wall st crisis
26 Sep 2008
From Bad Loans to Bailout
The massive US Treasury intervention seems to have averted disaster for now, but how did we get here exactly? Ben Eltham looks at the problems underlying the US financial crisis
The US financial crisis rolls on. On Wednesday night, President George W. Bush gave a speech in which he said "the entire economy is in danger." As debate rages in the US and here in Australia on the merits of the US$700 billion bailout package proposed by US Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, attention has also turned to the origins of the current crisis.The Paulson-Bernanke bailout will represent one of the largest ever government interventions in the US economy (although Richard Nixon's wage and price-fixing regulations of 1971 were probably bigger). Its announcement initially calmed financial markets before doubts began to emerge on Tuesday.
The markets have consequently yo-yoed, as the massive losses of last week were replaced by massive gains on Friday and Monday, followed by cautious trading in recent days. The result leaves financial markets in Australia, the US and UK still well and truly in bear market territory — more than 25 per cent below their peak.
Paulson's package was feverishly prepared during the dramatic closing stages of last week and was presented to US Congressional leaders on the weekend. It is a remarkable document.
Despite being less than three pages long, it proposes that Paulson be authorised to spend no less than US$700 billion on essentially whatever he wants — not just bad loans and dodgy mortgage-backed securities, but "other assets, as deemed necessary to effectively stabilise financial markets". Further, "the timing and scale of any purchases will be at the discretion of Treasury and its agents."
As prominent economist Nouriel Roubini told Bloomberg, "He's asking for a huge amount of power. He's saying, 'Trust me, I'm going to do it right if you give me absolute control'."
It's not surprising that financial markets are now becoming worried about the likelihood of this bill passing US Congress quickly. Indeed, Paulson's plan has enraged liberals and conservatives alike.
Democrats and liberals want the bill to include curbs on executive salaries, on the not-unreasonable principle that the US Government should not seek to reward the very men responsible for the crisis in the first place. "This plan cannot be a welfare program for Wall Street executives," Barack Obama said at a news conference yesterday.
Conservatives, meanwhile, have railed against the socialist overtones of a package which essentially nationalises huge swathes of privately issued debt.
Free market evangelist Peter Schiff, President of Euro Pacific Capital in Connecticut, told ABC radio's PM program on Tuesday, "I think what we're doing is the equivalent of selling our financial souls to the devil, because it was the government that got us into this mess."
Schiff believes that, yes, leaving the mess for the markets to sort out would have had disastrous effects, but that the bailout is going to have even worse consequences down the track, at least for the US economy.
In many ways, the bailout plan is a textbook example of Naomi Klein's "shock doctrine thesis". As Australian economist Nick Gruen pointed out on Wednesday, "while it might well have been necessary for something to be done, this something comes from the very worst tradition of Wall Street capitalising its profits and socialising its losses."
If the cure is this bad, just how bad is the illness?
Really bad. Everyone agrees that some kind of bold action was necessary to arrest the crisis in the financial markets.
Crisis is certainly not too serious a word for the situation on Thursday afternoon last week, when the forward international currency exchange markets completely ceased. US dollars could not be exchanged, because panicked banks everywhere in the world were not prepared to lend them. The international finance system really was just moments from apocalypse. If it had been allowed to continue, there is every chance that massive banks all over the world would have failed.
As I asked in my article about the fall of Lehman Brothers last week: how did it come to this?
Surprisingly easily. In this article, I'll examine the origins of the subprime crisis. It turns out the origins of the current crisis can be traced back to the mid-1990s and a little known credit rating agency: the Fair Isaacs Corporation.
Sociologist of finance Martha Poon has traced the subprime crisis back to its roots in a prize-winning paper entitled "From New Deal Institutions to Capital Markets". The mechanisms of the lending spree that started it all can be found in the implementation by the US mortgage industry of a new credit score system, called the FICO. Developed by the Fair Isaac Corporation in the 1950s, the FICO score "numerically tags an estimated 75 per cent of the US population eligible for consumer credit on a linear scale of 300-850 units." Actually a series of three different scores from a number of different credit rating agencies, FICO scores were one of the first and most successful numerical credit score systems. They played a useful but low-key role in the US finance system for three decades.
All this changed in the mid-1990s, when the giant Federal Home Loan Mortgage Corporation — also known as Freddie Mac — began to use the FICO score as its main tool for screening home mortgages. Freddie Mac drew a credit-worthiness line at 660. A score above this number was a "prime" mortgage. A credit score below this number was labelled "subprime".
Initially taken up as a way to implement better IT systems, the fact that it was used by Freddie Mac, combined with its ease and scalability, meant that the FICO soon became the basis on which nearly all consumer credit in the US was assessed.
As Poon explains in painstaking detail, the adoption of the FICO score across the mortgage industry meant that it also became the test by which mortgage backed securities (like the now notorious "collateralised debt obligations", or "CDOs") were constructed.
CDOs were essentially bonds that paid a return based on the underlying mortgage interest of a series of home loans. Because each CDO was designed to have only a small proportion of risky loans, merchant banks were able to get ratings agencies like Moody's to give them AAA ratings.
The process by which these ratings were calculated is explained in a fascinating New York Times article by Roger Lowenstein. He convinced Moody's to let him have a look at an example of a mortgage-backed security, which Moody's called "Subprime XYZ". This bond was rated as AAA — the top investment grade. Despite this, it actually contained 2393 mortgages, all of them subprime.
Lowenstein shows, from Moody's own data, just how risky this bond really was:
"Three-quarters of the borrowers had adjustable-rate mortgages, or ARMs — 'teaser' loans on which the interest rate could be raised in short order. Since subprime borrowers cannot afford higher rates, they would need to refinance soon. This is a classic sign of a bubble — lending on the belief, or the hope, that new money will bail out the old. Moody's learned that almost half of these borrowers — 43 per cent — did not provide written verification of their incomes."
Moody's — like Fair Isaac and the mortgage industry in general — justified their ratings on statistical risk models based on previous default rates. This was a sound method of calculating the risk — as long as those historical trends continued. But risk is about future scenarios. And the conditions on the ground had changed.
"Credit scores," Lowenstein wrote, "long a mainstay of its analyses, had not proved to be a 'strong predictor' of defaults this time. Translation: even people with good credit scores were defaulting."
The reason was widespread fraud in the mortgage lending industry. This ranged from the usual "gaming" of the FICO score so customers could break through the magical 660 barrier, to outright loan-sharking and con-artistry.
A good example is Raymond Zwego, who was sentenced to 13 years jail in Kansas City last week for mortgage fraud. Zwego had used falsified documents to purchase 61 properties, obtaining US$16.9 million in fraudulent mortgages.
But for every Raymond Zwego, there were tens of thousands of ordinary Americans who convinced lenders they could buy the home of their dreams, despite lacking the income to pay for it.
Joe Bageant's coruscating book Deer Hunting with Jesus, includes a chapter in which he investigates the practices of a leading mortgage agent in his home town in rural Virginia. Bageant reports that outright falsification of employment records to increase the FICO score — knowingly abetted by mortgage lenders — was rife.
The scale of the problem is shown by the fact that the FBI reportedly has 1400 investigations underway into organisations including Fannie Mae, Fredie Mac, AIG and Lehman Brothers.
The final piece of the puzzle was lax regulation. The reason that subprime crisis spread out into the broader financial markets was largely because of the size of the unregulated financial derivatives markets, of which mortgage backed securities were only a small proportion. The market for so-called credit-default swaps, for instance, is valued at $US62 trillion. No, that's not a typo.
The sheer size of the derivatives markets is related to the enormous leverage required by institutions like merchant banks and hedge funds to gamble on various indices. Lehman Brothers is a good example. The bankrupt merchant bank had around $30 billion in cash and assets when it went to the wall. But it had liabilities on its books in excess of $600 billion. The size of that leverage meant that plunging investor confidence and a falling share price quickly proved terminal.
As I wrote back in March, the vast tides of unregulated derivatives washing around world money markets make periodic catastrophic failure in the financial markets almost certain: in sociologist Charles Perrow's words, a "normal accident". In that article, I predicted that "stabilisation may require the US Treasury to step in and effectively take on trillions of dollars of bad debt".
That's what we're seeing this week. Who knows what next week will bring?
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UPDATE:
The financial turmoil continued overnight with the failure and forced sale of big US bank Washington Mutual.
The Washington Mutual failure is the biggest bank failure in US history.
http://online.wsj.com/article/SB122238415586576687.html
I agree with Rockjaw! Gaol, or better still, kill the people who took out the mortgages and give their possessions to the Wall Street bankers who are suffering terribly in the crisis. It’s because the finance industry is so over-regulated that this happened in the first place, so we need to eliminate all regulation. Cut the brake cables and think how fast the car will go! Wheeeeee!
We really need to re-state the basic fact: there is virtually no regulation anyway - that is why this system has got away with it for so long (nice quip though, peterbest! We still need a chuckle in this gloomy context of global super-crime. Check out this finance sector professor of chutzpah for another laugh: http://www.youtube.com/watch?v=gUkbdjetlY8, http://www.youtube.com/watch?v=ayGcF8dnTV0&NR=1, http://www.youtube.com/watch?v=SGkrNJ19DSU&NR=1 and http://www.videosift.com/video/Jim-Cramer-Blows-a-Head-Gasket).
Your piece got that part right about deregulation, Ben, but you are off again where you fail to use either historical reference or some sound imagination. Your "prediction" was lame then as it is now i.e., "stabilisation may require the US Treasury to step in and effectively take on trillions of dollars of bad debt". That was not a real prediction anyway, but a simple assessment of a process that was already underway with Bear Stearns, predicted by many mid-2007, and even earlier, and obviously set to continue given the absence of political vertebrae in Washington, London, Canberra, etc.
Instead of claiming there is some "requirement" for bail out, why not drag yourself out of such bystanding, political passivity and try calling for real economic stabilization i.e., by performing the obviously needed bankruptcy proceedings for a start? And keep in mind that bail-outs do not equate to either stabilization (or nationalization) at all. I think you also missed a lot of wood for those cute lil’ ol’ trees planted around the finance shysters’ places of business. I believe your article could be much more effective if you revise its take on causality here; less politely, you made some other points which seem "A-about-face".
First, contrary to your statement (echoing as it does repeated blurbs in the mainstream press), this is not some "government intervention" in the US economy at all: it is the other way around. Like the World Bank and IMF, the US Fed is stacked with people who have a vested interest in ensuring the continued plunder of public assets, including physical infrastructure, state services, and tax-based money reserves. Bernanke and Paulson are just such people, hence their already successful passage of several huge bail-out packages since the Bear Stearns implosion.
Of course, Bernanke, Paulson and the Fed are not alone; administrators of state reserves across the OECD have been busy following suit with such neolib and neocon "de facto financier interventions" into the state coffers. The US Congress, like our parliamentarians, have been mostly very meek in their compliance with such "usurer interventions" into the currency foundations of our governments and common wealth. Perhaps these politicians believe that their meekness will ensure they inherit the earth’s hedge and equity funds? Or maybe they just want to avoid a well-targeted "terrorist attack" by some shadowy "Muslim extremist" bogeymen?
But much of the current reported opposition to Paulson’s bill appears more a desperate bid by corrupt politicians to secure their political future too, as they sense the looming fury and vengeance from many millions of citizens - including as they do yet more destitute and unemployed victims. Remember that such politicians have repeatedly let masses of public treasure sink into the funny-money market after Bear Stearns. The subsequent increased danger of hyper-inflation was obvious, but so was the prospect of many politicians getting a more opulent life on the financiers’ juicy payroll on retirement and/or being kicked by voters. On a scale of organized corruption and dishonesty, these guys make the likes of Soeharto, Mobutu and Ceaucescu look like primary schoolers grabbing other kids’ lunch money.
My second point concerns Obama’s (and others’) spiel about curbing executives’ obscene salaries. Well, they could have tried speaking out about that many years ago when those fat horses started bolting. Moreover, the bail-out packages overall amount to "welfare for wall street" and "reward for mediocrity and failure" regardless; belated and spurious commentary like Obama’s avoids the bulk of the rip-off, and its very nature, by trying to shift attention onto a smaller scale and some individual though high-profile fat cats in the banking hierarchy.
In other words, calls like Obama’s would translate as: "forget about those even bigger investors and speculators, who aim to keep creaming off masses of bail-out loot". Such relatively trivial and populist distraction is what we should expect from Obama. He is, after all, on the payroll of seasoned looter-speculator George Soros.
Thirdly, to the matter of causality behind this crash. The mainstream media and its robber-baron owners keep mystifying the phenomenon as though it all started with some flutter of butterfly wings in a Thai jungle. Thus do we keep hearing silly euphemisms e.g., "credit crunch", "sub-prime debacle", "finance crisis", and so on. Well, it is actually a crash. Sure, it is a crash of such scale that we should also recognize it as the disintegration of the prevailing international financial system itself. But it is not some technical hitch or glitch with dynamics so hard to grasp by even the average punter.
This crash has obviously particular dynamics in time and space, but it is still a crash brought about by the age-old folly of people who refuse any limits to their own ego, greed, and pretences, instead regarding themselves as virtual deities in this world. Therefore, the "sub-prime mortgage collapse" is merely a symptom of a far more profound failure in the over-heated, "free market" nonsense that went into overdrive after the Cold War.
The doling-out of debt, whether as US "sub-prime", exotic loans, or Australia’s supposed "higher-grade" debt, all blew out because debt eventually became - in the more influential finance circles, at least - such an attractive commodity despite its fictitious quality. The race for bigger debt was not necessarily the choice of most bankers themselves; many were and are horrified by this madness. However, such an environment meant that banking businesses could not survive, even in a short term of months, unless they played the game with the same new "balls" of MBS, CDO, CDS and various other esoteric bundles of toxic play money.
The situation demonstrates clearly that our political system is not only profoundly corrupt and plundered, but ideologically bankrupt too. The western media still talks seriously about even the most obviously compromised of characters like Obama and Turnbull who are, by their own statements and business dealings, no better than streetwalkers in such a fake, unsustainable and destructive economy.
"Everyone agrees that some kind of bold action was necessary to arrest the crisis in the financial markets."
That’s quite presumptuous. I don’t agree. Neither I suspect, do millions of American (and British, for Gordon’s part) taxpayers who, while not reaping the benefits of the bailouts, will be legitimising it through their labour/taxes.
For most of us, letting them fall is the bold action. We will be affected, but so will we be by contributing (against our will) to the bail out funding. When the government comes to the aid of ordinary citizens in financial strife with as much gusto as it does to the financial sector, I might support such moves.
cheers,
Derek
Nice call, Derek. I disagree entirely too. When the body is dead, you bury (or cremate) it. When the financial entity is bankrupt, you put it into BANKRUPTCY PROCEEDINGS. Time for the politicians to put a pair of pants on (and not just Penny Wong)! Or maybe it is time we buried them too.
C’mon Ben! Your daddy or uncle are not some of those nice hedge fund managers too - are they?
Yeah, it’s really bizarre - and a bit sick.
If we workers sank ourselves in debt via gambling the track or speculating on real estate, or on Babcock or Merrill shares, no-one would really give a toss. Now, I work in a pretty basic logistics job as a laborer, but my work effectively helps feed, clothe and clean thousands of people. Nonetheless, no-one in the state or finance sector would seek to sustain me like some pampered junkie if such costly habits as outlined above put me out of action from my necessary work!
Yet that is precisely the leadership elite’s response in maintaining a great welfare-freeloader program for people who contribute absolutely nought to society except obscene inequality, false, vain hopes, wasted energy, and - even if the state does finally recall FDR’s example of courage and leadership - much misery through homelessness, unemployment, starvation and sickness (we could probably throw further terrorism and war in there too).
Bankruptcy would not be "bold action", but a natural and fitting conclusion to the perpetrators’ parasitic, degenerate and useless existence. As with normal failures at lower levels, these usurers’ bankruptcies would follow a very routine and established process with much logical, moral and legal justification and precedent. The persistent bail-out reflex by this ship of fools is an affront to humanity, conjuring such concepts as "worldwide abomination" promising to yet worsen an epochal catastrophe.
Its about time for another Reichstag fire, eh chaps? The rulers will need a scapgoat/diversion for this one - and I don’t think cave dwelling terrorists quite cut the mustard. As Keynes well knew, nothing stimulates demand like a war economy.
As usual, Ben Eltham has delivered a well-researched, albeit harrowing article of interest. I don’t believe that massive governmental intervention will achieve anything, certainly vis-a-vis getting the American/world economy back to a position of stability. Markets, like water, have to find their own level. This is achieved by letting it do so.
Mil-Observer had my attention up until he brought up the following points.
1) His tiresome anti-free market shibboleths. If he can come up with a superior system, and convince other people to make it work; the world will be forever in his debt.
2) By sitting back and spouting the sort of stuff prevailing in Europe at the beginning of the 20th century he reduces the value of his opinions by an incalculable margin. In effect his remarks are juvenile because they are irrelevant to the 21st century. Advances in technology have changed the 21st century’s working force and its dynamic, so completely and for such completely different reasons to those which were germane to Europe of the 20th century as to be as outdated as scythes being used to cut grass.
3) This is the hardest part of his rant for me to deal with. It is his astonishing assertion that as a labourer his life is of greater value to mankind than other jobs? This reasoning is risible. He tries to convince us his life is of greater moral importance to the human race than that of an air-traffic controller, an ambulance driver, a member of the CFA, or a street cleaner?
Thus has he rendered his opinions to be the equivilant of the nearest WPB. Except that a WPB actually holds something.
In reverse order:
1. No, my work (not "life") is of higher value than that of a hedge fund manager - or that of media flunkies and politicians who suck up to hedge fund managers - or that of M. Turnbull. Bad try - fail.
2. The tech-internet nexus of the funny-money market cuts no mustard as a case against state controls of state reserves. Such mystical case for "free market" tyranny is an old one now, never actually substantiated, but dependent upon an aura of the supposed "freedom of the world wide web". The notion of such an omnipotent and innately unrestrainable virtual market has as much value as online porn: transitory, very short term, illusory, and unsatisfactory (but such big business!)
3. I do not need to come up with a better system - FDR already did that before me. It defeated both the Depression and fascism. JFK revived the better system later on.
4. Btw, the bail outs are not a "government intervention"; they are a government prostitution.
Ben, I notice you include, in your reference work, Martha Poon’s piece on GSEs and the current mortgage crisis.
Don’t you also find it quite astonishing, now that it is too late to put the crap back in the horse, that we are suddenly swamped with experts who can tell us all about what went wrong? Where were these award winning articles BEFORE the crisis?
Surely those who were ridiculed for trying to warn of this crisis BEFORE it occurred should be given a little more attention now that it is obvious that they were entirely correct? Or has the "herd mentality" grown so strong that we should ignore these people even now?
One good example of such a person is the indefatigable Catherine Austin Fitts, the same person who was probably responsible for exposing the Iran Contra scandal and who later also resigned from the office of Secretary of the US Federal Department of Housing and Urban Development (HUD).
You will recall that her resignation, almost two decades ago, was the result of her frustration with the irregularites in the Federal Housing Department responsible for GSE’s like Freddie and Fannie Mae as well as her prediction that these same GSEs would cause huge financial distress if they did not stop certain dodgy practices.
A New Zealand website makes reference to some of these matters raised by Fitts here:- http://www.scoop.co.nz/stories/HL0808/S00344.htm
Ben, we don’t need more "experts" to tell us what happened AFTER the mess emerged, what we need to do is to go back and examine why our economists and financial media were all that stupid and that arrogant that they chose to ignore those few who DID warn us of this impending disaster decades ago, those people whom we ridiculed, and at a time when it was still possible to prevent this disaster.
I ask again, why should we take seriously those experts who assured us all that the world’s financial markets were safe and healthy before the crisis but who now all trundle out and tell us all that those same markets were in fact not so healthy but that we should have faith in their ability to "fix" the problem or to deal with the issue?
If they did not see this coming, how on earth will they know what hit us or how we should deal with it?
The FICO scoring system caused this crisis? A crisis which might become a greater disaster than the Great Depression? Wow, that really is a huge stretch of faith don’t you think Ben?
Excuse those of us who do not follow the ramblings of the herd Ben, but some of us prefer economists who accurately alert us to problems BEFORE they occur!
Bob Karmin, your comments are a perfect reflection of my fears right now. Have you noticed all the talk of war with Russia lately?
Have no doubt Bob, the herd will easily unite in one last magnificently stupid rush over the edge and down into the nuclear abyss, and all because a few billionnaires placed a few losing bets on the wrong politicians.
Peterbest? Is that you again? Speaking of "cars" and "brake cables" this time as if these are reasonable substitutes for your ignorance surrounding the topic being discussed.
What, have you run out of domestic animals to talk about?
And what is all this talk of gaol and killing people peterbest? You should relax mate, because only socialism could criminalise intellectual deficiency - so you are perfectly safe from prosecution or punishment at the moment but.
Rockjaw, there have been a lot of people warning about the fragility of global financial markets for a long time. They range from influential derivatives traders like George Soros to economists like Nouriel Roubini and Joe Stiglitz to heads of state like former Malaysian PM Dr Mahathir.
In terms of the subprime crisis, Roubini in particular was well ahead of the curve.
Neither myself nor Martha Poon are claiming the FICO score caused the current crisis. It’s a more nuanced case than that: the spread of the FICO score throughout the US mortgage industry greatly facilitated the securatisation of mortgage debt through RMBS’s and the financial instruments based on these, like CDO’s.
I must admit I get confused by exactly what you’re trying to argue here Rockjaw: is that economists should have foretold the crisis? There are many who did, including Hyman Minksy and here in Australia the University of Western Sydney’s Steve Keen. Is is that we shouldn’t listen to the wisdom of the majority? That’s a position which will get you into trouble on those occasions when the majority happen to be right.
You know Ben, I work with traders 24/7 and I can assure you, the battle we have experienced to keep traders away from mainstream economists and mainstream financial press, (in particular), over the past decade, has been like fighting millions of re-enactments of the relief of Mafeking.
From George Bush’s "go out and spend" speech back in 2001 through to the current crisis and beyond, the mainstream has had it all wrong, (with the exception of the brief period during which the US$ rallied after Bush’s Iraq "victory" speech).
It is ironic that I too have referred to Joe Stiglitz in my attempt to convey my point, but Joe Stiglitz is anything but mainstream! Criticised and often isolated for his views, he is too infrequently referenced by any but a small number of more experienced traders.
No Ben, Stiglitz can hardly be regarded as "mainstream" despite his fame. I recall an example when Stiglitz withered bitter attack from most mainstream economists during the Asian crisis which he labelled "a crisis of confidence", and the loudest criticism against him for that view was not that he was wrong, but rather that he had expressed his views in public!
Apparently he should have possessed the sense of responsibility to understand that his expressed views "fuelled the crisis" in that it "undermined the very confidence he spoke of".
That is partially my point about the "mainstream".
Moreover, Joe Stiglitz is primarily an academic, and, apart from his academic views and his various theories on the topic or his criticisms of such institutions as the IMF, I cannot recall that he specifically alerted us to this crisis other than in a generic sense.
Mainstream economists, particularly those involved with policy, as opposed to our academics - for example those who critised Stiglitz during the Asian crisis - appear to have adopted an attitude of aloof misrepresentation to misinform rather than to specifically advise, to forecast or to provide accurate and reliable economic data or opinion. All this in an apparent misguided attempt to prevent some or another economic disaster - which further highlights one of my grievances.
And then you ask why we should not listen to the majority? Adding that not doing so could "get you into trouble". Good heavens Ben, if the extent of a person’s skills and abilities are defined or limited by popular opinion, well then one should really not have an opinion at all, least of all a professional opinion!
My only exposure to Steven Keen has been his "debunking economics" website and his far too few contributions to NM, and so I cannot comment on Steven Keen.
There is insufficient space in this blog to do justice to a response to your post because the best I can do in this short space is to be long on innuendo and short on explanation and reference. Instead let me conclude by pointing out simply that had "mainstream" economists forecast this crisis, as is your claim, well then the public’s huge surprise, the financial media’s huge surprise and the "day late and dollar short" crisis management going on in Washington and New York right now, would not be happening.
PS Your Dr Roubini, like Dr Marc Faber whom I referred to, are not really "mainstream" either are they? And ironically both are referred to as "Dr Doom" - why? To undermine their credibility to the public? Are they conspiracy theorists or economists? What is it exactly about bad economic news that "mainstream economists" feel they should hide from the public, particularly if mainstream economists were always “aware of the problem”?
If you are correct in your assessment that "mainstream economists" were aware of the crisis, well then why on earth did the mainstream financial media make my life helping misguided junior traders avoid disaster such an awful hell over the past 10 years?
No Ben, this crisis is very much a huge surprise to the public, aparently also to many Australian Banks and institutions caught on the wrong side of these bad investments, as well as to the majority of professional traders who rely on accurate and good economic data BECAUSE the mainstream opinion on which they rely so heavily, and which you express fear opposing, has been entirely inaccurate.
Forgive me Ben, I omitted to thank you for the indulgence of responding to my rants.
So, the latest hustling in Congress indicates that we really are set to see the creation of a global Weimar. What next? A "green" New Order based on fart/carbon currency run by such feudal types as Sting, Branson and some our "green" fund managers?
Two concerns about Ben’s text:
1. From Ben Eltham: "Is [it] that we shouldn’t listen to the wisdom of the majority? That’s a position which will get you into trouble on those occasions when the majority happen to be right".
What is "the wisdom of the majority" here? Does Ben mean the majority of fund managers and other such con artists? The majority of neoliberal ideologues? Or the majority of economics-accredited academics, which would comprise a higher-than-natural proportion of the former two categories given their propensity for aggressive, lavish sponsorship of toadies and corresponding marginalization of dissidents?
Note this following sycophantic comment in a recent limp, gutless, but purported "protest letter" by US academics: "America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity". Yeah right. Say that while standing in front of the record US debt bubble, proportionally far bigger than Weimar and promising similar inflationary fevers. Or go tell this era’s skyrocketing US population of working homeless, incarcerated, and ignored war veteran cripples, for example - see: http://faculty.chicagogsb.edu/john.cochrane/research/Papers/mortgage_pro…). So much for "academic freedom" and "peer-reviewed accreditation"! In this case, those concepts would be eerily similar to any ordinary institutional conditions of prevailing intellectual and moral cowardice, and weak individual character; rather conjures for me the assessment that “it is too late to put the crap back into the chickens”.
If my implicit guesses above are more or less correct, when did such a majority "happen to be right" at all, as Ben seems to presume they were? If, as I would claim, they were never right on the substantial matters of finance sector regulation and relevant state responsibilities, what is the point of Ben’s question and cautionary advice? I suspect that he really meant that not listening to “the majority” is “a position which will get you into trouble on those occasions when the majority happen to be” rich, powerful and utterly remorseless psychopaths. That would reflect our reality rather more accurately.
2. And again from Ben Eltham: "Everyone agrees that some kind of bold action was necessary to arrest the crisis in the financial markets." Given the responses from Derek, Venise and myself, as well (presumably) from peterbest, and rockjaw’s quip "it is too late to put the crap back in the horse", clearly Ben earned fairly straightforward contradiction with that problematic statement.
Therefore, it appears that in the context of this thread the only reliable confirmation from Ben Eltham’s sentence would actually be that he himself "agrees that some kind of bold action was necessary to arrest the crisis in the financial markets". That would mean he must support some particular mutation of Paulson’s current bail-out looting operation being thrashed out with the Fed (and stalked by de facto minders for the RBA and BoE). Given Ben’s conviction that the finance markets’ "crisis" must be arrested, he must also offer in-principle support for the structure, function and very existence of those same financial markets and, to some extent, defence for their ideological justification and general effects on humanity.
So I take it from Ben’s silence that his daddy and/or uncle are not hedge fund managers. Does he draw directly from such business interest himself, or is it merely that he admires and believes in them implicitly?
douglas jones
Not being one of the expert economists I naively find some of the assumptions made in making the market model a little far from the real world. Was it not Kenneth Archer who found similarly for the assumptions made at the start of the modelling?
Anyway we are asked to believe that this “mistake”, as Bush has labelled the scam, whether this refers to the failure of the market to correct, concealment or to a misreading of finance data by players is not clear.
A mistake despite the plethora of financial advisors accountants and well paid CEO’s? Though the later remuneration like that of Brokers in the subprime is unrelated to the longer term performance of companies. Like the broker’s vested interest an excuse?
But then there is the board of well qualified gentlemen well supplied with performance figures and health of the company and we are asked to suppose that all these with their financial tools ,the rating agencies and their superior business knowledge, surely could see through even the well disguised tranches before marketing or pontificating.
Here again the plethora the alphabet soup of new and old derived derivatives and their parcelling in tranches plus so much of this kind of transaction being off balance sheets may have served to confuse these well versed gentlemen. Intelligent scams use any and all possible excuses.
Any way to turn to the other side what would happen if these folk were allowed to go bust, the expression of the market economy discipline, which until the recent apostate behaviour they so worshipped.
Smaller folk would be hurt?
This fact has value apparently suited to the occasion thus going to war even when doing so on a lie, constituting danger to the lesser folk is cloaked in patriotism, good and evil and similar secret words for the new American Century. Thus does not apply.
So okay the system goes.
Last time it took a war to make the economy good again. One might ask was this the extra funding greater than that currently accorded the industrial military complex or was it the destruction of so much making for high demand at wars end, on which the economy could ride ?
We don’t, apart from the idiots at the top want another war but we have an alternative to war in developing and implementing methods for combating global warming. Sure like war needs deficit government finances but would meet a demand, escaping potential environmental collapse, and provide many jobs,.
Might even drive the lesson home that we do live in a finite environment even if many elements can be substituted, the mantra of the economist, it now becomes apparent that some cannot.
Flannery in the latest quarterly essay waxes lyrical about the possibilities for investment in Australia. Hot Rock, the existing infrastructure of Santos even companies making pyrolysis machines to turn our waste into charcoal, carbon dioxide stable for many years. Worth a read though for those accustomed to the pap of the media and our political brethren, perhaps an adults only sticker should be added to this frightening forecast so the kiddies and immature of the populace are not upset.
Despite Bush, dismissing warming as yet to be shown to be true, creating demand by advertising playing on human desires, fears and similar, American entrepreneurs could be tempted to risk something?
After all the American Century though it might welcome the holders of American debt to be frozen, decertified, drowned or just fried, some would need to be left if only worship the great democracy and freedoms given.
Rockjaw, it seems like we agree on more than I thought!
If you mean by "mainstream" economists the type we typically see on TV with the titles "Chief Economist of such-and-such bank" then I tend to agree. But they in turn are simply taking their cues from the academic neoclassical consesnus, for instance Mankiw and Merton. I argue that in fact Mankiw has much to answer for in this current crisis for helping to create a set of accepted facts that are in reality is far closer to conjecture.
Mil-observer, I would hope that you would not take anything from my silence. Let me attempt to answer briefly some of your points. Firstly, my dad is a retired social planner and my uncle is a freelance journalist, so no, they don’t run hedge funds LOL.
Secondly, you are right to pick me up on a sweeping statement to the effect that an intervention is necessary to stem the current crisis. Not everyone in fact believes something should be done. You may argue, and indeed the House Republicans agree with you, that there are a range of problems with the Paulson bail-out including the massive moral peril it introduces into the system.
However, allowing for my imprecision, the sense of what I was arguing is this: there is a considerable consensus from across the political and academic spectrum for the need to arrest the current financial crisis before it spreads further and threatens the integrity of the entire US banking system. Let’s remember that in the 1990’s during the Asian financial crisis, several of those economies were indeed urged to simply let banks fail, and this is largely what the South Koreans did. The nominal US dollar GDP of Korea fell by $170.9 billion fall in 1998, equal to 33.1% of the 1997 GDP. On some measures, it took Indonesian GDP nearly ten years to recover to 1997 levels.
The US faces a similar crisis. It’s very surprising the US dollar hasn’t been attacked speculatively yet, one possible reason being the sheer amount of foreign liabilities tied up in the US financial sector has so far deterred foreign investors from rapidly pulling out their money. This is why most economists have been arguing there should be a recapitalisation of thee US financial system.
UPDATE MONDAY 29th SEPT: The financial crisis is shifting focus to Europe with two big European institutions in deep trouble: the UK’s Bradfield and Bingley and Belgium’s Fortis.
The Financial Times on Fortis:
http://www.ft.com/cms/s/0/effbc82e-8d8d-11dd-83d5-0000779fd18c.html?ncli…
The Guardian on Bradfield and Bingley:
http://www.guardian.co.uk/business/2008/sep/28/bradfordbingley.banking2
Thanks Ben. More liquidity to solve a solvency crisis hey? That’s like taking a knife to a gunfight!
Strewth! In the final analysis, the world has finally gone completely mad!
"In the end we are all dead" - J M Keynes.
I am taking my bat and my ball, my few ounces of gold and silver, and I am out of here, I’m going fishing on the world’s greatest coastline - call me in a few years when all this insanity is finally over!
PS. Details of the only socialists who managed to come close to resolving this type of problem can be accessed here:-
http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?em
ERRATUM, rockjaw: it’s probably more like taking a knife to a gunfight, then plunging said rusty knife into one’s own spleen, then calling those paramedics from that creepy (and expensive) private hospital run by doctors Ayn Rand, Kevorkian and Frankenstein.
Thanks for the reply, Ben. My prodding on your relatives was just my obnoxious way of provoking some response at all, so sorry for the bolshie taunts. Your reply was an honorable one that enriches the discussion (for want of a more meaningful and less fiscal-related verb)!
However, I do not think that your comparison with the ‘97 melt-down is an apt one here. I believe Mahathir has been all but vindicated in his call on the Ringgit; for similar strategic reasons, more recent Malaysian calls to repeat the Ringgit’s pegging this time seem to me a tad optimistic! As for Anwar, his official conduct in ‘97 could well be enough for his own unedifying epitaph.
The problem this time is that the entire financial system is already long dead, and its main currency is very ill; it seems like the OECD reserves have just been pumping naltrexone and crystal-meth into the corpse, then slamming the chest with repeated electric shocks - and all as though such treatment has been drawing the entire Medicare / national health budgets. The writing was indeed on the wall when Bear Sterns went into freefall around mid-last year. When lay punters like myself understood that "Bear" was not just some mere totemic symbol of market sentiment, but a more specific indicator of systemic disaster, we could be sure the sky was in fact crashing down on these critters. Confirmation even came through the post and by phone, as the friendly neighborhood banks offered me and my wife the sort of extra credit ratios that might have made some puppet-regime dictators blush.
To continue the semantic adventures here, why don’t we consider the term "bail out" in its original context? A pilot jumped from a plane after it was either malfunctioning or shot up in a dogfight - s/he "bailed out". That metaphor extended to unlucky, incompetent and/or corrupt executives doing likewise with a "golden parachute" of generous termination pay, bonus and share options. Therefore, these "bail outs" from the Fed, BoE, RBA et al would remind one of scenes from "A Bridge Too Far", as Bear, Freddie, Fannie, Merril, Macquarie, etc., jump over Holland with many shiny golden parachutes stamped "G.I.". Trouble is, as rockjaw may have suggested with his take on the precious metals market, the parachutes’ sparkling sheen is really an illusion too; it’s just gold-colored spray paint.
Note too that there are many grass-roots democrats and US unionists who are absolutely ropable about Bernanke’s helicopter and Paulson’s latest package.
I support your mention of speculators’ apparent trepidation around the greenback. That situation worries me for its signs of potential distraction through warmongering mischief, especially since the recent dirty troublemaking around South Ossetia and Abkhazia (perhaps that echoes Douglas Jones’ and Bob Karmin’s gut feeling?). To Russia’s credit, appeals from Putin and Medvedev seem to have been prominent in pointing towards the necessary bankruptcy reorganization and international regulation of a whole new financial system.
Didn’t Mahathir propose a new currency (a gold dinar or something) and Islamic trading bloc about 15 years ago. Is that where all the gold went.
I know that the USD is fiat, but isnt the Euro backed by bullion? This is all so confusing!!
banville, the last european currency to be backed by gold was the Swiss Franc, but even the good old Swissie has finally succumbed to the banking thieves and their "lobby group".
The Russians are whispering about a gold backed Rouble and there is even talk of a gold backed common currency for the Arab oil producing states - although this is unlikely given the pressure Arab states remain under by the same lobby group which hijacked America’s Republic.
The Arab states will probably have a new common currency within the next 5-8 years though, but it will probably not be backed by gold and it is likely to be linked to the Euro.
I am struck by the way this bailout is being pitched as "necessary." So I’ve been trying to get my hands on the the actual rationale and aims of the intervention. Details on the ACTUAL bailout are scant, although there is a heap of stuff on hypothetical interventions in the order of US$700 Billion.
Reuters has some of the highlights:
http://www.reuters.com/article/idINTRE48S01420080929?virtualBrandChannel…
The highlights are presented in a ‘fact box’. According to the ‘factbox’ one of the aims of this bailout is to:
"permit the Federal Reserve to begin paying interest on bank reserves from October 1, giving it another tool for easing credit strains."
Now, I presume, that the bank reserves in this instance are the ones held by the Fed itself. (The ones deposited there by banks etc). Does this mean that the US taxpayer is also bailing out the Fed?
[N.B. - the following e-mail was hacked from a US congressman’s office PC. It is apparently NOT spam, and is NOT from Nigeria]
Dear American:
I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.
I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.
I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transactin is 100% safe.
This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.
Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to wallstreetbailout@treasury.gov so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.
Yours Faithfully
Minister of Treasury Paulson
Saw this, thought you lot might find it interesting although maybe way over the top:-
"excerpt
Banker’s coup?
Financial industry rep. Paulson is the ringleader in a banker’s coup the results of which will decide America’s economic and political future for years to come. The coup leaders have drained tens of billions of dollars of liquidity from the already strained banking system to trigger a freeze in interbank lending and hasten a stock market crash. This, they believe, will force Congress to pass Paulson’s $770 billion bailout package without further congressional resistance. It’s blackmail.
As yet, no one knows whether the coup backers will succeed and further consolidate their political power via a massive economic shock to the system, but their plan continues to move jauntily forward while the economy follows its inexorable slide to disaster.
The bailout has galvanized grassroots movements which have flooded congressional FAX and phone lines. Callers are overwhelmingly opposed to any bailout for banks that are buckling under their own toxic mortgage-backed assets. One analyst said that the calls to Congress are 50 percent “No” and 50 percent “Hell, No.” There is virtually no popular support for the bill.
From Bloomberg News: “Erik Brynjolfsson, of the Massachusetts Institute of Technology’s Sloan School, said his main objection ‘is the breathtaking amount of unchecked discretion it gives to the Secretary of the Treasury. It is unprecedented in a modern democracy.’”
“‘I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,’ said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.” (Mish’s Global Economic Trend Analysis)
Brynjolfsson’s suspicions are well-founded. “Market Ticker’s” Karl Denninger confirms that the Fed has been draining the banking system of liquidity in order to blackmail Congress into passing the new legislation.
Here’s Denninger: “The effective Fed Funds rate has been trading 50 basis points or more below the 2% target for five straight days now, and for the last two days, it has traded 75 basis points under. The IRX is demanding an immediate rate cut. The Slosh has been intentionally drained by over $125 billion in the last week and lowering the water in the swamp exposed one dead body — Washington Mutual — which was immediately raided on a no-notice basis by JP Morgan. Not even WaMu’s CEO knew about the raid until it was done… . The Fed claims to be an ‘independent central bank.’ They are nothing of the kind; they are now acting as an arsonist. The Fed and Treasury have claimed this is a ‘liquidity crisis’; it is not. It is an insolvency crisis that The Fed, Treasury and the other regulatory organs of our government have intentionally allowed to occur.”
No bailout today, by the looks of things. You can’t help but think that they’ll work something out, though – those who voted against this one will point to some superficial differences in the new version as a victory. I’m wondering myself whether this will spark a war; if so, I imagine it will be for scapegoating, not for war’s supposedly good effects on economies. It’s a persistent myth, but really war provides only some short-term stimulus. If you’re on the winning side and your country is little-touched relative to others, your economic power will grow – I imagine that this is the myth’s genesis in Australia and the US.
Just wanted to add my two cents on why so many people who should have seen this coming didn’t: many were blinded by free-market ideology, I’m sure, but I think a lot did know; the market runs on confidence though, and derivative-piling is a confidence game. Nobody wanted to be the one that stopped the party, especially given that the US was remaking itself as the centre of finance capitalism rather than the productive economy that the Second World War had left it
Anyway, Mike Whitney quotes Nouriel Roubini, whop quotes an IMF survey of the way governments have dealt with banking crises:
"First of all only in 32 of the 42 cases there was government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any government financial intervention. Of the 32 cases where the government recapitalized the banking system only seven included a program of purchase of bad assets/loans (like the one proposed by the US Treasury). In 25 other cases there was no government purchase of such toxic assets. In 6 cases the government purchased preferred shares; in 4 cases the government purchased common shares; in 11 cases the government purchased subordinated debt; in 12 cases the government injected cash in the banks; in 2 cases credit was extended to the banks; and in 3 cases the government assumed bank liabilities. Even in cases where bad assets were purchased – as in Chile – dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course in most cases multiple forms of government recapitalization of banks were used." (Nouriel Roubini’s Globl EonoMonitor http://www.rgemonitor.com/blog/roubini)
This seems to say, sure, put some government money in, but make sure you’re actually buying something for it that will return your money. In this case, the mountain of derivatives is so far from the productive economy that this probably isn’t possible. And apparently some European banks are more leveraged than their counterparts in the US. Does any government have the gumption to stop non-productive capital flying around the world creating crisis on crisis? Speaking of which, Ben, I think the Asian ‘Tigers’ would have been encouraged to let banks fail so that they could be bought for cents on the dollar. Haven’t researched that, but it fits with a few other things I know a little of.
philannetta.blogspot.com
God, nationalisation of the High Street Banks by the US Government. Socialism hits America at long last. Whatever next? A decent medical system in the US?
If you look more closely I think you’ll realize that it is not "nationalization of banks", just as it is not "government intervention".
If your bank is bankrupt at this level, and the federal reserve pumps public money into it while claiming a certain (very optimistic!) stake in its future operation, that is not nationalization. It is more accurate to describe it as a very nasty form of privatization of the federal reserve, because the bankrupt entitiy is still bankrupt - it has no hope while the entire system has fallen apart and the debt troughs are that deep.
Actual "nationalization" would involve taking on a living business entity, not a dead one; this current, ongoing state prostitution will merely pump nutrition into the corpse so that the cockroaches (fund managers, investors, etc.) can keep feeding off it longer, without having to choke just yet on the corpse’s original gangrenous body parts.
While governments lumber themselves with such corpses as contractual obligations, instead of meeting their proper commitments to the people and the state, they make it harder to effect real reform, nationalization and recovery.
banville - nice post mate - if reality and academics (especially the human sciences department) ever converged, the study of economics, for one, would be moved to the law faculty’s criminal psychology department.
Hey Patman, it’s not only a good medical system they need in the US, but after yesterday’s decision, they could do with a good mental health system.
Does it not occur to you Rockjaw, that these developments might not be the result of anything which you claim is the fault of "socialism". Is it not perhaps possible that these economic problems might merely be the result of simple bad fiscal and monetary management by government, of whatever persuasion?
It is clear from your rather numerous posts that you are well rehearsed in one or another of the markets, and that you have obviously gained some experience, but it is a little rich to come strutting about these pages throwing rude remarks about your political views in the face of others who contribute to these articles.
I will reluctantly admit that your posts have prompted much thought and that I have been motivated to do some research of my own into this topic which now interests me greatly. Thanks to your posts I believe I now have a much broader and better understanding of the economic crisis the world faces, but is it really necessary for you to be so coarse and abrasive in your presentation?
Don’t worry Shock - nearly everyone’s got stuck on that cunning roadblock of rockjaw’s. It seems he actually enjoys this situation and uses the foil about "socialism" (his latest mischief is to throw in "statism" too!) to distract many of us from the true substance of cause and effect, and more specific location of criminal intent, behind these events.
Shockdoc, I thank you for your kind words, and it pleases me to learn that you have not mistaken me for the fairy godmother or the tooth fairy.
In my environment there is no room for cute little fantasies or pretty talk of Utopia, there is only the daily battle of ensuring that the blood and sweat of hard workers does not become the milk and honey of those who neither contribute to our communal wealth nor earn an honest wage (like most of our bankers and too many of our politicians).
[guffaws from his mates - champagne corks popping]
Such deception characterizes the decadence that has led to this crash and its fascist coup via Wall St. Dissipation of genuine political struggle by cynical manipulators who presume god-like privilege and ability.
When I was a youngster I came up with the idea that you could solve economic crises by simply printing more money, but keeping it a secret so as not to fuel inflation.
Having read several of the phrases on this page, I think this is a perfect plan still.
Nationalisation, mil-observer, not nationalization. God save us all.. If you can’t spell, don’t get political (or am I being too intellectual now?).
"When I was a youngster I came up with the idea" - since then did you ever manage to come up with an idea again Pobjie?