[A-List] Let the Banks Fail
tal1 at cogeco.ca
Fri Jan 2 14:50:29 MST 2009
...clear analysis...up to a point, and that point is: the author harbours a
strangely Panglossian view of capitalism itself. Thus, whilst criticizing
'finance capitalism' he seems immune to the rather transparent fact that the
'short termism' of the latter is built into the very fibre of its parent
[and 'corporate social responsibility' is an oxymoron]... More
----- Original Message -----
From: "Bill Totten" <shimogamo at ashisuto.co.jp>
To: "a-list" <a-list at lists.econ.utah.edu>
Sent: Friday, January 02, 2009 4:27 AM
Subject: [A-List] Let the Banks Fail
> Why a Few of the Financial Giants Should Crash
> The finance industry still owns mountains of bad paper and must absorb
> these losses - or else we'll face a very long recession.
> by Joshua Holland
> AlterNet (December 15 2008)
> So far, much of Washington's ad hoc, ham-fisted response to the economic
> crisis has been based on the dictum that the financial institutions must
> be prevented from taking their losses.
> That should come as no surprise. Big finance's lobbyists have been all
> over the "bailout" (it should be bailouts, plural) from the very start,
> Wall Street pumped piles of cash into the elections - AIG, recipient of
> tens of billions in taxpayer largesse, ponied up $750,000 for both the
> Democratic and Republican conventions - and the whole thing's been
> designed by "free-market" ideologues who came to Washington directly
> from Wall Street.
> But the hard reality is that the institutions that created this mess
> have to take their losses - no doubt huge losses in many cases - if
> we're to have any chance of avoiding a deep recession that drags on for
> Some will be wiped out in the process, but propping up firms that have
> massive - and not entirely known - quantities of so-called toxic
> securities on their books only delays the inevitable day of reckoning.
> The rot has spread far beyond real estate, but that offers a nice
> concrete example of the danger of keeping Big Finance from taking its
> lumps. So far, their lobbyists have fought off attempts to force them to
> renegotiate mortgages, especially plans that call for writing down the
> value of the loans to reflect the post-bubble market. This is
> understandable. But the reality is that there are a lot of homes "under
> water" - that is, worth less than the value of their mortgages - and a
> lot of mortgages with "teaser rates" are about to adjust upward.
> Foreclosures only drive down the value of the whole market further - who
> wants to pay today's fair value when two other houses on the same street
> are headed toward foreclosure and might be had for a song in a few months?
> The justification for creating the big bailout honeypot for Wall Street
> was that banks are hoarding money, causing a "credit crunch" that's
> killing the whole economy. But that's only true to a point; while
> financial institutions are holding cash, including, reportedly, those
> billions they gouged from the taxpayers, they appear to be doing so to
> protect their balance sheets, and in some cases, to fund mergers. The
> bigger problem - one the bailout is hardly touching - is that trillions
> in home equity and retirement accounts have vanished, and there aren't a
> lot of people - or firms - looking to borrow money to buy stuff or
> expand right now.
> Economist Dean Baker explains the dominance of the "credit crunch"
> narrative like this:
> The media "largely ignored the growth of an $8 trillion housing bubble,
> by far the most important economic phenomenon of the decade. Now that it
> has burst and sent consumption plummeting, they are blaming the economic
> collapse on a 'credit crunch' instead of the more obvious problem that
> consumers just lost $6 trillion of housing wealth and another $8
> trillion of stock wealth."
> We hear a lot about banks not lending to one another these days -
> another reason we have to buy up shares of their tanking stocks and
> guarantee their funky securities. But consider that as I write, a
> benchmark "interbank" lending rate (the LIBOR, if you care) is at its
> lowest point in history, meaning that banks aren't, in fact, charging
> each other an arm and a leg for cash.
> But, at the same time, William Prophet, an analyst at UBS, Switzerland's
> biggest bank, told Bloomberg News that "the volume of loans apparently
> is still close to zero, and that hasn't changed".
> People are just maxed out, and they're not borrowing or buying.
> Are the Titans of Finance Too Big to Fail?
> Letting the banks - the ones that went out furthest on the ledge of
> those newfangled debt-backed securities and indulged in the worst
> lending practices - take a beating does represent a conundrum. On the
> one hand, there's an almost visceral satisfaction to the idea of letting
> high-flying financiers get their comeuppance. It was the titans of Wall
> Street, after all, who turned a housing bubble into a shaky house of
> cards worth tens of trillions of dollars based on little more than
> "irrational exuberance" and a wave of deregulation.
> But, at the same time, the financial services sector - banking and
> insurance - employs over six million people. Last month, CitiGroup
> announced that it would layoff 53,000 employees, the second-largest
> workforce cut by a single company in American history. That will bring
> the total number of people out of a finance job to 180,000 this year,
> and those people will spend less, pay fewer taxes, and many will have
> trouble paying their mortgages and staying in their homes. The sector's
> unemployment rate rose from 3.9 percent to 4.6 percent in just four
> months, between August and November.
> The assertion that we should do what's necessary to avoid adding to our
> unemployment and other woes just at the moment would be more persuasive
> if not for one crucial point: our financial sector has become bloated,
> swimming in capacity the larger economy doesn't need. That house of
> cards it built is simply too big to prop up, and spending billions to do
> so is only throwing good money after bad - saving an industry that has
> grown out of proportion to the purpose it serves.
> Here's a fun fact about the finance industry. Historically, it's grown
> and contracted along with the business cycle. When the economy was going
> gang-busters and businesses were expanding, it was there to provide
> capital and insurance and connect investors with entrepreneurs and
> innovators. Then, when the business cycle took its inevitable turn and
> the economy slowed down, it would contract. But a funny thing happened
> on the way to the financial meltdown; as the Associated Press noted,
> "when the Internet bubble burst in 2000, the sector never stopped
> growing. Instead, it ballooned over the past eight years to around ten
> percent of the US economy, puzzling economists."
> It's not such a puzzle. In large part, the continued growth of the
> sector was based on the explosion in derivatives - high-value vapor -
> rather than anything connected to real growth in the "nuts and bolts"
> economy. (As I explained in more detail here, a derivative is a piece of
> paper that can be bought and sold for real money but isn't attached to a
> concrete asset. Its value is simply derived from something tangible -
> hence the name. It is, in essence, the equivalent of investors making a
> bet that a company, industry or just about anything else with a tangible
> value will move up or down.)
> The recession of 2001 officially started in March, when the financial
> services sector employed 5.7 million people. At the time, the total
> value of derivatives held by US commercial banks was estimated to be
> around $42 trillion. By the third quarter of 2007 - before the crash -
> the financial sector was employing almost 6.2 million people, and the
> value of derivatives held by American banks had skyrocketed to almost
> $170 trillion - almost three times the value of the entire world's
> During the intervening period, the "real" American economy was in
> doldrums: between 2000-2007, median household income dropped; the number
> of families living in poverty grew by almost 11 percent and the economy
> added jobs at the lowest rate in the post-World War II era. (I should
> add that those employment numbers look a lot worse when you take out the
> job growth in government and our uniquely inefficient health sector -
> between 2001 and 2006, health care added 1.7 million (net) new jobs
> while the rest of the economy added zero.)
> As Bloomberg reported, "The bundling of consumer loans and home
> mortgages into packages of securities - a process known as
> securitization - was the biggest US export business of the 21st century".
> So much of the economic output of recent years has been ephemeral,
> fueled by the ever-growing financial industry and enabled by the
> deregulation for which it lobbied hard for years. When this "speculation
> economy" - or at least the big chunk of it built on consumer debt and
> home mortgages (which I discussed in greater detail here) - began to
> crash, it drove much of the real economy into the ground with it, and
> that's where we stand today.
> But the importance of this analysis goes beyond assigning blame. Today,
> we have a finance sector that is straining under the weight of a ton of
> fishy paper - those much-discussed toxic securities - and nobody knows
> exactly who's holding what. What we do know is that since 2001, $27
> trillion worth of bundled, debt-backed securities were issued, and a
> significant, if equally unknown, portion of those are nearly worthless.
> This was always the fundamental flaw with the original "Paulson plan" -
> buying a couple hundred billion worth of crappy paper when there's
> trillions worth of the stuff on American banks' book is tantamount to
> trying to bail out the Titanic with a thimble.
> But more important is what these numbers suggest moving ahead. The hard
> reality is that these financial institutions must take huge losses on
> that paper or else this recession will likely deepen and drag out for
> years. Basic economic theory says that when a business is not
> sustainable and goes belly-up - or a sector has unnecessary capacity and
> shrinks - its capital, physical plant and other assets, expertise and
> employees will become integrated into firms that are productive.
> When the Financial Tail Wags the Corporate Dog
> The financial sector's size isn't the only thing to consider as we watch
> our government take a page from Venezuela's President Hugo Chavez and
> blow wads of state money purchasing bank stocks and those "troubled
> assets". The influence of the financial sector on the behavior of the
> rest of the corporate economy is something that we take for granted -
> it's business as usual in America - but in a time of crisis, a rethink
> of the entire financial order is imperative.
> The modern system of finance developed during the progressive era - from
> the late 1890s through the 1920s - and its creation was heavily
> influenced by the prevailing anger at the power of the huge trusts.
> Dispersed ownership and new forms of finance - through stocks, corporate
> bonds and other securities - were seen as an antidote to the influence
> of the robber barons, that handful of dynastic families who controlled
> key sectors of the American economy.
> Since then, the original function of the financial markets - to link
> investors' capital with innovative firms - has been turned on its head.
> Today, corporate behavior is very much dictated by the markets -
> quarterly earnings, stock prices and the like - and not the other way
> around. That's not a good thing.
> Lawrence Mitchell, a professor of business law at George Washington
> University, notes in his book, The Speculation Economy (2007), that a
> recent survey of CEOs running major American corporations revealed that
> almost eighty percent would have "at least moderately mutilated their
> businesses in order to meet [financial] analysts' quarterly profit
> Cutting the budgets for research and development, advertising and
> maintenance and delaying hiring and new projects are some of the
> long-term harms they would readily inflict on their corporations. Why?
> Because in modern American corporate capitalism, the failure to meet
> quarterly numbers almost always guarantees a punishing hit to the
> corporation's stock price.
> And corporate managers' own fortunes are tied to their companies' share
> prices through bonuses, stock options and other incentives. The desire
> to make the financial sector happy often dwarves other imperatives;
> Mitchell calls it "short-termism" and suggests that making a company's
> balance sheet look good quarter to quarter drives CEOs to sacrifice
> values like worker safety, environmental protection and other social
> A good example of this financial market-driven short-termism can be seen
> in a 2004 study of CEO compensation conducted by United for a Fair
> Economy and the Institute for Policy Studies (PDF). It found, "CEOs at
> companies that outsource the most US jobs are rewarded with bigger
> paychecks ... average CEO compensation at the fifty firms outsourcing
> the most service jobs increased by 46 percent in 2003, compared to a
> nine percent average increase for all CEOs at the 365 large companies
> surveyed by Business Week".
> There's no doubt that offshoring decent jobs that paid living wages was
> good for those firms' short-term bottom lines, and those corporate
> managers were rewarded on that basis. But was it good for the economy?
> With consumer spending in the tank and inequality at levels not seen
> since the robber barons were tamed, it's hard to argue that such
> short-term thinking served the nation's economy very well.
> Let's return a moment to the fact that banks aren't lending money. There
> are multiple causes for the freeze, including the fact that businesses
> and individuals aren't in the market to borrow money to purchase goods
> or expand their operations. Another reason is that, as Bloomberg
> reported, "With three weeks to go until the end of the year, financial
> institutions are vying for loans that mature after December 31 to
> bolster their balance sheets as they prepare to report to investors".
> As the financial meltdown forces the economic establishment to chart a
> new course, we should not only let the financial sector contract
> significantly, but curtail its influence as well. That can be achieved
> in a number of ways: by banning corporate compensation based on firms'
> stock values, creating new forms of socially responsible financing or
> encouraging the expansion of what Bill Gates calls creative capitalism -
> a nebulous phrase that's been interpreted to mean adding corporate
> social responsibility to the traditional imperative of maximizing
> profits over the short term.
> That won't be easy - and would be politically impossible in a normally
> functioning economy. But letting a few banking giants sink, and the
> financial sector as a whole write down massive amounts of the junk it
> produced during the last decade just might help focus the mind on newer
> and more creative models of finance.
> The original version of this article at the URL below contains numerous
> links to other sources of information.
> Joshua Holland is an AlterNet staff writer.
> (c) 2008 Independent Media Institute. All rights reserved.
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