied States as the preeminent financial center of the world (the U.S. investment banks vaporized in a nanosecond), and in the final verdict, the dollar will no longer be the reserve currency of the world
The End of Credit Expansion & Ever-Increasing Leverage
It is not just the federal government. Every household, every city, every county, every state in America has wanted things it was unwilling to pay for. And it made up the difference by borrowing in an era of cheap credit. We wanted larger houses than we could afford, more TVs, more laptops --- more of everything. And we did it all by racking up debt.
It's not just America. Around the world. Britain, Spain, Ireland, other over-leveraged societies have all faced the same problem. We've run our companies, countries, households on principles that just didn't make sense. In all venues, leverage was miscounted for wealth, and the nation, and households, are broke. Now, a reordering of our attitude about debt will ask us, just how much stuff do we need and how large do we need to live? How much wealth do we need, how much do we need to spend, and at what cost to the sustainability of the planet upon which all species depend?
We'll have to change, and it will mean deep and wrenching pain, probably a tough recession. But in the end, it will make for a more robust American economy and a stronger global system. The house of cards is collapsing. But there is an opportunity here to build a house of bricks instead. In the reconstruction, we will need fewer financial engineers and more electrical, chemical, and civil engineers.
A Chance for Other Kinds to Survive?
As we reduce consumerism relative to the growth of the economy so as to not be dependant on foreign capital, there is also an opportunity to take honest stock of what our rampaging consumerism has wrought upon the planet Earth, and to choose to shrink our impact, retreat our assault. As we detox from our four-decades long binge of obscene consumerism, positive consequences could be released. If we shrink consumption to what we really need to live, and make those things last the lifespan, we could significantly conserve the precious and finite natural resources and materials gobbled up in the manufacture and transportation of unnecessary goods. Living modestly with less should arrest the relentless incursion to seize more of the earth’s surface to reconfigure for our purpose, and to destroy more & more of the natural and wild habitats of other species whom we have pushed to the edge of extinction by ravaging their homes, raiding their land, and deforesting the earth. We can choose this way as the human way on Earth, trying to make the smallest footprint instead of the largest.
Maybe we humans could even disappear off the face of the earth without a trace, so that they, the innocent and truly magnificent creatures could survive, as more than handbags rugs, and fur coats.
Recommended:
Andrew Bacevich, The Limits of Power
Kevin Phillips, Bad Money
Bill Bonner, Empire of Debt
Pete Petersen, Running on Empty
I.O.U.S.A
Jeffrey Sachs, Common Wealth
Jared Diamond, Collapse
Mathew Scully, Dominion
Paul Ehrlich, The Dominant Animal
Fareed Zakaria GPS, CNN October 12, 2008
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