[R-G] [BillTottenWeblog] Trillion Dollar Rescue for Wall Street Gamblers

[Bill Totten]

Nothing for Families and Retirees

by Michael Hudson

CounterPunch (Apri1 14 2008)

If the move to a Unitary Executive of unfettered presidential power
frightens you, America's radical right turn to Unitary Finance should
compound your fears - and your debts as well. The financial events of
the last two weeks of March 2008 demonstrate that the "economic
royalists" and "money changers" whom Franklin Delano Roosevelt (FDR)
drove from the temple of finance have returned to mismanage our economy
into dire straits of unprecedented risk - debt creation, euphemized as
"leveraging" and "wealth creation".

The few checks and balances that remain in the way of the financial
sector's increasingly centralized planning, especially at the state
level, are being swept aside under the guise of "saving the system". Few
Wall Street beneficiaries who use this phrase explain just what the
system is. For starters, its political managers are industry lobbyists
appointed to high managerial and planning positions in the public
agencies that are supposed to regulate these industries. Their idea of
financial planning is to put a trillion dollars in government agency
funds and credit guarantees at risk. This agency funding was supposed to
be used to help average American families obtain housing and health
care, and to protect their savings and provide for their retirement.
Instead, it is being mobilized to support the economy's bankers and
financial managers. Indeed, the past few weeks have seen seemingly
trillions of dollars committed for war making and bank support.

The banking system's free creation of credit, doubling each five years
or so for the economy at large, threatens to culminate in debt peonage
for many American families and also for industry and for state and local
governments. The economic surplus is being quickly absorbed by a
combination of debt service and government bailouts for creditors whose
Ponzi schemes are collapsing right and left, from residential to
commercial real estate and corporate takeover loans to foreign
bubble-economy credit.

This is the context in which to view the past few weeks' financial
turmoil surrounding Bear Stearns, JPMorgan/Chase and the rapidly
changing debt landscape. "The system" that the Treasury, Federal Reserve
and the New Deal agencies captured by the Bush Administration is trying
to save is an economy-wide Ponzi scheme. By that I mean that the
business plan is for creditors to lend debtors enough money for them to
pay the interest costs so as to keep current on their loans.

For the past few years this system has depended on asset prices for real
estate, stocks and bonds to be inflated by enough to enable debtors to
pledge these assets as collateral at a higher market price for more and
more new loans. But now that the real estate bubble has burst (and
indeed, as stock prices sink), the problem is how to bail out the tip of
our economic iceberg that has sunk into negative equity - a condition in
which the debts attached to property exceed its market value. Someone
must take a loss - but whom?

Normally, it is the banker or investor who takes the loss. But they are
now supposed to be "rescued". This is being presented as a return to
stability. But it was a system that never was stable to begin with. In
fact, for the rescue to work, most Americans will have to own less and
owe more, while being told that all this is the path to wealth creation
- as if it were their wealth, not that of their creditors. The Bear
Stearns/JPMorgan Chase/monoline insurance giveaway to "save the
financial system" provides a vivid illustration of how Unitary Finance
has developed a parasitic relationship with American labor in its role
as pension contributor, consumer and homeowner. The system being
subsidized enables the FIRE sector to direct and live off the productive
efforts of others - people who make real things and provide real services.

Saving Wall Street with a trillion-dollar bailout of bad mortgage debt

The bailout started on Sunday, March 16. The government and JPMorgan
Chase had reason to be embarrassed about the negotiations, for the
details trickled out on the Federal Reserve or Treasury websites and Mr
Paulson's speeches went far beyond just Chase and Bear Stearns. It
turned out that on the same Sunday on which he had negotiated the $30
billion Fed bailout, Mr Paulson started a frenetic ten days
orchestrating actions by the Treasury, Federal Reserve, and other
government agencies to earmark a trillion dollars to re-inflate
financial markets for mortgage holders and their associated creditors
and speculators. Behind the scenes, as matters turned out, the Bush
Administration was mounting a financial surge: It decided to throw
everything its mortgage financing agencies could muster to prevent
property markets from collapsing on its watch.

The surge of support for the mortgage and real estate markets was headed
by the two largest US mortgage holders and packagers: the
government-sponsored National Mortgage Association (FNMA) and Freddie
Mac. These two agencies were created to develop tradable markets for
mortgages that banks traditionally had kept on their own books by buying
home mortgages from the banks and mortgage brokers that originated them.
This created a vast new demand for mortgages by making them marketable
in large packages for institutional investors such as pension and mutual
funds. Being implicitly government-guaranteed, Fannie Mae and Freddie
Mac were able to borrow at fairly low interest rates, and sell mortgages
at a premium. Demand for these packaged mortgage securities provided an
enormous new source of lending. It also turned banks into mortgage
originators rather than mortgage holders.

Together, Fannie Mae and Freddie Mac bought more than three-fourths of
all US mortgages issued in the fourth quarter of 2007, bringing their
holdings to $1.4 trillion. However, the fact that their capital base was
under $70 billion - for a twenty to one debt-leveraging ratio - led
investors to sell their stock steadily over the past year. Rather than
insisting that Fannie Mae and Freddie Mac rebuild their capital
position, the Office of Federal Housing Enterprise and Oversight (OFHEO)
did just the opposite. It reduced their capital requirements from thirty
percent to twenty percent, and encouraged them to use this increased
leverage to pour an extra $200 billion to the nation's mortgage market.
Limits on the size of mortgage loans that these two agencies could make
were raised sharply in order to help re-inflate the troubled high-cost
California and New York property markets in particular.

Designed to bring temporary relief, this maneuver threatened to further
destabilize matters by simply kicking the can down the road. The same
applied to the Federal Housing Administration (FHA), set up in 1934 as
part of the New Deal. Its insurance fund of about $20 billion backs some
3.8 million mortgage loans totaling $365 billion, for an eighteen to one
debt-leverage ratio. On Monday, March 24, it promised $400 billion in
new mortgage credit insurance. This means that government agencies can
use their capital to lend much more money to prospective homebuyers. The
FHA, Fannie Mae and Freddie Mac also will be on the line for any losses,
"socializing the risk" to a higher degree than ever before.

What was so worrisome about this strategy was that the FHA already was
in financial straits as a result of its subprime loans. For the first
time in its history it was running a deficit. Over a third of the loans
it insured were made by home sellers to new buyers to cover their down
payment - enabling homes to be bought without any down payment at all.
(Traditionally, twenty percent has been the norm.) This was a brand-new
market, barely existing in 2000 on the eve of the Greenspan-Bush real
estate bubble. The Secretary of the Housing and Urban Development Agency
(HUD), Alphonso R Jackson, told a Senate committee: "These types of
loans have pushed F.H.A. to the brink of insolvency". And now it was to
double its activities to prop up the real estate and mortgage market.

The Federal Housing Finance (FHF) board dutifully did its part to
increase the system's debt leverage. It doubled the ability of the
twelve regional Federal Home Loan Banks (FHLB) to leverage their
purchase of mortgage securities, from three times their capital to six
times, twice the existing debt/equity ratio. The aim was to help them
serve their clients, the nation's eight thousand savings banks, S&Ls,
credit unions and insurance companies, finance the purchase of $160 to
$200 billion new mortgage-backed securities issued by Fannie Mae and
Freddie Mac. The target was for these two agencies to buy up about half
a trillion dollars worth of mortgage securities from the private sector
this year.

The Federal Home Loan Banking system also announced plans to start
offering its own "monoline" mortgage insurance against the looming
economic downturn at prices way below what private-sector insurance
writers were willing to match. The aim is to shore up the nation's
crumbling mortgage-insurance coverage at taxpayer expense. Again, the
concept of a "free market" is being subjugated in order to socialize the
losses for the FIRE sector's big players. The situation is much like the
government insurance of beachfront properties against flood damage,
paying for a chronically losing proposition at public expense. Of
course, a disproportionate number of the owners of those beachfront
properties also come from the campaign-contributing class.

Gillian Tett of the Financial Times noted that this mortgage insurance
subsidy is "likely to trigger further debate about how policymakers are
turning to state, or quasi-state, entities to stabilise the financial
sector" by addressing "an absence of the market". Instead of shaping the
market along less risky, less debt-leveraged lines, it was now another
case of the government socializing financial risk at below-market rates.
John Price, chairman of the Federal Home Loan Bank board, claimed that
this "is what Government State Enterprises are for", in view of the fact
that private insurers would charge higher rates. But the government's
present plan being coordinated by Treasury Secretary Paulson seeks to
avoid letting markets work in a way that would raise costs to Wall
Street and hence leave less revenue for homeowners to pledge for debt
service. This policy is presented sanctimoniously as lowering the price
at which the financial sector "serves" the economy, not as putting it at
risk.

The most amazing moves were still to come. On March 11 the Federal
Reserve created a new Term Securities Lending Facility to extend $200
billion in loans to primary bond and securities dealers against their
holdings of mortgages and other packaged securities as collateral. The
aim was to rapidly re-inflate mortgages that the free market was pricing
as junk, as low as twenty percent of face value.

Then came the double bombshell. In a true showing of the green on St
Patrick's Day, March 17, the Fed extended nearly unlimited credit to
non-bankers for the first time since the Great Depression. It accepted
their toxic mortgages as collateral - dubious assets that "the market"
was refusing to touch. So much for "market-based" solutions when it
comes to high finance! For the first time since the 1930s, non-banks
could borrow from the Fed's loan window against their junk mortgages,
apparently at full face value. It was too late for Bear Stearns, but
other investment bankers and brokerage houses saw the green lifeline as
the Fed opened its discount window to non-bankers, that is, to
investment bankers such as Lehman Brothers, in contrast to commercial
bankers that are regulated by the Fed.

The volume of credit seemed to be unlimited, collateralized by
mortgage-backed securities that "the marketplace" was pricing around the
levels Third World loans were selling at after Mexico's 1982 insolvency.
Labor economist Tom Palley wrote in his March 26 blog: "These subsidies
are a travesty. Goldman Sachs, Lehman Brothers and Morgan Stanley are
extraordinarily profitable. They also have been the drivers of the worst
trends in the American economy over the past generation, pushing
excessive CEO pay that has spread like a cancer throughout corporate
America, even reaching into universities and non-profits. Additionally,
they have pedaled the shareholder value paradigm that has pushed
companies to emphasize short-term gain over long-term investment, and
contributed to ripping up America's social contract. Meanwhile, their
business model has promoted speculation that is behind repeated asset
and commodity price bubbles."

It is to support this business model that the Fed and Treasury officials
seem to be making up new rules on a daily basis - rules that receive
only a superficial or perfunctory review by Congress. Critics point out
that investment bankers are not subject to Federal Reserve oversight or
other regulation. Perhaps even this does not really matter in view of
the Fed's extreme non-regulatory mode ever since Alan Greenspan's
four-term Chairmanship. Even more important, of course, is the fact that
the Fed's new clients, investment banks and brokerage houses, do not
serve the middle-class depositors in need of special protection for
their life savings. The financial investments being saved from adverse
market conditions are ultimately speculative in character.

It seems a biting irony that the institutions now being mobilized to
bail out Wall Street creditors - the Federal Home Loan Banks to pump
credit into the mortgage market, the Federal Housing Administration to
insure mortgage loans, Fannie Mae and Freddie Mac to buy and package
mortgages for bulk resale to institutional investors - were created to
help homebuyers, not their creditors and speculators. But bailing out
speculators and high finance has now becoming their primary function.
This shift has turned America's housing, mortgage and banking agencies
upside down. Wall Street of course has welcomed the capture of these New
Deal and post-1945 institutions. But their doctrinaire ideology has
accused Glass-Steagall, Social Security, and most recently
Sarbanes-Oxley regulations by the Securities and Exchange Commission
(SEC) as leading down the road to serfdom.

Politically, such bailouts require an ostensibly humanitarian cover
story. They need to be presented as a subsidy not to banks and other
wealthy creditors, but to debtors. This means that the "ideal" (that is,
most smoothly hypocritical) bailout takes the form of new credit to pay
banks and other bondholders and mortgage holders enough to keep the debt
bubble afloat. That means enough more credit to keep it growing, at
least by the amount of interest that must be paid.

The result is a true road to debt peonage. It is much more destructive -
and certainly more real - than the imaginary road to serfdom that Hayek
and other anti-government ideologues envision. While these
free-enterprise boys wring their hands and denounce government power,
their sponsors realize full well that when government steps back, the
financial sector moves in to fill the vacuum. The banks and money
managers become society's planners and resource allocators - in their
own short-term interest. This interest leads them to oppose laws
protecting, labor, consumers and debtors. This means that the "freedom"
at issue is a one-way favoritism for employers, monopolistic privilege
and creditors. What these vested interests mean by the "road to serfdom"
is an economy managed by hands other than their own, an economy
protecting the workers, consumers and debtors whom they seek to victimize.

No money left for Social Security and health insurance after the real
estate bailout?

The American public may justifiably be puzzled by how the government can
seem to come up trillions of dollars for foreign wars and banker
bailouts, but so little for them. The United States is spending an
estimated $3 trillion for an illegal war that has made us less safe, and
$1 trillion so far to rescue bankers in a way that is destabilizing the
economy. But it can't seem to secure health care or retirement security
for all Americans. On Tuesday, March 25, fresh from providing a trillion
dollars to underwrite the financial and real estate sector, Mr Paulson
revived the Bush Administration's pretense that there is no money to pay
Social Security. Yet "fixing" Social Security - if indeed there is a
problem (which is no means certain) - would be relatively easy. Merely
restoring the Bush tax cuts for the top one percent of Americans (those
earning over $414,000 a year) to the high thirty-percent tax rates of
the 1990s (nowhere near approaching the 94% top marginal rate of the
1940s, or even the seventy-percent rates of the 1970s) would provide 46%
more than the Congressional Budget Office's estimate of the Social
Security shortfall. The Administration does not acknowledge such
inconvenient truths, or do the "reporters" who simply pass on its
handouts to the mass media.

The claim that there is no prospective funding to meet the government's
Social Security and Medicare obligations was rendered blatantly
incredible in the last week of March, which saw the five-year
anniversary of the Bush Administration's war in Iraq. As its death toll
to US soldiers reached 4,000, newspaper accounts across the country
reported the calculations by Nobel Prize winner Joseph Stiglitz that the
war's cost has reached the $3 trillion mentioned above, taking into
account its legacy of interest charges and medical treatment for the
more than 25,000 troops that had been wounded or had post-traumatic and
other psychiatric stress disorders. (Mr Stiglitz recently updated his
analysis to say $3 trillion is a conservative number.)

Five years, four thousand lives, and three trillion dollars for the war
- but no money for Social Security and Medicare! Did Mr Paulson not feel
just a little bit discomfort in claiming with seeming urgency that
Social Security funding would be exhausted in just over another thirty
years, by 2041? Medicare is supposed to be in even worse shape, having
accumulated enough wage set-asides to last only until 2019, due largely
to rising health costs - which the Bush Administration refused to
control by negotiating prices with the drug companies, among others.

The historical road to serfdom is that of debt peonage to a financial
oligarchy concentrating wealth in its own hands. Contemporary
anti-government "libertarianism" creates a vacuum that the financial
sector moves to fill. The problem for society at large is that finance
finds its major gains to lie not in raising living standards, but in
promoting a free lunch for its customers - while turning corporate
profits, monopoly rent-seeking and real estate price gains into a flow
of interest to itself, by advancing the credit to finance the purchase
of these assets and privileges.

There is only one way to reverse this evolution toward debt peonage.
That is to scale back existing mortgages, especially for properties with
negative equity, to reflect the plunge in property values today -
admittedly under distress conditions, but nonetheless real constraints
on the debtor's ability to pay. Once the principal was reduced to
realistic levels, adjustable-rate mortgages would be replaced by
fixed-rate mortgages.

The problem with this solution is that to the financial institutions,
the housing crisis is not their problem. Their blame-the-victim attitude
holds it to be the mortgage holders' problem - and now increasingly the
taxpayers' problem. This perspective on how to resolve the housing
crisis can only succeed by creating a populist rhetoric for public
officials to use in promoting financial interests as if all this is in
the best interest of homeowners and other debtors.
_____

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 US, 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
edition, Pluto Press, 2002) He can be reached via his website,
mh at michael-hudson.com

http://www.counterpunch.org/hudson04142008.html


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