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Bankers Shake Down Congress and the G-20

by Michael Hudson

www.counterpunch.org (November 17 2008)


The financial press has been negligent in reporting how last week's two
top financial stories are linked: first, the testimony by Treasury
Secretary Henry Paulson and his evasive Interim Assistant Secretary Neel
Kashkari defending why they followed a completely different giveaway
plan to the banks (their own Wall Street constituency) than what
Congress authorized; and second, the G-20 standoff among the world's
leading finance ministers this weekend.

The dollar glut is one of the key factors that has aggravated the
junk-mortgage problem in recent years. Looking forward, if foreign
countries are no longer to invest their dollar inflows in Fannie Mae,
Freddie Mac and toxic packaged mortgage derivatives, what are they to do
with these dollars? The US Government refuses to let foreign government
funds acquire anything but financial junk such as the plunging Citibank
shares that Arab oil sheikhs have bought.

Here's the problem that faced global finance ministers this weekend: The
US payments deficit has been pumping excess dollars into foreign
economies, whose recipients have turned them over to their central
banks. These central banks have saved their currencies from rising (and
thus losing foreign markets by making their exports more expensive) by
buying Treasury bonds so as to support the dollar's exchange rate by
recycling their dollar inflows back to the United States - enough to
finance most of our federal budget deficit, and indeed much of Fannie
Mae's mortgage lending as well.

Mr Bush for his part would like to shape the global financial system so
that foreign economies continue giving the United States a free lunch.
US officials control the International Monetary Fund and World Bank and
use these institutions to impose neoliberal privatization policies on
foreign countries, thereby destroying the post-Soviet economies,
Australia and New Zealand since the 1990s, just as they destroyed Third
World economies from the 1960s through the 1980s. That's why, until last
month, the IMF had lost its clients and was almost universally shunned.
French President Nicolas Sarkozy led foreign calls for a "new Bretton
Woods", by which he meant not just an upgrading of US dollar hegemony
but a different world order - more regulated with a fairer quid pro quo.
And as the Financial Times reported: "Spain's governing Socialist party
summed up the heady mood in some parts of Europe in an internal
document, seen by El Mundo, that identified the summit as a moment of
historic change. 'The origins of this crisis lie in neoliberal and
neoconservative ideology', it said."

Mr Paulson and other US officials have long been promising foreign
finance ministers that Fannie Mae and Freddie Mac securities are as good
as US Treasury bonds while yielding higher interest. The resulting
investment in these two mortgage-packaging agencies was a major factor
in their $200 billion bailout. Letting their securities go under would
have ended Dollar Hegemony for good. So getting foreign acquiescence in
financing future US balance-of-payments deficit is inextricably bound up
with how to resolve the US financial and real estate bubble.

Its bursting has prompted Congress to authorize $700 billion supposedly
to re-inflate the property market. The Troubled Asset Relief Program
(TARP) gives Wall Street money in the hope that it will lend enough to
start inflating asset prices again, enable borrowers to get rich by
going into debt again - "wealth creation" Alan Greenspan-style. It is as
if the neoliberal bubble years 2002-07 were a golden age to be
recovered, not the road to financial perdition. In doing this, Mr
Paulson is using junk economics to cope with the junk mortgage problem
that in turn was based on junk mathematical models. His problem is to
keep the fantasy going.

Congress has caught onto the game being played. Now that the bailout
looks like a last-minute giveaway to insiders while the giving is good,
Congress held hearings last week to ask why the Treasury abandoned its
plan to buy the "troubled assets" (junk mortgages) that Mr Paulson had
originally said was the problem. Why has the Treasury bought $250
billion of ersatz "preferred common stock" in banks at prices far above
what private investors such as Warren Buffett paid?

Drawing a picture of a just-pretend world to rationalize Wall Street's
free lunch, Mr Paulson sought to deflect the issue by postulating a
series of "ifs". The Treasury's $250 billion in bank stock would give
lenders money that might be used to re-inflate the credit supply if
banks chose to re-enter the commercial paper market and provide more
mortgages on easier terms. This trickle-down patter talk is what passes
for neoliberal economic theory these days. The fantasy is for banks to
restore "balance" by granting more credit, increasing the indebtedness
of bank customers so as to restore the housing market to its former
degree of unaffordability.

Congressional interrogators pointed out that banks were not lending more
money. Mortgage interest rates have risen, not fallen, even though the
Fed is supplying banks with credit at only a quarter of a percentage
point (an average of about 0.30 per cent last week). Credit standards
(understandably) have been tightened to require prospective buyers to
put up more of their own money. Foreclosures and evictions are up and
real estate prices continue to plunge. Also plunging almost straight
down has been the Dow Jones Industrial Average, sinking below the 8000
mark last week to the lowest levels in years. Nothing is working out the
way Mr Paulson promised.

The word being used most by Treasury officials these days is
"unexpected". At his subcommittee hearing on Friday, November 14, Dennis
Kucinich asked Mr Paulson's sidekick, Neel Kashkari, whether the
Treasury's lack of realistic foresight was an innocent error or a case
of bait and switch. Mr Kashkari stonewalled by repeating a "talking
point" loop-tape claiming that giveaways were the way to get the economy
"moving" again. The banks would use their newfound power to help
customers run back into debt even more deeply, presumably at the
exponential rates needed to re-inflate property and stock prices

Republican Congressman Darrill Issa asked just when the Treasury decided
to dump the law as written and pursue an alternative giveaway to Wall
Street rather than help defaulting homeowners. Why hasn't it done what
the law that Mr Paulson himself insisted that Congress agree to -
arrange orderly debt write-downs by using the promised $50 billion of
public money to buy mortgages headed for foreclosure, and re-set
unrealistically high mortgages to reflect current price levels?
Renegotiating bad mortgages down to this price for existing
owner-occupants - or selling the property to a buyer who could afford
fair terms - would avert the distress sales that are poisoning local
property markets. Isn't this what the Congressional plan called for,
after all?

Mr Kashkeri kept trying to run out the time clock by explaining rote
Treasury procedure. He assured the committee that he worried each night
about the fate of homeowners, and said that Mr Paulson also was wringing
his hands in empathy, but they had found it much better to give money to
the banks in the hope that they would show  similar concern for their
customers. The committee members simply gave up when it became apparent
that the Treasury officials were stonewalling, just as the Fed has
stonewalled Congress by refusing to give any details of the $850 billion
giveaway it's been conducting under its own cash-for-trash program. On
November 12, Mr Paulson gave his excuse: "We changed our strategy when
the facts changed".

What were these facts? For starters, the Federal Reserve found that it
was able to pump an even larger amount into the "cash for trash" program
than the Treasury originally was to have provided. The Treasury plan
would have obliged the banks to take a loss by selling their "troubled
assets" (junk mortgages) at today's post-bubble prices. Bankers don't
like to take losses. That's what the government is supposed to do. The
Fed can do anything it wants in order to "stabilize markets", under an
umbrella clause inserted into its Act for just such purposes. Applying
the "privatize the profits, socialize the losses" rationale that bank
lobbyists have polished over the past century, it has decided that the
best way to "stabilize the economy" is to swap Treasury bonds for
high-risk junk assets at face value, saving the banks from having to
take a loss.

The more wealth that is concentrated at the top of the economic pyramid
and the more banks that can be consolidated into just a market-setting
few, the more "stable" markets will be. This is the neoliberal economic
doctrine used to justify the Fed's purchase of junk mortgages, junk
bonds and the bad gambles in insuring derivatives that AIG had drawn up.
One can only conclude that Mr Paulson was knowingly deceptive when he
told Congress on November 12 that the government has found a better way
for the giveaway to trickle down from the banks to the credit markets
than to buy their bad loans. It has indeed been doing just this, but via
the Fed at full price and in secret, away from the prying eyes of
Congress rather than through the Treasury program that Congress
authorized under more current market-oriented terms intended to protect
"taxpayer interests". The Fed values junk mortgages at the high fantasy
prices that banks, AIG and other companies had bought them  for, saving
them from having to take a loss. Hedge funds and speculators who had
bought junk-insurance from AIG were made whole, and AIG stockholders
were saved by the infusion of government capital so that players would
not have to take losses in the Wall Street casino.

Now that the Fed is doing this, the Treasury can turn to its own form of
giveaway: buying bank stocks at far above their market price (that is,
the price paid by investors such as Warren Buffett for Goldman Sachs
stock), on terms that permit the banks to turn around and use the money
to buy other banks, pay out as dividends to shareholders or pay high
executive salaries rather than helping mortgage debtors. "I don't think
the government should put money into failing institutions", Mr Kashkari
assured Congress, explaining that the bailout of AIG, Fannie Mae and
Freddie Mac would be in vain without yet further government bailouts.
Representative Kucinich's final remark to Mr Kashkari was: "That
statement that you just made, you will hear about for the rest of your
career".

The internal contradiction here is that why the Republican logic of
breaking up Fannie Mae and Freddie Mac into smaller companies does not
apply to the commercial banking system. Rather than consolidating the
banking system in the hands of New York and East Coast banks, why
shouldn't the government break up financial institutions "too big to
fail"? Instead, the Treasury is simply investing in stocks of banks,
leaving existing stockholders in place rather than wiping them out.

Mr Paulson under George Bush in 2008 is looking like the US counterpart
to Anatoly Chubais under Boris Yeltsin in 1996. Just as Russian
neoliberals led by Chubais were promoted by Clinton Treasury Secretary
Robert Rubin of Goldman Sachs, today's Wall Street power grab to replace
the government as the economy's central planner is being orchestrated by
another Treasury Secretary from Goldman Sachs, empowered to decide which
kleptocrats are to receive what public resources and on what terms,
aided by "Helicopter" Ben Bernanke at the Federal Reserve. Mr Bernanke's
famous quip about helicopters dropping money to get the economy moving
seems to be limited to Wall Street for use in buying financial assets,
not real goods and services for the population at large.

The road to G-20

Speaking on Thursday, November 13, before the Manhattan Institute, a
lobbying organization for finance and real estate, President Bush
repeated the myth that foreign countries recycle so many dollars to
America because of our "strong economy" and free markets.

The reality is quite different. There is no such thing as a "free
market". For a few days after announcement of the $700 billion giveaway,
some knee-jerk opponents of government spending accused this of being
"socialism", but they quickly discovered that not all government
spending is socialist. Regardless of what economic system is followed,
all markets are planned, and have been ever since calendars were
developed back in the Ice Age. Most market structures throughout history
have been organized in a way that provides the vested interests with a
free lunch. This remains the essence of post-feudal capitalism - or as
some have expressed it, corporativism.

What happens in practice is that foreign central banks recycle the
dollars that their exporters and asset sellers receive because (as noted
above) their currencies would rise if they failed to do this. That would
price their exports out of world markets, leading to unemployment.
Foreign countries thus are in a dollar trap. They send their savings to
finance the domestic US Government budget deficit instead of helping
their own domestic economics, because they have not been able to create
an alternative to the dollar. Next to Treasury debt, real estate
mortgages are the only category large enough to absorb the excess
dollars being thrown off by the US payments deficit - thrown off, that
is, by US military spending abroad, consumer spending to swell the trade
deficit, and investment outflows as investors here and abroad
diversified their holdings outside of the United States. The upshot is
that world monetary reserves have come to consist of central bank loans
to finance the US bubble economy. But the knee-jerk deregulatory
philosophy of the Clinton and Bush eras has killed the US investment market.

What makes this dynamic unstable is that US exports become even less
competitive as higher housing costs and debt-service charges push up the
cost of living and doing business. The more dollars foreign countries
recycle, the less the US economy will be able to work off its debts by
exporting more. So the dynamic is guaranteed to be a losing game for
foreign governments - unless anyone can explain how the United States
can generate the $4 trillion to repay its debt to the world's central
banks. To make matters worse, the dollar's downward drift against the
euro and sterling obliges foreign creditors to take a loss on their
dollar holdings as denominated in their own currencies.

Nobody has found a "market-oriented" solution to this problem. That is
what doomed the G-20 meetings this weekend to failure, just as there
could be no agreement at the G7 meetings a few weeks ago. In the face of
US Treasury dreams of re-inflating the mortgage market, Europe is trying
to draw the line at financing a losing proposition. But now that gold no
longer is the means of settling balance-of-payments deficits, foreign
central banks lack an alternative to the US dollar to hold their
monetary reserves. This leaves them with (1) US Treasury securities, and
(2) US mortgage securities. Recent years have seen a further
diversification via "sovereign wealth funds" into (3) direct ownership
of mineral resources, industrial companies, privatized national
infrastructure and other equity investment rather than debt. But rather
than welcoming this, the US Government seeks to limit foreign central
banks to buying junk mortgages, junk bonds and other financial garbage.
To call this "market equilibrium" is to indulge in the feel-good argot
that fogs today's international financial dialogue.

To put matters bluntly, the issue at the G-20 meetings is mistrust of
the unregulated US banking system and, behind it, government
"regulators" who refuse to regulate. China and other foreign dollar
recipients have been treating the dollar like a hot potato, trying to
spend it on buying foreign minerals, fuels and other assets from any
country that will accept payment in dollars. Most of the takers are
third world countries still committed to paying the heavy dollarized
debts owed to the World Bank and other global creditors. The price of
their remaining in the Bretton Woods system is to sacrifice their public
domain in a kind of pre-bankruptcy sale rather than repudiating their
debts under the "odious debt" and "fraudulent conveyance" escape valves.
What is needed is not to "reform" the World Bank and IMF, but to replace
them. But that is another story, one that other countries dared not even
bring up at the November 15-16 meetings.

Euroland is officially in a recession for the first time since the birth
of the single currency. Part of the reason is that its member countries
have felt obliged to use their monetary surpluses to support the dollar
- and hence, the US Treasury's budget deficit - instead of supporting
their own domestic economies. Just before flying to America this
weekend, French President Nicolas Sarkozy announced his position: "The
dollar, which at the end of World War II was the only world currency,
can no longer claim to be the sole world currency ... What was true in
1945 can no longer be true today". Stating this fact was not a matter of
'courage', but 'good sense'. Italian Prime Minister Silvio Berlusconi
made a point of defending Russia, criticizing the US for 'provoking'
Moscow with its missile defense shield. But Mr Paulson insisted that the
global financial crisis was "no nation's fault".

US officials chose to brazen it out, including a new wave of American
protectionism for the auto industry in what may be a foretaste of
economic nationalism to come. "Bankers complain that the financial
rescue plans put in place in many countries distort competition because
they operate on very different terms while others say that the bail-outs
under consideration for US carmakers represent a classic effort to
protect national champions that could inspire copycat efforts
elsewhere". So wrote Krishna Goha in the Financial Times, describing
why, when  G-20 finance ministers reaffirmed their support for free
trade, they were talking largely at cross-purposes.

The past eight years have demonstrated the folly of imagining that the
stock market and real estate can provide steady rates of return that
compound into exponential increases in savings sufficient to pay
retirement income and make homeowners and small investors rich without
really having to work. Money managers advertise "Let your money work for
you", but only people actually work. Financial returns are paid in the
form of command over labor power - workers "doing time". What banks do
provide is debt, and this remains in place after the force of
asset-price inflation is spent and market prices fall below liabilities
to cause Negative Equity. That is how economic bubbles operate. But to
hear Wall Street's neoliberals tell the story, it is not necessary to
pay retirees out of what is produced. Finance capitalism can replace
industrial capitalism without a "real" economic base at all.

Who Really Gets the "Free Lunch"?

So much for the material conditions of production! We can all live free
as financial engineering replaces industrial engineering. The Treasury
is now reported to be discussing bailouts for credit card issuers by
taking over their bad debts. The banks presumably would even be able to
charge the government for the accumulation of exorbitant penalty fees.

The banks and Wall Street are threatening to wreck the economy by "going
on strike" and creating a credit squeeze forcing foreclosures and
economic collapse, if Congress and the Federal Reserve don't save them
from taking a loss on their bad loans and financial derivatives.
Foreigners also must play a subordinate role in this game, or the
international financial system itself will be collapsed. Financial
customers must absorb the loss.

The most reasonable response to this brazen stance may be to return the
Federal Reserve's monetary functions to the US Treasury. This is where
they were conducted with great success prior to 1913. Back in the 1930s
the "Chicago Plan", put forth in the wreckage of the banking system's
and Wall Street misbehavior that aggravated the Great Depression,
proposed to turn commercial banking into classic-style savings banks
with 100 per cent reserves. A modernized version is put forth in the
American Monetary Institute's proposed Monetary Reform Act as an
alternative to the dysfunctional high finance that Wall Street lobbyists
have created as a Frankenstein debt-selling machine. The US economy has
been living on a combination of foreign dollar recycling and bank credit
that has been used simply to "create wealth" by inflating asset prices,
not by financing new capital formation.

As matters have turned out, the banks have gone broke doing this. The
Treasury has given them trillions of dollars of aid, and even more as
special tax favoritism, loan and deposit insurance guarantees. This can
only continue as long as banks can make the inevitable collapse of
compound interest schemes appear to be unthinkable. That attempt is what
doomed the G-20 meetings this weekend, and it will doom any future US
administration that tries to follow in its footsteps.

_____

Michael Hudson is a regular CounterPunch contributor. He is a former
Wall Street economist He has advised the US, Canadian, Mexican and
Latvian governments, as well as the United Nations Institute for
Training and Research (UNITAR). He is a professor at University of
Missouri, Kansas City (UMKC) and 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/


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