[R-G] [BillTottenWeblog] America's Own Kleptocracy

[Bill Totten]

The Market and the Terminator Machines

by Michael Hudson

www.counterpunch.org (September 20/21 2008)

	
Nobody expected industrial capitalism to end up like this. Nobody even
saw it evolving in this direction. I'm afraid this failing is not
unusual among futurists: The natural tendency is to think about how
economies can best grow and evolve, not how it can be untracked. But an
unforeseen road always seems to appear, and there society goes off on a
tangent.
	
What a two weeks! On Sunday, September 7, the Treasury took on the $5.3
trillion mortgage exposure of Fannie Mae and Freddie Mac, whose heads
already had been removed for accounting fraud. On Monday, September 15,
Lehman Brothers went bankrupt, when prospective Wall Street buyers
couldn't gain any sense of reality from its financial books. On
Wednesday the Federal Reserve agreed to make good for at least $85
billion in the just-pretend "insured" winnings owed to financial
gamblers who bet on computer-driven trades in junk mortgages and bought
counter-party coverage from the AIG (the American Insurance Group, whose
head Maurice Greenberg already had been removed a few years back for
accounting fraud). But it is Friday, September 19, that will go down as
a turning point in American history. The White House committed at least
half a trillion dollars more to re-inflate real estate prices in an
attempt to support the market value of junk mortgages - mortgages issued
far beyond the ability of debtors to pay and far above the going market
price of the collateral being pledged.
	
These billions of dollars were devoted to keeping a dream alive - the
accounting fictions written down by companies that had entered an unreal
world based on false accounting that nearly everyone in the financial
sector knew to be fake. But they played along with buying and selling
packaged mortgage junk because that was where the money was. Even after
markets collapse, fund managers who steered clear were blamed for not
playing the game while it was going. I have friends on Wall Street who
were fired for not matching the returns that their compatriots were
making. And the biggest returns were to be made in trading in the
economy's largest financial asset - mortgage debt. The mortgages
packaged, owned or guaranteed by Fannie and Freddie alone exceeded the
entire US national debt - the cumulative deficits run up by the American
Government since the nation won the Revolutionary War!
	
This gives an idea of just how large the bailout has been - and where
the government's (or at least the Republicans') priorities lie! Instead
of waking up the economy to reality, the government has thrown all its
resources to promote the unreal dream that debts can be paid - if not by
the debtors themselves, then by the government - "taxpayers", as the
euphemism goes.
	
Overnight, the US Treasury and Federal Reserve have radically changed
the character of American capitalism. It is nothing less than a coup
d'etat for the class that FDR called "banksters". What has happened in
the past two weeks threatens to change the coming century -
irreversibly, if they can get away with it. This is the largest and most
inequitable transfer of wealth since the land giveaways to the railroad
barons during the Civil War era.
	
Even so, there seems little sign that it even may end the free-market
patter talk by financial insiders who have managed to avert public
oversight by appointing non-regulators to the major regulatory agencies
- and thus created the mess that Treasury Secretary Henry Paulson now
says threatens the bank deposits and jobs of all Americans. What he
really means, of course, are simply the largest Republican campaign
contributors (and to be fair, also the largest contributors to
Democratic candidates on key financial committees).
	
A kleptocratic class has taken over the economy to replace industrial
capitalism. Franklin Roosevelt's term "banksters" says it all in a
nutshell. The economy has been captured - by an alien power, but not the
usual suspects. Not socialism, workers or "big government", nor by
industrial monopolists or even by the great banking families. Certainly
not by Freemasons and Illuminati. (It would be wonderful if there were
indeed some group operating with centuries of wisdom behind them, so at
least someone at least had a plan.) Rather, the banksters have made a
compact with an alien power - not Communists, Russians, Asians or Arabs.
Not humans at all. The group's cadre is a new breed of machine. It may
sound like the Terminator movies, but computerized Machines have indeed
taken over the world - at least, the White House's world.
	
Here is how they did it. AIG wrote insurance policies of all sorts of
things that people and businesses need: home and property insurance,
livestock insurance, even aircraft leasing. These highly profitable
businesses were not the problem. (They therefore will probably be sold
off to pay the company's bad gambles.) AIG's downfall came from the $450
billion - almost half a trillion - dollars it was on the hook for as a
result of guaranteeing hedge-fund counterparty insurance. In other
words, if two parties played the zero-sum game of betting against each
other as to whether the dollar would rise or fall against sterling or
the euro, or if they insured a mortgage portfolio of junk mortgages to
make sure that they would get paid, they would pay a teeny tiny
commission to AIG for a policy promising to pay if, say, the $11
trillion US mortgage market should "stumble" or if losers placing
trillions of dollars in bets on foreign exchange derivatives, stock or
bond derivatives should somehow find themselves in a position that so
many Las Vegas patrons are in, and be unable to come up with the cash to
cover their losses.
	
AIG collected billions of dollars on such policies. And thanks to the
fact that insurance companies are a Milton Friedman paradise - not
regulated by the Federal Reserve or any other nation-wide agency, and
hence able to get the proverbial free lunch without government oversight
- writing such policies was done by computer printouts, and the company
collected massive fees and commissions without putting in much capital
of its own. This is what is called "self-regulation". It is how the
Invisible Hand is supposed to work.
	
It turned out, inevitably, that some of the financial institutions that
made billion-dollar gambles - usually in the form of a thousand
million-dollar gambles in the course of a few minutes or so, to be
precise - couldn't pay up. These gambles all occur in microseconds, at
strokes of a keyboard almost without human interference. In that sense
it is not unlike alien pod people taking over. But in this case they are
robot-like machines, hence the analogy I drew above with the Terminators.
	
Their sudden rise to dominance is as unforeseen as an invasion from
Mars. The nearest analogy is the invasion of the Harvard Boys, World
Bank and USAID to Russia and other post-Soviet economies after the
Soviet Union was dissolved, pressing free-market giveaways to create
national kleptocracies. It should be a worrying sign to Americans that
these kleptocrats have become the Founding Fortunes of their respective
countries. We should bear in mind Aristotle's observation that democracy
is the political stage immediately preceding oligarchy.
	
The financial machines that placed the trades that bankrupted AIG were
programmed by financial managers to act with the speed of light in
conducting electronic trades often lasting only a few seconds each,
millions of times a day. Only a machine could calculate mathematical
probabilities factored in regarding the squiggles up and down of
interest rates, exchange rates and stock and bonds prices - and prices
for packaged mortgages. And the latter packages increasingly took the
form of junk mortgages, pretending to be payable debts but in reality
empty flak.
	
The machines employed by hedge funds in particular have given a new
meaning to Casino Capitalism. That was long applied to speculators
playing the stock market. It meant making cross bets, lose some and win
some - and getting the government to bail out the non-payers. The twist
in the past two weeks' turmoil is that the winners cannot collect on
their bets unless the government pays the debts that the losers are
unable to cover with their own money
	
One would have thought that this requires some degree of control over
the government. The activity probably never should have been licensed.
In fact, it never was licensed, and hence never regulated. But there
seemed to be a good reason: Investors in hedge funds had to sign a paper
saying that they were rich enough to afford to lose their money on this
financial gambling. Your average mom and pop investors were not
permitted to participate. Despite the high rewards that millions of tiny
trades generated, they were deemed too risky for the uninitiated lacking
trust funds to play with.
	
A hedge fund does not make money by producing goods and services. It
does not advance funds to buy real assets or even lend money. It borrows
huge sums to leverage its bet with nearly free credit. Its managers are
not industrial engineers but mathematicians who program computers to
make cross-bets or "straddles" on which way interest rates, currency
exchange rates, stock or bond prices may move - or the prices for
packaged bank mortgages. The packaged loans may be sound or they may be
junk. It doesn't matter. All that matters is making money in a
marketplace where most trades last only a few seconds. What creates the
gains is the price fibrillation - volatility.
	
This kind of transaction may make fortunes, but it is not "wealth
creation" in the form that most people recognize. Before the
Black-Scholes mathematical formula for calculating the value of hedge
bets, this kind of put and call option was too costly to provide much
profit to anyone except the brokerage houses. But the combination of
powerful computers and the "innovation" of almost free credit and free
access to the financial gambling tables has made possible a frenetic
back-and-forth maneuvering.
	
So why has the Treasury found it necessary to enter this picture at all?
Why should these gamblers be bailed out, if they had enough to lose
without having to become public wards by going on welfare? Hedge fund
trading was limited to the very rich, for investment banks and other
institutional investors. But it became one of the easiest ways to make
money, loaning funds at interest for people to pay out of their
computer-driven cross-trades. And almost as fast as it was made, this
revenue was paid out in commissions, salaries and annual bonuses
reminiscent of America's Gilded Age in the years prior to World War I -
years before the income tax was introduced in 1913. The remarkable thing
about all this money was that its recipients didn't even have to pay
normal income tax on it. The government let them call it "capital
gains", which meant that the money was taxed at only a fraction of the
rate that incomes were taxed.
	
The pretense, of course, is that all this frenetic trading creates real
"capital". It certainly does not do so in the classical 19th-century
concept of capital. The term has been decoupled from producing goods and
services, hiring wage labor or from financing innovation. It is as much
"capital" as the right to conduct a lottery and collect the winnings
from the hopes of the losers. But then, casinos from Las Vegas to
riverboats have become a major "growth industry", muddying the language
of capital, growth and wealth itself.
	
For the gaming tables to be closed and the money paid out, the losers
must be bailed out - Fannie Mae, Freddie Mac, AIG and who knows what to
come? This is the only way to solve the problem of how companies that
already have paid out their revenue to their managers and stockholders
instead of putting it in reserves are to collect their winnings from
insolvent debtors and insurance companies. These losers also have paid
out their income to their financial managers and insiders (along with
the usual patriotic contributions to the political candidates on the key
committees in charge of deciding the nation's financial structuring).
	
This has to be orchestrated well in advance. It is necessary to buy
politicians and give them a plausible cover story (or at least a
well-crafted set of poll-tested euphemisms) to explain to voters just
why it was in the public interest to bail out gamblers. Good rhetoric is
needed to explain why the government should let them go into a casino
and let them keep all their winnings while using public funds to make
good on the losses of their counterparties.
	
What happened on September 18-19 took years of preparation, capped by a
faux ideology crafted by public-relations think tanks to be broadcast
under emergency conditions to panic Congress - and voters - right before
the presidential election. This seems to be our September election
surprise. Under staged crisis conditions, President Bush and Treasury
Secretary Paulson are now calling for the country to come together in a
War on Defaulting Homeowners. This is said to be the only hope to "save
the system". (What system is this? Not industrial capitalism, or even
banking as we know it.) The largest transformation of America's
financial system since the Great Depression has been compressed into
just two weeks, starting with the doubling of America's national debt on
September 7 with the nationalization of Fannie Mae and Freddie Mac. (My
computer's spellchecker will not permit me to use the euphemism
"conservatorship" that Mr. Paulson applied to bailing out the Fannie Mae
and Freddie Mac fraudsters.)
	
Economic theory used to explain that profits and interest were a return
for calculated risk. But today, the name of the game is capital gains
and computerized gambling on the direction of interest rates, foreign
currencies and stock prices - and when bad bets are made, bailouts are
the calculated economic return for campaign contributions. But this is
not supposed to be the time to talk of such things. "We must act now to
protect our nation's economic health from serious risk", intoned
President Bush on September 19. What he meant was that the White House
must make the Republican Party's largest group of campaign contributors
whole - Wall Street, that is - by bailing out their bad gambles. "There
will be ample opportunity to debate the origins of this problem. Now is
the time to solve it." In other words, don't make this an election
issue. "In our nation's history there have been moments that require us
to come together across party lines to address major challenges. This is
such a moment." Right before the presidential election! The same guff
was heard earlier on Friday morning from Secretary Paulson: "Our
economic health requires that we work together for prompt, bipartisan
action". The broadcasters said that half a trillion dollars was
discussed for this day's maneuverings.
	
Much of the blame should go to the Clinton Administration for leading
the call to repeal Glass-Steagall in 1999, letting the banks merge with
casinos. Or rather, the casinos have absorbed the banks. That is what
has put the savings of Americans at risk.
	
But does this really mean that the only solution is to re-inflate the
real estate market? The Paulson-Bernanke plan is to enable the banks to
sell off the homes of five million home mortgage debtors faced with
default or foreclosure this year! Homeowners with "exploding
adjustable-rate mortgages" will lose their homes, but the Fed will pump
enough credit into the mortgage-lending agencies to enable new buyers to
go deeply enough into debt to take the junk mortgages off the hands of
the gamblers who presently own them. Time for another financial and real
estate bubble to bail out the junk mortgage lenders and packagers.
	
America has entered into a new war - a War to Save Computerized
Derivative Traders. Like the Iraq war, it is based largely on fictions
and entered into under seeming emergency conditions - to which the
solution has little relation to the underlying cause of the problems. On
financial security grounds the government is to make good on the
collateralized debt obligations packaged (CDOs) that Warren Buffett has
called "weapons of mass financial destruction".
	
Hardly by surprise, this giveaway of public money is being handled by
the same group that warned the country so piously about weapons of mass
destruction in Iraq. President Bush and Treasury Secretary Paulson have
piously announced that this is no time for partisan disagreements over
this shift of public policy to favor creditors rather than debtors.
There is no time to make the biggest bailout in history an election
issue. Not an appropriate time to debate whether it is a good thing to
re-inflate housing prices to a level that will continue to oblige new
home buyers to go so deeply into debt that they must pay some forty
percent of their take-home pay on housing.
	
Remember when President Bush and Alan Greenspan informed the American
people that there was no money left to pay Social Security (not to
mention Medicare) because at some future date (a decade from now? twenty
years? forty years?) the system might run a deficit of what now seems to
be merely a trivial trillion dollars spread over many, many years. The
moral was that if we can't figure out how to pay, let's plow the program
under right now.
	
Mr Bush and Greenspan did have a helpful solution, of course. The
Treasury could turn Social Security and medical insurance money over to
Bear Stearns, Lehman Brothers and their brethren to invest at the "magic
of compound interest".
	
What would have happened to US Social Security had this been done?
Perhaps we should view the past two weeks' events as having assigned to
Wall Street gamblers all the money that has been set aside since the
Greenspan Commission in 1983 shifted the tax burden onto FICA wage
withholding. It is not retirees who are being rescued, but the Wall
Street investors who signed papers saying that they could afford to lose
their money. The Republican slogan this November should be "Gambling
insurance, not health insurance".
	
This is not how the much-vaunted Road to Serfdom was mapped out to be.
Frederick Hayek and his Chicago Boys insisted that serfdom would come
from government planning and regulation. This view turned upside down
the classical and Progressive Era reformers who depicted government as
acting as society's brain, its steering mechanism to shape markets - and
free them from income without playing a necessary role in production.
The theory of democracy rested on the assumption that voters would act
in their self-interest. Market reformers made a kindred happy assumption
that consumers, savers and investors would promote economic growth by
acting with full knowledge and understanding of the dynamics at work.
But the Invisible Hand turned out to be accounting fraud, junk mortgage
lending, insider dealing and a failure to relate the soaring debt
overhead to the ability of debtors to pay - all of this mess seemingly
legitimized by computerized trading models, and now blessed by the Treasury.

http://www.counterpunch.org/hudson09202008.html


TO POST A COMMENT, OR TO READ COMMENTS POSTED BY OTHERS, please click
on the word "comment" highlighted at the end of the version of this
essay posted at http://billtotten.blogspot.com/