“At the heart of this credit crunch mess is something called "derivatives." The Initiative for Policy Dialogue at Columbia University offers a good primer: "A derivative is a financial contract whose value is linked to the price of an underlying commodity, asset, rate, index or the occurrence or magnitude of an event. The term derivative refers to how the price of these contracts is derived from the price the underlying item."
It's kinda like playing craps at the casino, where instead of gamblers betting on the dice-roller to crap-out, with derivatives, investors are betting on whether a creditor is going to go under. But instead of buying chips, the lender buys risk-insurance and makes a "swap" with a third party. If the borrower doesn't pay the loan back, the lender loses the loan but collects the insurance. To make things even more confusing, there are different kinds of derivatives. Futures. Forwards. Swaps. Options.
Ever since Mesopotamians were writing on clay-tablets, derivatives have played a useful role. But, IPD cautions, "they also pose several dangers to the stability of financial markets and the overall economy" because they can be used "for unproductive purposes such as avoiding taxation, outflanking regulations designed to make financial markets safe and sound, and manipulating accounting rules, credit ratings and financial reports. Derivatives are also used to commit fraud and to manipulate markets."
I guess that's why Warren Buffet (in 2002, mind you), said derivatives were a "financial weapon of mass destruction." He was ridiculed at the time but now even John McCain is suggesting that people like Buffet and others tell us how to regulate the market.
According to Marketwatch, the derivatives market is somewhere around $500 trillion. No, that's not a typo. That's trillion. To put it in perspective, Marketwatch reminds us that the U.S. gross domestic product (GDP) is about $15 trillion. The GDP of all nations combined is approximately $50 trillion. The total value of all the real estate in the world is estimated at $75 trillion and the total value of all the world's stocks and bonds is about $100 trillion. But there's a $500 trillion market in derivatives! If you find this all confusing, we're in good company. Because "what we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid August," Bond fund giant Bill Gross told Marketwatch.
Marketwatch goes on to observe: "In short, not only Warren Buffett, but Gross, Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't 'figure out' the world's $516 trillion derivatives." That's because we're talking about a "shadow banking system," in which derivatives are not just risk management tools but "a new way of creating money outside the normal central bank liquidity rules. How? Because they're private contracts between two companies or institutions." Deregulation? Cutting taxes on the super rich? Arguing that government "hand-outs" are a "moral hazard" leading to "dependency" and welfare queendom? All of this unregulated free-market ideology that has dominated American politics and the GOP since the Reagan revolution has brought the country to its financial knees.”
THE PROBLEMS: Part II
“On September 9, 2008, CNBC’s popular financial show “Squawk Box Europe” interviewed Jim Rogers (CEO of Rogers Holding) on his view of the government takeover of Fannie and Freddie: “You can see that this is welfare for the rich. This is socialism for the rich. It’s bailing out the financiers, the banks, the Wall Streeters... This is outrageous. Who are these people who are taking our money and doing this and ruining America?"
On March 21, 2008, The August Review wrote, “As the global financial crisis unfolds, one thing is certain: The major investment and commercial banks who have wrecked our economy and financial system are now successfully sucking unlimited amounts of money from the people's Treasury to bail themselves out.” The August Review has demonstrated repeatedly that the net effect of the New International Economic Order (term coined by the Trilateral Commission in 1973) was to devise new and more effective ways to divert money from the public sector into certain private hands.
With their right hand, elite bankers, investors and brokers can well afford to take on all the risk they desire, knowing that their left hand can get into the U.S. treasury to bail themselves out when they hit the financial brick wall. And with the government takeover of Fanny Mae and Freddie Mac, they have simply outdone themselves: The magnitude of this bailout is on an order higher than anything ever recorded in our planetary history. Of course, everyone in the financial elite are feigning shock and dismay at the tragic turn of events. Saving these companies, they say, will supposedly save our financial system from utter destruction. It’s an ultimatum: Pay up or collapse.
Is it all a smokescreen for yet another planned plundering of our Treasury?
In November 2005, Dr. Laurence J. Kotlikoff wrote a 23 page report titled, “Is the U.S. Bankrupt?” It was issued by the Federal Reserve Bank of St. Louis and quietly posted on their website – and it was totally ignored by the U.S. press. With irrefutable logic and statistical data, he concluded that “Countries can and do go bankrupt. The United States, with its $65 trillion fiscal gap, seems clearly headed down that path.” Being that the U.S. government is the only and exclusive banking client of the Federal Reserve, it is inconceivable that the Fed did not fully understand what Kotlikoff was saying. It is also inconceivable that the Fed would not take action to protect itself, its money, its private stockholders, and hence, to appoint a conservator.
A man for all seasons?
In May of 2006, former Treasury Secretary John Snow was sacked by the Bush administration and was simultaneously replaced by the chairman of Goldman Sachs, Henry “Hammerin’ Hank” Paulson. Goldman Sachs is one of a dozen or so global institutions that are allowed to purchase Bills, Bonds and Notes directly from the Treasury, and is among the top five investment banks in the world. Conflict of interest, you say? Apparently, it is not to the Bush administration or to the Senate who unanimously confirmed his appointment.
If you follow financial news, you will have noticed that Paulson and Fed Chairman Ben Bernanke are appearing together in public on a continual basis these days– joint testimony before the Congress, joint press conferences, meetings at the White House, etc. Headlines like these have been hot and heavy: “Paulson, Bernanke call on Congress to act”, “Bernanke, Paulson Push for New Regulatory Powers”, “Paulson, Bernanke Say Housing Woes May Last”, and “Paulson Meets with Bernanke, Fannie, Freddie Chiefs”.
Interesting. It never used to be this way.
On March 31, 2008, Paulson quietly released a 200 page document titled, “Blueprint for a Modernized Regulatory Structure,” that he and Bernanke are now actively pushing Congress to adopt. It basically calls for the complete restructuring of U.S. markets and their regulatory structures to meet new “global standards”. After all, our regulatory bodies have been created over the last 75 years and are not compatible with today’s financial challenges. In addition, the Blueprint calls for much more self-regulation by the banking/securities industry itself. The very people who brought us this financial chaos in the first place, want us to let them do whatever is in their self-perceived best interest to protect and increase their profits.
Meanwhile, Paulson recently demanded and received from Congress a blank check for the bailout of Fannie and Freddie. The alternative, he boldly claimed, was the further meltdown of the U.S. housing market and likely destruction of the economy.
Does this appear like a bankruptcy proceeding?
- The banker and the CFO (Paulson) make autocratic decisions
- The bankrupt company gets reorganized
- New capital or financing is secured to pay off creditors
U.S. citizens are getting hosed while banks, brokerages, hedge funds, sovereign wealth funds, wealthy investors, etc., are saved from trillions of dollars in well-deserved losses. By assuming the debts of Fannie and Freddie, the national debt virtually doubles overnight. Even worse, the government risks a downgrade to our existing debt, potentially pushing borrowing costs up by hundreds of billions of dollars per year.
Americans can and should demand that Congress let Fannie Mae and Freddie Mac fail like any other grossly mismanaged company. And in the process, they ought to investigate their senior management for malfeasance and cooking the books to cover it up. Let the free market provide new lenders who perhaps won’t be so greedy and ill-principled.
If a few more commercial or investment banks succumb in the process because of such action, let it serve as a warning to those survivors that they had better shape up or risk losing everything. Allowing Bernanke and Paulson to administrate our financial crisis is like giving an ax and frying pan to the foxes who were left in charge of the hen house.”
“Ralph Nader warned eight years ago that the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) were about to tank like the savings and loan industry of the 1980s and '90s. Because his warnings were ignored, taxpayers today face losing billions of dollars to cover these bad debts.
Nader, in a letter to Securities and Exchange Commission Chairman Christopher Cox in 2006, criticized the exorbitant salaries of government-sponsored enterprise executives Jamie Gorelick, Daniel Mudd, Robert J. Levin and Timothy Howard. He noted in his letter that their financial incentives were in direct conflict with consumer financial security. A grave moral hazard was created by the accounting manipulations they sanctioned, Nader said. These manipulations benefited their personal wealth, yet there was no penalty for being caught.
Nader has called for an immediate halt to the increase in the national debt. He demands an end to corporate subsidies and unconditional taxpayer bailouts of corporations. And he has called for aggressive prosecution of corporate criminals.
"Given the contrast between the ‘free market' ideology of the Republicans and the corporate or state socialism that is their increasing practice, the time is ripe for full Congressional hearings next year on the organized power, greed and lack of regulation that is shaking the foundations of Wall Street," Nader said.
Nader has come up with 10 market reforms that he says need to be implemented immediately along with any bailout. These reforms are:
- 1. No bailouts without conditions and reciprocity in the form of stock warrants.
- 2. No more lobbying for any company that is bailed out.
- 3. No golden parachutes or get-out-of-jail-free cards for guilty executives.
- 4. No bailouts without public hearings.
- 5. Reduce the moral hazard in U.S. mortgage markets by introducing covered bonds for the majority of mortgage products, as is done in Western Europe. That gives institutions that finance mortgages an incentive to be prudent, because they cannot just unload them and wipe their hands clean of the liability, but are instead on the hook if the homeowner defaults.
- 6. Maintain neighborhood stability and housing security by passing a law with a sunset clause allowing below-median-value homeowners facing foreclosure the right to "rent to own" their homes at fair market value rates.
- 7. Avoid future housing bubbles by removing implicit government guarantees for new mortgages that exceed thresholds of greater than 15 to 20 times the annual fair market rent value of the home.
- 8. Make the Federal Reserve a Cabinet position, so it is accountable to Congress, as well as make sure all Federal Reserve Bank presidents are appointed by the president and answerable to Congress.
- 9. Reduce conflicts of interest by taking away power for auditor and rating agency selection from companies and placing it in the hands of the SEC to be administered on random assignment.
- 10. Implement a securities speculation tax, starting with derivatives, to deter casino-style capitalism.
PROBLEMS I & II: -Sean Gonsalves, “The Death of A Myth”, CommonDreams.org, 9.22.08, -Patrick Wood, (“Globalist Ultimatum: Pay up or Collapse,” The August Review, 9.10.08. SOLUTIONS: -Chris Hedges, Excerpt: “Fleecing What’s Left of the Treasury,” Truthdig,9.22.08. Image: "Hennessy Leroyle's Famous Success: Other People's Money" from Hoyt's Theater, New York : by E.O. Towne. U.S. Printing Co., 1889).
VIOLETPLANET SAYS: And let's not forget Phil Gramm & The Commodity Futures Modernization Act (see 9.19.08 post below). Unweaving this intricate capital web will take time. After all, this financial house of cards took 30 years to implement as did the Neo-Conservative philosophy in general. They're one in the same. Chief motivation: individual profits for the crony cabal...right under our noses yet... again.