December 30, 2010
February 20, 2009
The lastest from Dr. Michael Hudson
Finance Capitalism Hits a Wall
The Oligarchs’ Escape Plan – at the Treasury’s Expense
By Prof. 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.
February 18, 2009 "Global Research" -- - 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% 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% 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 like rats fleeing a sinking ship. 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.1
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 autumn’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% 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.2 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 of these renegotiations of $100,000 each. 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 danger is 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.
U.S./post-Soviet Convergence?
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% 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.
NOTES
1 Ambrose Evans-Pritchard, “If Eastern Europe falls, world is next,” The Telegraph, February 14, 2009.
2 Krishna Guha, “US closes in on subsidy plan to stop foreclosures,” Financial Times, February 13, 2009.
© Copyright Michael Hudson, Global Research, 2009
February 03, 2009
November 18, 2008
Solution to fiscal crisis by creditory economists
Productive Financial Heresy
How to Fix the Banking System and Ensure Employment Now
Open Letter to All Political Leaders from Creditary Economists
The present proposals to solve the current crisis mainly include interest reductions and loan based fiscal stimulus, and some belated limitations on speculation.
These ‘solutions’ will not function; not in the short term and not in the long term.
They will fail to invigorate the banking system and also add to the public debt burden.
The ‘solutions’ are based in a lack of understanding of the how the financial systems works.
We will try to explain why, and how to solve the problem.
A solution, put shortly
Some 98 % of credit in the financial system is normally created privately by banks etc..
The immediate solution must therefore ensure that the private credit system again will create credit. This is done simply by letting governments print new money to buy rotten debt and finance fiscal stimuli for productive purposes. This will not cost tax-payers anything, nor will it produce inflation.
A longer term solution is to establish credit channelling, guiding credit to productive purposes and thereby limiting non-productive speculation. This will reduce both consumer price inflation and also limit asset inflation, reducing the risk of credit bubbles.
Criteria
In response to the current crisis, the world needs
(1) an efficient, and socially just way of stabilising economies and employment, and
(2) a mechanism to reduce the frequent recurrence of banking crises and significant economic cycles, with all their costs, distortions and injustices.
Any proposal must meet these two criteria. The proposals aired hitherto in the mainstream media fail. Here is an outline of a proposal that passes.
First, we need to understand:
The credit creation’ process:
Empirical research shows that close to 98% of the money supply is not created by central banks or governments, but by privately-owned commercial banks and other financial institutions.
Furthermore, there is no such thing as a ‘bank loan’. Banks do not mainly lend ‘old’ money from deposits belonging to customers. Instead, banks are allowed by the regulatory framework to create new money out of nothing. This process is called ‘credit creation’. After initial requests for credit from the public, the bank staffs then determine how much money is created, who gets the newly created money and they also see what it is going to be used for.
The only institutions that have both the knowledge and the power to interfere in this process are the central banks.
Projects are evaluated by the banks according to potential (in) security and gain, and it is normally assumed that the decisions made by banks will be the best possible.
Unsound banking
The current crisis has once again demonstrated that indeed we can not always expect banks’ credit decisions to be beneficial, for the overall economy or social welfare. Apart from creating ‘innovative’ and speculative financial instruments, the incentive structure at banks tend to create too much credit, when not needed, and in the large for unproductive use, thereby also stimulating inflation.
And again, we now see that this is followed by banks creating too little money, when precisely more would be needed.
How to End Banking Crises and Severe Economic Cycles
Productive vs. unproductive credit creation
There are some simple rules for sound banking and sound economies:
Whenever credit is created and used for productive purposes, to increase the amount of goods and services provided, it will be non-inflationary and wealth promoting: More money comes about, but also more goods and services.
Whenever credit is created and used for unproductive purposes, inflation comes about: more money chases limited goods or assets. The unproductive credit creation can take two forms: When credit is extended for consumption, it will result in consumer price inflation.
When credit is extended for ‘non-productive’ transactions (meaning financial and real estate transactions) , there will be inflation in these markets; asset inflation.
Both cases are unsustainable and if sufficiently large, result in banking and economic crises.
Credit channelling against bubbles and depressions
To prevent banking crises, the bulk of credit creation must be guided to productive purposes. Specifically, aggregate bank credit for transactions that are not directly productive (something that can be easily verified by loan officers) needs to be monitored, and suppressed when it rises in excess of overall bank credit growth.
This simple measure would have prevented the recent credit bubbles, which have now burst and caused crisis. It would also have prevented depressions, such as in Japan since 1990 or internationally in the 1930s.
Such credit guidance differs from commando economics and ‘dirigisme’, but corresponds well with proposals from Nobel laureates such as Ragnar Frisch’s Channelling Model, a Quality Theory of Credit, and ideas initiated by J.M. Keynes in 1946
Deregulation abolished ‘credit guidance ‘
Central banks used to monitor credit usage, but in the wake of financial deregulation most abolished their ‘credit guidance’ policies and instead let go unproductive bank credit expansion. Accompanied by excessive speculation in ‘innovative’ financial instruments, this once again caused bubbles of ‘asset inflation’.
Where Were the Regulatory Authorities?
We need to ask why those institutions that could have prevented the bubbles and thus the current bust, failed to do so, although they had expressly been given unusually strong powers: The central banks (and the Banking, Insurance and Securities Commissions) .
This suggests that the very independence and lack of accountability of central banks has been a major factor in allowing the creation of credit bubbles and the propagation of the current crisis. Not only have private banks failed, but also the central banks have failed, not despite, but perhaps because of their excessive independence.
Thus central banks should be made far more directly accountable to democratically elected assemblies and their independence reduced.
Furthermore, it is doubtful that the private ownership of The Federal Reserve by the Wall Street banks is socially optimal.
Modern Money Creation
More profoundly; the archaic system of money creation by unaccountable privately-owned commercial banks is dubiously beneficial. Today, technology allows more efficient, transparent, and harmonious systems of money creation, for instance directly through the government, which would ease a framework. Such a system of money creation would reduce national debt.
The above are key long-term lessons.
Current policies will not help
What are the immediate measures to end the current crisis and avoid large-scale unemployment? Just like the Japanese government in the early 1990s, governments have responded by increasing fiscal expenditure, funded by borrowing, and central banks have responded by lowering interest rates.
However, neither will help:
The privately-owned creators of the bulk of the money supply are seeking refuge; in their increased risk aversion they will continue to reduce credit creation. Just as their excessive credit creation affects us all, so does their reduction of credit.
Fiscal expenditure as such does not create credit, but also depends on how this is financed. By borrowing the money for public fiscal stimulation, the same money is removed from the private economy through bond issuance. Thus fiscal policy, if not backed by new credit creation, will crowd out private demand and the stimulus is ‘sterilised’. Furthermore, national debt is increased by this policy, which places an unfair future burden upon tax payers.
And lower interest rates will not help – even if they drop to zero – if the quantity (NB!) of credit does not increase. This is why Japan will soon be in the twentieth year of recession after its own credit bubble burst in 1990.
The solution is simple
For productive economic growth, new credit creation is necessary.
Fiscal stimulation, in the form of purchases of non-performing assets from banks, and public purchases of bank equity, should be funded either by the issuance of ‘new’ government money, by the governments’ Treasury or, by the central banks. In both cases, national debt and interest liabilities will not increase, but credit creation will.
Growth will hence not collapse.
This also makes sense from a moral hazard perspective:
Tax payers are not responsible for the current mess, but the central banks are – so let them pay, by issuing new money. As explained above this will not create inflation, nor will it put new burdens upon tax payers.
Conclusion repeated
The immediate solution must therefore ensure that the private credit system again will create credit, by letting governments print new money to buy rotten debt and finance fiscal stimuli for productive purposes. This will neither burden tax-payers nor produce inflation.
A longer term solution is to establish credit channelling, for productive purposes. This will reduce consumer price inflation and limit asset inflation, reducing the risk of credit bubbles.
October 07, 2008
Reminder WHY there is a banking crisis: Dr. Michael Hudson
The Big Bank Job
The Insanity of the $700 Billion Giveaway
By Dr. Michael Hudson
Sept. 25, 2008
The banksters’ plan now is for icing on the cake – to take Mr. Paulson’s $700 billion and run. It’s not a “bailout of the financial system.” It’s as giveaway – to insiders, to sell out all their bad bets. Companies across the board will get rid of their bad mortgages, and also their bad car loans, furniture time payments, credit-card loans, student loans – all the debts that any competent actuary could have told them never could have been paid in the first place.
This is not what Treasury Secretary Paulson is acknowledging, and shame on him for it. Last Friday, Sept., he was joined by Fed Chairman Ben Bernanke singing in unison an advertising jingle for America’s new kleptocracy that rings so false that Congress and the American public must hear the off-notes. London’s Financial Times, as well as a host of Europeans realize it. That is what has been driving the dollar’s exchange rate this week. It seems easier for foreigners to recognize the threat to turn American democracy into a rapacious kleptocracy.
This change always is sudden, arranged under emergency conditions. Those with a 12-year memory will see George Bush as playing the role of Boris Yeltsin in Russia in 1996, paying off his campaign contributors by giving them all the economic surplus that the government could expropriate in the notorious “loans for shares” plan applauded and supported by Clinton Treasury Secretary (and current Obama advisor) Robert Rubin. (The moral: do we have a Putin in our near future to lock in the anti-democratic coup?)
How ironic all this is! Back in the 1970s there was theorizing that the Russian and American economies were converging. The idea was that both were moving toward more centralized state control, state financing, state subsidy, and a military-industrial complex. Nobody expected the convergence to occur Yeltsin-style in government giveaways to insiders to create a new group of financial billionaires – the “seven bankers” under Yeltsin in 1996, and Mr. Paulson’s Crony Capitalist gang today.
Let’s look at the euphemisms as an exercise in doublethink. Mr. Paulson defended his “troubled asset relief program” (TARP) by claiming that “illiquid mortgage assets … have lost value … choking off the flow of credit that is so vitally important to our economy.” The credit that is “so vitally important” has taken the form of bad loans. Contra Mr. Paulson’s pretense, the problem is not that they are “illiquid.” If that were the problem, it would be merely temporary. The Federal Reserve banks are designed to provide liquidity – on good collateral, of course.
As Financial Times columnist Martin Wolf noted on Wednesday, Sept. 24, the problem is that the face value of mortgage loans and a raft of other bad loans far exceeds current market prices or prices that are likely to be realized this year, next year or the year after that. They are packaged into what the financial press rightly calls “toxic.” The bailout is not efficient, he writes, “because it can only deal with insolvency by buying bad assets at far above their true value, thereby guaranteeing big losses for taxpayers and providing an open-ended bail-out to the most irresponsible investors.”[1] “The simplest way to recapitalize institutions,” He concludes, is “by forcing them to raise equity and halt dividends. If that did not work, there could be forced conversions of debt into equity. The attraction of debt-equity swaps is that they would create losses for creditors, which are essential for the long-run health of any financial system.” This is the key: if debts cannot be paid, then creditors must take losses.
These bad loans are toxic because they can only be sold at a loss – if at all, because foreign investors no longer trust the U.S. investment bankers or money managers to be honest. That is the problem that Congress is not willing to come out and face. Many of these loans are outright fraudulent. And they are being sold by crooks. Crooks who work for banks. Crooks who use accounting fraud – such as the fraud that led to the firing of Maurice Greenberg at A.I.G. and his counterparts at Fannie Mae, Freddie Mac and other companies engaging in Enron-type accounting.
This is not what the magic of compound interest promised. But it is where it had to end up, with mathematical inevitability. It was an advertising come-on for Wall Street money managers and promoters of “pension-fund capitalism” (or “peoples’ capitalism” as it was called in Chile by the Chicago Boys working for General Pinochet’s murderous regime, and Margaret Thatcher’s Conservatives in England). The promise is that if people consign these funds to individuals who make much, much more than they do but have the survival-of- the-fittest advantage of being much, much more greedy, they will receive a perpetual doubling of interest. That is how retirements for American workers are still supposed to be paid – by magic, not by direct investment. Prospective retirees are supposed to ensure a good life by investing savings in loans to corporate raiders who fire, lay off, downsize and outsource these very workers. The trick is to persuade employees to hand retirement funding over to financial managers whose idea was to make money off the economy by extracting interest and dividends off workers, homeowners and companies being bought on debt leverage. In the final analysis it is debt leverage by itself that is supposed to fuel capital gains.
This has led to madness. The maddest solution of all would be for the government to give the extractive financial sector even more money – funds that no private lenders have been willing to provide, not even vulture funds. No private firm has been able to discover what Mr. Paulson and the unfortunate Mr. Bernanke are sanctimoniously promising: that a viable deal, even an almost money-making one, can be made by buying junk now and waiting for “the economy” to make it good.
Just what is “the economy” that is supposed to perform this remarkable feat, if not its mortgage debtors and corporate debtors? The government is to do what law enforcement officials have moved to prevent Countrywide Financial and other predatory lenders from doing: squeezing exploding Adjustable Rate Mortgages and “negative equity” mortgages out of debtors, on terms that often were bait-and-switch to begin with. Private companies could be challenged and their array of penalty fees thrown out of court. But perhaps Congress can craft a law imposing these harsh terms on voters. It is not as if we live in a system where people vote their self-interest.
Promises that “taxpayers” will be able to recover a large part of this money are a fiction. If there were a hope of recovering this money, then investors abroad – foreign buyout funds, foreign banks, foreign sovereign wealth funds – would have been willing to buy Bear Stearns, Lehman Brothers, A.I.G. and other companies at some price. But they wouldn’t touch this at any price.
Why then should the U.S. Treasury pay three times as much as the Iraq War for money that will end up being lost after paying off the gamblers from their own bad bets. These are the bankers who already have placed all the risk onto their clients and, by lobbying to rewrite the bankruptcy laws, onto debtors. As matters now stand, the $700 billion is to be used to finance this year’s annual bonuses, this year’s million-dollar salaries and sales commission, and to contribute yet more to the retirement funds for the golden parachutes that financial managers have siphoned off to provide a safety net for themselves. So we are back to the basic motto these days: “You only have to make a fortune once in a lifetime.” Now is the time to make these fortunes as big as they’re going to get. Because it’s all down hill from here.
Why the banks won’t lend
Here’s why the government giveaway logic is fallacious: It’s a giveaway, not a bailout. A bailout is designed to keep the boat afloat. But the existing Wall Street boat crafted by the investment bankers seeking to unload their junk must sink. The question as it sinks is simply who will be able to grab the lifeboats, and who drowns.
There is a reason why the banks won’t lend: Housing and commercial real estate already are so heavily mortgaged that there is no rental value available (over and above operating expenses, current taxes and debt service) to pledge to the banks. It still costs more to buy a house than to rent it. No increase in the amount of credit, short of hyper-inflation can cure this. No lowering of interest rate, will lead banks to risk making a bad new loan – that is, a loan that probably will go bad and end up with the bank taking a loss after the borrower walks away or defaults.
Does Congress know what it is being told to do? Suppose that “taxpayers” are to squeeze money out of the “toxic” junk mortgages they buy from the investors that have bought these bad loans. The only way to do so would be for real estate prices to be raised to even higher levels. This means an even higher proportion of take-home pay by prospective homeowners.
Mr. Paulson realizes this. That’s why he’s directed Fannie Mae and Freddie Mac to inflate real estate prices all the more. At least, by the existing mortgage-holders to get paid off by existing debtors selling to the proverbial “greater fool.” The hope in Mr. Paulson’s plan is that there are enough “greater fools” with enough money to borrow from yet more foolish new mortgage lenders. Only Fannie Mae, Freddie Mac and the Federal Housing Agency are willing to make such foolish loans, and that is only because they are being directed to act in a foolish way by Mr. Paulson.
Here’s the problem with following Mr. Paulson’s orders and lending yet more: Every major real estate advisor on record has forecast a further drop of between 20 to 30 percent in property prices over the coming twelve months. This is now the standard forecast. It means that over and above the five million arrears and foreclosures that Mr. Paulson acknowledged already are on the books, yet more families are to give up the fight by this time next year. Is the $700 billion giveaway fund to try and recoup by evicting them too from their houses – to pay the “taxpayer” enough to bail out Countrywide, Washington Mutual and other predatory lenders for loans that state Attorneys General have accused of being fraudulent?
For the government to even begin to recover some of the value of the $700 billion in junk mortgages it has bought would force new homebuyers to pay even more of their income to the banks. And if they do that, they will have less income to spend on goods and services. The domestic market will shrink, and tax revenues will fall at the state, local and federal levels. The debt overhead will deflate the economy, causing shrinkage all down the line.
So here’s where the cognitive dissonance comes in: It is necessary, even inevitable, for the volume of debt to come down – not up – to restore equilibrium. The economy was well on its way to preparing the ground for this last week. As Alan Meltzer of the American Enterprise Institute (of all places!) explained on McNeill-Lehrer, Merrill Lynch was able to be sold at 22 cents on the dollar; and the economy survived Lehman Brothers and Bear Stearns being wiped out.
Such debt writes-offs are a precondition for writing down America’s mortgage debts to levels that are affordable. But Mr. Paulson’s plan is to fight against this tide. He wants the Wall Street to keep on raking in money at the expense of the economy at large. These are the big banks who lobbied Congress to appoint de-regulators, the banks whose officers paid themselves enormous bonuses and gave themselves enormous golden parachutes. They were the leaders in the great disinformation campaign about the magic of compound interest. And now they are to get their payoff.
The pretense is that not to pay them off would threaten “the economy.” The reality is that it only would stop their predatory behavior. Worse than that, for the economy at large a government take-over of these bad loans would prevent the debt write-down that the economy needs!
It gets worse. If Congress should be so destructive as to buy out $700 billion of bad loans (for starters), the sellers will do just what Russia’s kleptocrats did. They will take their money and move it abroad to a “hard” currency country. This will help collapse the dollar. Up will go gasoline costs and prices for other imports. America will be turned into a Russian-style post-Soviet economy, having endowed a new domestic kleptocracy of insiders, who use some of their gains to finance the campaigns of American Yeltsins such as McCain.
So let us admit that the economy has been taking a wrong track for a number of decades now. As John Kay noted : “When the dust settles, many banks and hedge funds will have lost more money on their trading activities in the past year or so than they had made in their entire history … The pursuit of shareholder value damaged both shareholder value and the business.”
I worry that Wednesday’s jump in the Dow Jones average signals that the big betters have decided that there is a good chance of the vast giveaway going through. The Republican protests seem to me to aim not so much at really stopping the measure, but on going on record that they opposed it – before they voted for it. When the public wakes up to the great giveaway, the Republicans can say, “It was a Democratic Congress that did it, not us. Read our anguished protests.” Everyone is trying to cover themselves. With good reason.
Don’t let them speak on behalf of voters and then act against the economy, claiming that they are trying to save it. A giveaway of unprecedented magnitude would cripple it for as far as the eye can see.
We have reached the point where it may finally be able to break through the membrane of cognitive dissonance that has been blinded people. The very first course in economics –starting in high school, followed up in college and then refined in graduate school – should explain to students why it is false to believe the advertisement that Wall Street has been trying to sell for the past half century: The deceptive promise that an economy can get rich off the mathematical “magic of compound interest.”
The unreality of this promise should be immediately apparent by looking at the math of exponential growth. Already at the time of the American Revolution, financial economists were popularizing the contrast that Malthus soon would imitate in his population theory: Debts grow at “geometric” rates, while the economy itself grows only “arithmetically,” in a slower and more linear way.
All that is needed is to put this idea together with the basic balance-sheet definition: One person’s savings are lent out to become other peoples’ debts. So the “magic of compound” interest to savers means an equal “magic of exploding debt” to somewhere else in the economy. And inasmuch as creditors insist on protecting themselves from inevitable default by possessing collateral, it is natural that most of the economy’s debts are owed on its largest asset: land and buildings. This explains why mortgage debts have become repayable and “gone toxic.”
The “magic of compound interest” refers to the tendency of savings to double and redouble exponentially, with a matching rise in what debtors owe on the other side of the balance sheet. These mathematics have been operated throughout history, ever since the charging of interest was invented in Sumer some time around 2750 BC. In every known society, the effect has been to concentrate wealth in the hands of people with money. In recent years, one’s own money is not even necessary to do this. The power to indebt others to oneself can be achieved by free credit creation. However, the resulting mushrooming exponential growth in indebtedness must collapse at the point where its interest and other carrying charges (now augmented by exorbitant late fees, bounced-check fees, credit-card costs and other penalties) absorb the entire economic surplus.
This is the point that has been reached – and passed – today. It has been developing for many decades. But there is a great reluctance to accept the fact that debts cannot be paid. “The poor are honest,” as one banker explained to me, and believe that “a debt is a debt” and must be paid. (This is not what Donald Trump, Bear Stearns or A.I.G. believe, but they are at the top of the economic pyramid, not its base.)
Numerous publishers turning down my proposed books on the subject over the years. As they have explained to me: “Nobody wants to read how the bubble will break – at least, not until after it bursts. Can’t you write a book on how you can make a million dollars off the coming economic collapse? That would be a winner, Prof. Hudson. But to tell people that they can’t put aside savings and pay for their retirement ‘in their sleep’ is like telling them that they will have bad sex after the age of 50. It’s a no-seller. Come back when you have good news.”
These are the words I’ve been hearing since the mid-1980s. I’ve spent much of my time looking through history to read up on how the failure to wipe out the debt overhead led to the collapse of Rome’s imperial republic, and to the Ottoman Empire as what was known as “the spoiling of Egypt” and “the ruin of Persia” toward the end of the 19th century. I’ve also published a series of four colloquia by assyriologists and archaeologists describing how earlier, from about 2500 to perhaps 300 BC, Babylonian and other Near Eastern rulers kept their citizens free and preserved their landholdings by annulling personal and agrarian debts when they took the throne – a true “tax holiday” – or when economic or military conditions warranted a general Clean Slate. (The series was funded and published by Harvard’s Peabody Museum and is now available from CDL Press.)
These Clean Slates were adopted literally, almost word for word, in the Biblical Jubilee Year of Leviticus 25. Even the same Hebrew word, deror, was used for the Babylonian andurarum proclaimed by rulers of Hammurapi’s dynasty from 2000 to 1600 BC. So it is remarkable to me that men claiming to be Christian leaders today should ignore the fact that in the very first sermon that Jesus gave, in Nazareth (Luke 4:14-30), he unrolled the scroll of Isaiah 61 and promised that he had come “to proclaim the Year of the Lord,” the Jubilee Year. That was the literal “good news” that the Bible preached, as the Dead Sea scrolls have abundantly illustrated.
Yet it is a sign of the power of creditor ideology that even the essence of this founding document of Western civilization has been ignored by a distorted view of what early Christianity, Judaism and other religions were all about. Hardly surprising. Luke’s passage on this founding sermon of Jesus concludes by pointing out that “all the people in the synagogue were furious when they heard this. They got up, drove him out of the town, and took him to the brow of the hill on which the town was built, in order to throw him down the cliff.”
Down the cliff! This is where the revolting right-wing Roman senators drove the followers of the Gracchi brothers on the Senate hill, in an exercise of political violence that prevented Rome from granting debt relief toward the end of the second century BC. Livy, Diodorus, Plutarch and other historians of the epoch attributed the prospective fall of the Roman Empire to its harsh creditor-oriented debt laws. But today, historians publish books speculating that perhaps the problem was lead piping or lead goblets for their wine, or disease, or imperial overreaching, or superstition – anything but the cause to which the Roman historians themselves pointed.
We are still living with the consequences of Rome’s oligarchic revolution. That is what makes this week’s Congressional hearings on the $700 billion giveaway so important. First with military force and then via debt bondage and serfdom, Rome bequeathed to Europe a property-based, creditor-oriented body of law. But since the 13th century, country after country has shifted the balance back to favor debtors – to save them from literal debt bondage, from debtor’s prisons, from permanent indebtedness, to give them Clean Slates on an individual level.
Handel arranged the first performance of The Messiah as a benefit to raise money to bail debtors out of Irish debtors’ prisons, and every year the oratorio was repeated for that charitable purpose. Martin Luther warned about the mathematics of compound interest as the monster Cacus, devouring all. Yet Luther’s denunciations of usury are excluded from his collected works in English, and are available in this language only in Vol. III of Marx’s Capital and Book III of his Theories of Surplus Value. The discussion of interest and banking has become so marginalized that even when I taught money and banking at the New School in New York City in the late 1960s and early ‘70s, it was not part of the core curriculum but treated as a special topic. (Fortunately, that is not the case where I am now happily situated at the University of Missouri in Kansas City. But it took a long time to get here.)
Behind this shift in legislative choice was the perception that no economy can keep up with the burden of debts growing at exponential rates faster than the economy itself is growing. No economy can grow at steady exponential rates; only debts can multiply in this way. That is why Mr. Paulson’s $700 billion giveaway to his Wall Street colleagues cannot work.
What it can do is provide a one-time transfer of wealth to insiders who already have been playing the debt-credit system and siphoning off its predatory financial proceeds to themselves. The Wall Street bankers, brokers and fund managers to whom I’ve been speaking for many decades all know this. That is why they pay themselves such large annual bonuses and large salaries each year. The idea is to take as much as you can. As the saying goes: “You only have to make a fortune once in a lifetime.” They have been salting away their fortunes year after year, mainly in hard assets: real estate (free of mortgages), fine furniture, boats and trophy art. One last $700 billion heist and they can make their getaway.
[1] Martin Wolf, “Paulson’s plan was not a true solution to the crisis,” Financial Times, September 24, 2008.
Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson. com
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