by John Kelley
“A billion here, a billion there, pretty soon you’re talking about real money.” A quote that was for many years wrongly attributed to the late Senator Everett Dirksen seems applicable here. So far the cost of Fannie Mae, Freddie Mac, Lehman Bros. AIG and what Wall Street is asking for equals a trillion dollars. While its not peanuts in anyone’s book the real cost is probably more like 2-3 trillion dollars. That is in addition to the 100s of billions of dollars pumped into the economy by the fed to prevent a credit freeze up before last week.
August 9, 2007 $24 billion, August 10, 2007 $38 billion, November 12, 2007 $42 billion, November 27, 2007 $8 billion, March 12, 2008 $200 billion, August 13, 2008 $70 billion, September 18, 2008 $180 billion, September 24, 2008 $30 billion, pumped into the economy by the fed, all money printed producing more debt for America.
That is in addition to the $700 billion proposal. And that doesn’t count the money that was pumped into the economy through massive tax cuts for the rich and the deficit war spending that took us from a $5 trillion surplus to a $9 trillion dollar national debt.
This all happened for a simple reason. Trickle down economics doesn’t work. That extra money was used for speculation while squeezing equity out of the American worker for even more gambling cash. Bush was willing to do anything to avoid a recession on his watch, even if it meant creating a depression for the next guy. He just ran out of time.
Putting Marble in the Outhouse
For the American economy to work, consumer spending, which makes up 70% of the economic activity, had to continue even though consumer income when adjusted for inflation was falling. Wages and benefits fell almost 30% since 1970 when adjusted for inflation while corporate profits rose to record levels. The only way Americans have kept up is to work longer hours, put more people in the household work and live off credit.
How do you grow an economy when consumers don’t have any more money? Easy credit, made available by the extra cash infused into the system and low interest rates, pushed the American worker to borrow to keep up through home equity loans, credit card purchases and auto loans. Pushing people out of guaranteed retirement benefit plans and into 401(k)s added more gambling dollars to the players table.
While traditional and investment banks were getting loans to finance this consumer debt from the Fed at record low interest rates, consumers were paying record high interest rates. The money rolled in from this “spread”. The biggest product produced by our new financial transaction centered economy was debt based collateral instruments that were then used to borrow more.
All of these consumer liabilities were booked as assets. They were bundled into mortgage-based securities/bonds and bought at an inflated worth by people who borrowed more money to do it. Those in turn were sometimes rebundled into new financial instruments which investors leveraged already leveraged financial products to buy.
This has brought about the situation where, a large part, if not most of the economy was based not on investment of one’s savings, you know like they tell us commoners we should do, but on how much could be borrowed, which only depended primarily on how much the deal makers could make off the deal. The more money you had the lower the interest rate.
One of the primary maxims in business is to always use someone else’s money when possible. Buyers of these financial instruments borrowed 80-90% of their purchase money. In the hedge funds, qualified investors (in other words rich people) borrowed 90% of their investment money to get in, which was then leveraged again at sometimes twenty to one to play the market with and take over companies.
Banks became direct investors in those deals and leveraged buyouts, instead of just lending the money. Paying the money back was never intended. The debt was loaded on the purchased company or instrument making it someone else’s problem. One of the things that deregulation insured was that you could pass the responsibility on to the next guy and take your profits, except for the guy at the bottom—the homeowner.
So for every $250,000 home mortgage, the financial wizards multiplied the debt many times that at each step. See why even a small uptick in foreclosures can create economic catastrophe in this Ponzi scheme?
This excess magic capital that was generated by this scheme was not used to make America more competitive by huge investments into research and innovations but to help financial corporations, hedge funds and leveraged buyout companies go on a huge buying binge in order to try and dominate the new global economy. In return for this direct giveaway of American tax dollars and income, those favored rich shipped jobs overseas, established headquarters off shore to avoid taxes and gave themselves huge bonuses.
Then somebody asked the questions, what are these debt instruments standing behind more debt really worth? The answer is no one really knows, but they are worth nowhere near their posted value.
The Impact of a Debt Based Economy
Instead of setting free the supposed market magic of pure capitalism, the creation of this regulation-free, almost-free-money environment turned into a free for all where the most larcenous characteristics of Wall Street were glorified. According to the Scott Burns (www.scottburns.com) in an article printed September 28, 2008 Bear Stearns, Bank of America, UBS, Merrill Lynch, Morgan Stanley, Wachovia, GMAC Bank, IndyMac Bank, Countrywide, JP Morgan, Citigroup, CIBC, HSBC, Freddie Mac, Fannie Mae, Lehman Brothers and “independent rating companies” Standard & Poor, Moody’s and Fitch all worsened the problem through their deceptive and illegal actions.
What were those actions? They ranged from abusive and illegal loan practices, deceiving investors about the amount of risk they were taking, deceptive advertising, securities fraud, fraudulent ratings, structuring products to hide real risk, hiding their true positions and developing tax evasion schemes.
Fed Chairman, Ben Bernake says that we will buy up these bad debts at a price that is closer to what they would be “in a more normal market” or through a process of “price discovery”. What does that mean? Simply we’re going to give them more then their real value. Then hopefully other fools will rush in and pour more money into these institutions to recapitalize them. Then we will wait for who knows how long for those debts to reach a value somewhat close to the price they bought them for. When? Maybe never.
The powers that be in the Fed and SEC stopped short selling which they blamed for “crashing companies.” In all reality it was an attempt to stop the public from learning how worthless these financial instruments really are before a bailout value could be established based on their true value. Short sellers bid on what they think a stock will fall to (in other words its current present worth), something the bailout boys don’t want you to know.
Bernake also made the statement to Congress that the “economy was severely undercapitalized”. The economy is undercapitalized? That means the whole economy has borrowed too much money, issued Treasury Bonds with out sufficient capital behind them to print more money to prevent an economic slowdown. In other words, what took place was an expansion of the economy that outpaced actual growth in wealth creation through an inflationary money supply. Choices made out of political opportunism and blatant greed.
Now, Secretary Treasurer Paulson, who used to work for Goldman Sachs, is proposing we bail his former company and other friends out with more debt, and that they be the “experts” appointed to handle this mess they have created. Understand what Paulson is demanding: That we borrow MORE. Print an extra $700 billion and give it to him to do as he wishes. Take note that 200 well known university economists say the Paulson plan won’t work.
Consumers have started spontaneous protests all over the country against bailing out the big boys and with half of Congress facing re-election they are listening. The Conservative Republicans are not, as some have reported, asking to let the companies fail and the market correct itself. Instead they are asking for the government to set up an insurance plan financed by the companies and backed by the government that would insure the bad debts. Something like selling flood and wind insurance to a Galveston homeowner when Ike was 50 miles offshore.
Of course anyone who doubts the brazenness of the house Republicans only need look at the add-ons they want. They want even less regulation, to reduce the capital gains rate to 15% (half the tax rate on wage earners), and to lower taxes on money they have made on their offshore operations. And of course they are still lobbying like mad to keep the tremendous tax break for the rich implemented by Bush.
Showing their concern for those common citizens suffering from this mess of deregulation, Senate Republicans blocked a plan on Friday by the Democrats to pump $56 billion into the economy through public works projects, more help for the unemployed and money for states who are underfunded for Medicare. No worry however. Even if it had passed, Bush had promised to veto it. They did support the $630 billion spending bill to continue government operations past Wednesday, funding for the Pentagon, veterans medical care, homeland security and of course a $25 billion bailout for those geniuses in the auto industry.
The bankers, speculators and stock traders, who certainly don’t want to “out-brazened,” want the government to give Paulson complete control of the money no strings attached. Trust us they say. Paulson as recently as 2004 was advocating for these looser restrictions that created the problem.
Paulson has already helped big investment houses Goldman Sachs and J.P. Morgan buy companies while we take their bad debt. The reason they bought the bankrupt Washington Mutual was because they figured the government, you and I, would take WaMu’s bad debt off their hands.
The Democrats want some guarantees: 1) equity in the companies they give money to–exactly what any other creditor would ask for, 2) limits on management compensation, 3) authority for bankruptcy judges to demand refinancing or restructuring of mortgages where homes are worth less then their mortgage, 4) new regulatory controls, 5) bipartisan oversight of the Treasury Secretary’s management of the bailout, 6) and some realistic price on what they take on.
While a deal will be made and probably include most of the Democratic proposals and something for the House Conservative Republicans to save face, the problem is systemic and this bailout won’t solve the problem. It will only offer a short temporary boost in the market before it resumes a downward spiral.
The amount of bad debt in the mortgage market and in all of the other overvalued “exotic financial instruments” is much more than $700 billion and the system will continue to hemorrhage as commercial loans start to fail, most of that held by smaller regional banks. Inflation will not be far behind.
Bush’s false prosperity will leave a wake of devastation for decades. He’s hoping one more quick bailout by daddy’s friends will postpone utter disaster until he has stepped out of office. The only good news is that writers and historians will have a field day.