[R-G] [BillTottenWeblog] Congress Should Bail Out of the Bailout

[Bill Totten]

Rescue for the Few, Debt Slavery for the Many

by Michael Hudson

Counterpunch (October 13 2008)


We are now entering the financial End Time. Bailout "Plan A" (buy the
junk mortgages) has failed, "Plan B" (buy ersatz stocks in the banks to
recapitalize them without wiping out current mismanagers) is fizzling,
and the debts still can't be paid. That is the reality Wall Street
avoids confronting. "First they ignore you, then they denounce you, and
then they say that they knew what you were saying all the time", said
Gandhi. The same might be said of today's overhang of debts in excess of
the economy's ability to pay. First the policy makers pretend that they
can be paid, then they denounce the pessimists as spreading panic, and
then they say that of course students have been taught for four thousand
years now how the "magic of compound interest" keeps on doubling and
redoubling debts faster than the economy can squeeze out an economic
surplus to pay.

What has ended is the idea that "the magic of compound interest" can
make economies rich without having to work and without industry. I hope
we have seen the end of derivatives formulae seeking to make money by
playing in a zero-sum game. A debt overhang always ends either in
foreclosure of the debtor's property, or in a debt annulment to preserve
the economy's overall freedom and equity.

This means that the postmodern economy as we know it must end - either
in financial polarization and debt peonage to a new oligarchic elite, or
in a debt cancellation, a Jubilee Year to rescue society. But when the
government says that it is reviewing "all" the options, this reality is
not one of them. Treasury Secretary Henry Paulson's first option was to
buy packages of junk mortgages (collateralized debt obligations, CDOs)
to save the wealthiest institutional investors from having to take a
loss on their bad bets. When this was not enough, he came up with "Plan
B", to give money to banks. But whereas Britain and European countries
talked of nationalizing banks or at least taking a controlling interest,
Mr Paulson gave in to his Wall Street cronies and promised that the
government's stock purchases would not be real. There would be no
dilution of existing shareholders, and the government's investment would
be non-voting. To cap the giveaway to his cronies, Mr Paulson even
agreed not to ask executives to give up their golden parachutes,
exorbitant annual bonuses or salaries.

Plan A (the $700 billion to buy mortgage-backed junk that the private
sector will not buy) failed partly because it let financial institutions
avoid putting a fair value on the debt packages they were selling.
Instead of telling the truth about their financial position by marking
assets to market prices), they can "mark to model", Enron-style. We have
seen the result: A solid week of plunging stock market prices. The
public media call this a panic, but there is nothing irrational about
it. Who in their right mind would buy securities or buy into a bank
without knowing what the securities were worth? Faith in junk
mathematical models has ended.

So we still await a public response to the problem of how to write down
debts. Whose economic interest will have to give: that of debtors, as
increasingly has been the case over the past eight centuries; or that of
creditors, which have fought back to create a neoliberal economy
controlled by the FIRE sector?

It is not too late to decide which road to take, but Wall Street bankers
and creditors have taken the lead in positioning themselves. Seeing
which way the political winds were blowing, they moved to empty out the
Treasury before the November 3 elections much like medieval citizens
fleeing a horde of Mongolian raiders under Genghis Khan. "We're moving.
Clean out the cupboards", much as Lehman Brothers emptied out their
foreign bank accounts in Britain and elsewhere just before declaring
bankruptcy, taking what they could and steering it to their best friends.

The pretense was that a bailout was needed to restore confidence. But
the ensuing week showed that the claims were false. It didn't turn the
stock market around as promised. The Dow Jones Industrial Average fell
2,200 points from Wednesday, October 1 through the following Friday
October 10 - eight straight trading days, not even pausing for the usual
zigzags. Friday's plunge was 100 points a minute for the first seven
minutes - a 690 point drop to under 8000. Each 100 points was more than
a one percent drop, which was reflected on the NASDAQ. Nothing could
withstand the pressure of so many Americans cashing in their mutual
funds overnight and so many foreigners in earlier time zones putting in
sell-at-market orders.

Short sellers made one of the largest and quickest fortunes ever, and
then covered their positions by buying back the stocks they had
pre-sold. This pushed prices up even into positive territory just before
10:30 AM when George Bush began to speak. Half the financial stocks
showed gains - a sign that the Plunge Protection Team had jumped in. But
Mr Bush said nothing helpful and stocks went back into freefall, ending
down another 128 points despite the upcoming weekend G7 meeting. There
was no talk at all of reducing debt levels - only of giving more money
to banks, insurance companies and other money managers, as if "pushing
on a string" somehow would lead them to lend yet more to an already
debt-ridden economy.

If Congress really wanted to restore confidence, here's what it might
have done: First, mark to market, not to model. Investors no longer
believe America's Enron-style accounting, debt rating agencies or
monoline risk insurers. They don't trust US banks to be honest about
their financial positions. They worry about the fraud charges brought by
attorneys general in eleven states against predatory lenders such as
Countrywide and Wachovia that Citibank, JPMorgan Chase and Bank of
America were so eager to buy.

So is it too late for Congress to change its mind and repeal the
giveaway? If the $700 billion handout didn't stabilize the unsalvageable
for small investors, pension funds and even the financial sector itself,
what did it do?


What the Fed has been doing while the media have not been looking?

Let's put the giveaway in perspective. While Senators and Congressmen
subject to voters' choice were debating $700 billion for the major Wall
Street contributors to both parties (admittedly only for starters, Mr
Paulson explained), the Federal Reserve already had given even more,
without any public discussion and without the major media noticing.
Since Bear Stearns failed in March, the Federal Reserve has used the
small print of its charter to go outside its normal customers (which are
supposed to be commercial banks), to give investment banks, brokerage
houses and now large corporations almost indiscriminately some $875
billion in "cash for trash" swaps. (The statistics are released each
week in the Fed's H41 report.) Like Aladdin offering new lamps for old,
the Fed has exchanged Treasury securities for junk mortgages and other
securities that brokerage houses and investment banks did not have time
to pawn off onto OPEC, Asian sovereign wealth funds or other investors.

The press lauds Mr Bernanke as "a student of the Great Depression". If
he were, he should know that what led to the 1929 collapse were harsh US
Government creditor policies toward its World War I Allied governments.
This created a situation where the Federal Reserve had to provide easy
credit to hold interest rates artificially low so as to encourage US
investors to lend to Britain and Germany, which would use these dollar
inflows to pay their Inter-Ally arms and reparations debts. Mr
Bernanke's predecessor, Alan Greenspan, promoted easy credit simply for
ideological reasons, to enrich Wall Street by enabling it to sell more debt.

A student of the Great Depression would understand the conflicts of
interest between retail commercial banking and wholesale investment
banking and money management that led Congress to pass the
Glass-Steagall Act in 1933 - conflicts unleashed once again when
President Clinton backed then-Fed Chairman Alan Greenspan and Republican
leader (and McCain hero) Senator Phil Gramm in leading the repeal of
this act, opening up the floodgates to today's financial double-dealing
that has cost the American economy so much.

If Mr Bernanke does know this history, his behavior is simply that of an
opportunistic student of the art of political self-advancement, toadying
to Wall Street in campaigning for one last great rip-off before the Bush
Administration goes out of business. The Fed has given Wall Street newly
minted Treasury bonds, added to the national debt out of thin air. It
has done this without feeling any need to rationalize it by drawing
absurd public-relations pictures about how the government may "make a
profit for taxpayers".

The Fed Chairman is not elected democratically. He traditionally is
designated by the Wall Street financial sector that the Fed is supposed
to regulate, acting as its lobbyist for creditor interests - the top ten
percent of the population - against that of the indebted "bottom ninety
percent". This "independence of the central bank" is trumpeted as a
hallmark of democracy. But it is undemocratic, precisely by being
isolated from public control.


The Age of Oligarchy

Treasury Secretary Paulson has no such luxury. The Treasury is supposed
to represent the national interest, not that of bankers - even though
its head these days is drawn from Wall Street and acts as its lobbyist.
Mr Paulson presented his almost totalitarian giveaway gruffly to
Congress on a take-it-or-leave it basis, announcing that if Congress did
not save Wall Street from taking losses on its mountain of bad loans,
the banks were willing to crash the economy out of spite. "Please don't
make us wreck the economy", he said in effect. As Margaret Thatcher used
to say while selling off the British government's crown jewels in the
1980s, TINA: There is no alternative.

In making this bold threat Mr Paulson behaved as arrogantly as Lehman's
CEO Richard Fuld did when he tried to bluff Korea and other prospective
investors into paying the full, fictitiously high book value for his
company. (His bluff failed and Lehman went bankrupt, wiping out its
shareholders, including the employees and managers who held thirty
percent of its stock.) There turned out to be an alternative after all.
Responding to the loudest public condemnation in memory, Congress called
Mr Paulson's bluff.

What made his $700 billion Troubled Asset Relief Program (TARP) so much
more visible to the media than the Fed's actions is that Congress is
involved, and this is an election year. The level of deception and false
argument is therefore enormous - along with a few tradeoffs and tax cuts
to distract attention. Erstwhile Republican opponent Senator Jeff
Sessions of Alabama came right out and said that "This bill has been
packaged with a lot of very popular things to give it even more
momentum", so that (as The New York Times explained), "instead of siding
with a $700 billion bailout, lawmakers could now say they voted for
increased protection for deposits at the neighborhood bank, income tax
relief for middle-class taxpayers and aid for schools in rural areas
where the federal government owns much of the land".

Left behind while Wall Street's believers in the rapture of free markets
were swept up to heaven by "socialism for the rich" have been mortgage
debtors, student-loan debtors, the Pension Benefit Guarantee Corporation
(PBGC, some $25 billion short), the Federal Deposit Insurance
Corporation (FDIC, about $40 billion short), as well as Social Security
which, we are warned, may run up a trillion dollar deficit thirty or
forty years down the line. Only the wealthiest have been beneficiaries,
not voters, homeowners and other debtors.

Still, Congress was panicked into acting on Friday, October 3, because a
week earlier, September 26, stocks fell 777 points after Congressmen
responded to an unprecedented volume of voter protest against the
bailout. "This sucker could go down", President Bush warned as Wall
Street's lobbyists blamed the market downturn to the failure of Congress
to preserve the "monetary system", and specifically the banks and
insurance companies that already had lost their net worth and were
plunging deeper into Negative Equity territory. Democratic leaders
Barney Frank and House Speaker Nancy Pelosi said, in effect, "Look what
you've done! You irresponsible politicians are grandstanding on
principle, and wiping out peoples' stock market savings and threatening
their pension funds. If you don't give Wall Street firms enough money to
cover their losses so that everyone wins, they'll kill the economy until
they get their way". Well, they didn't quite say this, but that was
basically their message. It certainly was Wall Street's message: "Wall
Street to Economy: Your money or your life".

So Congress gave in. Democrats ran like lemmings to "save the economy".
Yet the stock market fell a few hundred points, and kept on plunging all
week long, much worse and much faster than had occurred right after
Congress had initially defeated the bill.


The "Reality Problem"

What did the "free market" theory underlying the giveaway leave out of
account? For starters, "the monetary system" turns out to be a euphemism
for the fortunes of financial gamblers using junk mathematics (the
Merton-Scholes derivatives formula) based on junk economics (blessed
with Nobel Prizes) to buy, speculate and even to insure junk mortgages,
junk bonds and junk commercial paper and derivatives based on their
relative prices. So what is left out first of all was full knowledge of
the value of what is being bought and sold. Mark-to-market models leave
the price up to the investment bankers. If trust existed and there
really was honor among these thieves, a government bailout would not be
necessary, because "the market" could clear.

"Free market" ideology assumes that each party will act in his or her
self-interest. If this is so, why should foreign governments accumulate
more dollar claims on the US Treasury, which already owes their central
banks $4 trillion? When there hardly were enough Treasury securities to
go around even as the United States ran unprecedented federal budget
deficits, US officials urged these banks and sovereign wealth funds to
buy packaged mortgages yielding a higher rate of return. And at least by
buying these bonds, foreign governments would not be accused of funding
America's war in Iraq that most of their voters opposed. But investors
made a fatal mistake in believing US representations of the value of
their junk-mortgage packages. This trust has now been lost, all the more
so since the bailout's permission to keep on "marking to market".

Congress thought that its $700 billion would distract attention at least
until the November 4 election. But to no avail. Markets fell 157 points
on Giveaway Friday, and kept on going down another 800 points on Monday,
October 6 (to about 9500) before bouncing 500 points off the floor, only
to fall even more through Friday. So the giveaway failed in its stated
purpose to rescue stock market investors ("peoples' capitalism") or
their pension funds. But that was not its real purpose. The time simply
had come to clear out and take whatever one could.

Making banks and insurers in the zero-sum derivative game whole, so that
winners can collect their bets while losers can sell their bad
investments to the Treasury, is supposed to re-inflate the credit
pyramid. The idea is to solve the debt problem with yet more debt to
prop up housing prices once again to unaffordable levels! This is not a
long-term solution, but it would give insiders enough time to arrange a
do-over and get out of the game more quickly, to sell out their junk
mortgages and junk bonds to the proverbial "greater fool" - in this
case, the "greater fool of last resort", the US Treasury, as long as it
can be run by Mr Paulson or, under Mr Obama, perhaps the former
Goldman-Sachs official Robert Rubin.

The banks are to "earn" their way out of their negative equity position
by selling more of their product - credit - to increase the economy's
debt levels and hence receive more interest payments. The problem is
that most families are already "loaned up". They have no more
discretionary income to pledge to carry more debt. Without writing down
their debts, there will be no fresh lending, and hence no source of
credit and purchasing power for new autos, appliances, goods and
services in general. Debt deflation is being imposed on the "real"
economy. Creditors and speculators alone are to be made whole.

If no revenue was available for future Social Security, public health
care and repair the nation's depleted infrastructure before this
giveaway, think of how bare the cupboard must be now that the government
has run up the recent trillions of dollars in new debt rather than
writing off a penny of the bad mortgage debts being blamed for causing
the debacle.

We can see where this is leading. The wealthiest one percent of the
population will come into possession of even more returns to wealth than
the 57 percent that they are now taking. In contrast to the Statue of
Liberty's inscription "give me your poor ... yearning to breathe free",
the Fed - and now the Treasury, with Congressional blessing - is taking
from the public purse and giving to America's wealthiest investors and
insiders. This "Robin Hood in Reverse" program is being done without
strings, without asking banks to stop paying dividends, exorbitant
executive salaries and golden parachutes, and without taking over banks
with negative net worth of the kind that many homeowners are experiencing.

Nobody is talking about a debt write-down or moratorium. The subprime
mortgage problem could have been solved by writing down just $1 or $2
trillion of the face value and interest rates of predatory loans.
Instead, the $10+ trillion in financial-sector damage in recent weeks
reflects Wall Street's fraudulent packaging and sale of junk mortgages
at unrealistically high prices, using junk mathematics to calculate junk
derivatives and sell them to gullible investors who believe that the
pretenses these mathematics, credit ratings and projected income have a
basis in reality.

The amazing feature of today's crash is how many Wall Street firms
actually believed that the game of musical financial chairs could go on
before they had to stop dancing and indeed, escape from the room. I
remember one day back in the 1970s when I warned Frank Zarb of Lazard
Freres about the likelihood of Third World debt defaults, and suggested
that the firm should do an ability-to-pay analysis. "We don't have to do
any such thing", he replied. "We have the schedule of what they owe
right here in this IMF report". It was a thick printout of the scheduled
debt service for an African country that soon became insolvent. But Wall
Street's mentalité was that of Herbert Hoover on the eve of the Great
Depression: A debt is a debt, and that is that. The response is to blame
the victim, as if the irresponsibility lies with debtors rather than
creditors.

No reversal of the Bush tax cuts is offered to re-inflate the economy,
no move toward more progressive taxation of Wall Street speculators who
pay only a fifteen percent "capital gains" tax rate instead of the much
higher income-tax and FICA withholding rates that wage-earners pay.
(Wall Street has its own golden parachute program, so why should it pay
for Social Security for the rest of society?) There is to be no
reduction in the special tax benefits for real estate, whose tax
favoritism led to the crisis by "freeing" more income from the tax
collector to be pledged to mortgage bankers as interest. The Bubble
Economy is to be re-inflated by Fannie Mae, Freddie Mac and the FHA
lending to help buyers bid up housing and commercial office prices once
again to a rate that promises to impose debt peonage on homeowners.

The budget deficit will soar, without any prosecution of tax evasion
scams by UBS or KPMG. Instead of a fiscal or regulatory comet driving
these dinosaurs to extinction, the climate has turned more conducive to
their proliferation. Our Age of Deception is to be locked in even more
tightly. The Congressional bailout's suspension of mark-to-market rules
to rely on Wall Street's "self-regulation" should win a prize for
Oxymoron of 2008 as investors have no clue as to what financial assets
are worth. No wonder lending has dried up, especially to banks themselves.

Just as financial victims fail to vote and support their self-interest,
predators also turn out to pursue self-defeating "free market"
strategies. The financial sector's short-termism is the greatest enemy
to its survival. It has translated its wealth into a fatal political
control of its legal climate, blocking [with the explicit support of
Barack Obama, Editors] Congressional efforts to rewrite the oppressive
bankruptcy laws that credit-card banks lobbied so hard to pass, [with
vital help from Joe Biden, the senior senator from credit card company
HQ, the state of Delaware, Editors] crucial. These hard bankruptcy terms
prevent the courts from renegotiating homeowner debts to keep property
occupied, accelerating the real estate price collapse. The result is
today's negative equity, posing the question of just who is to bear the
cost of bring debts back in line with the economy's ability to pay. Will
it be the financial institutions that sponsored asset-price inflation
and lobbied for deregulation of lenders? Or, will it be the debtors who
thought they were riding the wave to get an inflationary free lunch?

Instead of requiring creditors to absorb losses on the excess of debts
over what can be paid, the debts are being kept in place, not scaled
back to what the economy can pay. The government is to make creditors
and computerized derivatives speculators whole - and will act as
collecting agent for the overhead of bad debts the economy has run up.

Today we can see the debt-fueled bubble of asset-price inflation that
Alan Greenspan trumpeted as real wealth creation for what it really is -
credit creation to bid up real estate, stock market and packaged-debt
prices. Tangible capital formation has been left out of account, as if
postindustrial economies no longer need it.

Will voters see the asymmetry in Congress's failure to offer debt relief
for homeowners as real estate prices plunge below the mortgages that are
owed? Will its members be blamed for not rewriting the nation's
bankruptcy laws to free families from debt peonage - and free housing
markets from the price declines that result from today's proliferation
of foreclosure sales? For that matter, will there be no relief for
corporations having to cut back investment in order to service their
junk bonds and other debts with which Wall Street's corporate raiders
and "shareholder activists" have loaded then down?

Evidently not.

_____

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 & Company), 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.com/hudson10132008.html


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