Bailed Out: Financial Wise Guys & The Wall Street Casino...

"The Congress told the American people to go to hell."-Lou Dobbs, on the passage of the 700 billion dollar Wall Street bailout plan, 10.1.08.

PART I: REPEALING ROOSEVELT

"The federal reserve is still struggling to contain what is already the most severe credit contraction since the Great Depression. Yet in all of the press coverage, commentators have scarcely acknowledged that this old-fashioned panic is a child of deregulation. During the past decade, the financial economy has repeated the excesses of the 1920s -- too much borrowing to underwrite too many speculative bets with other people's money, too far beyond the reach of regulators, setting up the entire economy for a crash.

The Roosevelt schema of financial regulation was built around two principles -- disclosure and outright prohibition of inherent conflicts of interest. All publicly listed and traded companies were required to disclose to the Securities and Exchange Commission and to the public all financial information deemed "material" to investor decisions. The New Deal also prohibited stock trading based on insider information, and it created structural barriers against the kinds of temptations that ruined the economy in the 1920s. The most notable of these was the 1933 Glass-Steagall Act, which prohibited the same financial company from being both a commercial bank and an investment bank.

The Glass-Steagall wall was devised to prevent a repeat of the 1920s' scams, in which banks made speculative investments, turned the debts into securities, and sold them off to unsuspecting investors with the blessing of the bank. With Glass-Steagall, commercial banks were tightly supervised and given access to federal deposit insurance, to keep savings secure and prevent runs on banks. Investment banks, meanwhile, were not government-guaranteed and were free to do more speculative transactions for consenting adult customers. But Roosevelt's newly created SEC subjected securities markets to much tighter structures against self-dealing and insider conflicts of interest.

The New Deal also acted on the home mortgage front. Millions of people were losing their homes and farms to foreclosures, both creating human tragedies and deepening the Depression. In response, the Roosevelt administration literally invented the modern system of home finance. Pre–New Deal mortgages had typically been short-term notes, where most of the principal was due and payable at the end of a brief term, often just three to five years. The New Deal devised the modern long-term, fixed-rate, self-amortizing mortgage. Congress created the Federal Housing Administration to insure these mortgages and win their acceptance among lenders. It also created the Federal National Mortgage Association to sell bonds and buy mortgages, and thus replenish the funds of local lenders. And the New Deal devised a system of federal home loan banks to supervise and advance capital to savings and loan institutions. Deposit insurance was extended to government-supervised mortgage lenders.

The system worked like a watch, combining sound lending standards with expanded opportunity. The rate of home ownership rose from 44 percent in the late 1930s to 64 percent by the mid-1960s. Savings and loan associations almost always ran in the black, there were no serious scandals, and the government deposit-insurance funds regularly returned a profit.

If you fast forward to 2000, much of this protective apparatus has been repealed. Regulators who didn't believe in regulation and a compliant Congress have allowed financial engineers to evade what remains. In the 1980s, regulators began allowing exceptions to Glass-Steagall. In 1999, Congress finally repealed it outright, permitting financial supermarkets like Citigroup to operate ANY KIND OF FINANCIAL BUSINESS THEY DESIRED, and profit from multiple conflicts of interest. The scandals that pumped up the dot-com bubble of the late 1990s, as well as the most flagrant cases like Enron, and the crash that followed, were the result of the SEC and the bank regulators CEASING TO POLICE CONFLICTS OF INTEREST. In the scandals of the 1990s, corporate CEOs, their accountants, and stock analysts working for their bankers, all conspired to puff up corporate balance sheets and pump up stock prices on which executive bonuses depended. This is a little harder today, thanks to the honest accounting requirements of the 2002 Sarbanes-Oxley Act (which the Bush administration hopes to water down). But the same kinds of conflicts and potentials for abuse exist when a mega-bank underwrites a leveraged buyout by an affiliated hedge fund, and then hypes the sale of securities when the fund is ready to sell the company back to the public.

Meanwhile, the once staid and socially directed system of providing home mortgages was seized by financial wise guys and turned into another casino. In the early 1980s, exploiting the Reaganite theme of government-bashing, the savings and loan industry persuaded Congress to substantially deregulate S&Ls -- which then speculated with government-insured money and lost many hundreds of billions, costing taxpayers upward of $350 billion in less than a decade.

In 1989 when Congress reregulated S&Ls, the financial engineers just did another end run. Mortgage companies that were exempt from federal regulation came to dominate the mortgage lending business. This loop of the story begins in 1968 with the privatization of Roosevelt's Federal National Mortgage Association. In the wake of that move, investment bankers invented a daisy chain known as "securitization" of mortgage credit. Through securitization, a mortgage broker could originate a loan, sell it to a mortgage banker, who would then sell it to an investment bank like Salomon Brothers, who in turn would package the mortgages into securities. These were then evaluated and coded (for a fee) by private bond-rating agencies according to their supposed risk, and sold off to hedge funds or pension funds. Each of these worthies took their little cut, raising the cost of credit to the borrower. Rather than diffusing risks, securitization concentrated them, because everyone was making the same bet on real-estate inflation.

In the sub-prime sector, you could get a loan without a full credit check, or even without income verification. The initial "teaser" rate would be low, but after a few years the monthly payment would rise to unaffordable levels. Both borrower and lender were betting on rising real-estate prices to bail them out, by allowing an early refinancing. But when a soft housing market dashed those hopes, the whole sub-prime sector crashed, and the damage spilled over into other financial sectors.

How aggressively the Fed should move has been the subject of extensive commentary. If the Fed moves too slowly or doesn't cut enough, it ends up playing catch-up behind an advancing panic. If it moves too quickly or too generously, it just invites the next round of speculation with cheap money, and in passing might erode confidence in the none-too-robust dollar. But all of this commentary misses the larger point: If monetary policy is the only tool the government has at its disposal, the Fed can't possibly solve the larger crisis (or prevent the next one) by using interest rates alone.

Indeed, until Congress dismantled financial regulation, the Fed was not called upon to mount these heroic rescues, which have become so common in recent years. Until the 1960s, the central bank could keep interest rates low, confident that they would underwrite the growth of the real economy rather than risky financial speculation, for the simple reason that entire categories of speculation did not exist.

But during the past quarter-century, as deregulation has turned the economy into a casino, the Federal Reserve has had to mount major rescues at least six times. In the early 1980s, it bailed out the big New York banks, some of which lost more than the total amount of their capital in failed speculative third world loans; the money-center banks would have been adjudged insolvent if the Fed hadn't bent its usual capital-adequacy rules. Next, the Fed poured huge quantities of liquidity into financial markets after the stock market crash of 1987, in which the market lost more than 20 percent of its value in a single day. The Fed intervened again on several occasions after speculators destabilized several third world currencies and economies from Mexico to Malaysia. The Fed cleaned up after the aforementioned Long Term Capital Management collapse. It flooded markets with money after the dot-com crash and the attacks of September 11, and most recently in the credit crunch of summer 2007.

Indeed, markets have become so reliant on the Fed's bailouts that they even have a term for it -- "the Greenspan put." A put is a financial term meaning a right to sell a financial security at a predetermined price. The knowledge that the Fed would cheapen money in a crisis reassured speculators that they could always unload their paper. That awareness also influenced financial insiders to behave more recklessly."

PART II: WHOSE TO BLAME?

"There's plenty of blame to go around, and it doesn't fasten only on one party or even mainly on what Washington did or didn't do. As The Economist magazine noted recently, the problem is one of "layered irresponsibility ... with hard-working homeowners and billionaire villains each playing a role." Here's a partial list of those alleged to be at fault:

• The Federal Reserve, which slashed interest rates after the dot-com bubble burst, making credit cheap.
• Home buyers, who took advantage of easy credit to bid up the prices of homes excessively.
• Congress, which continues to support a mortgage tax deduction that gives consumers a tax incentive to buy more expensive houses.
• Real estate agents, most of whom work for the sellers rather than the buyers and who earned higher commissions from selling more expensive homes.
• The Clinton administration, which pushed for less stringent credit and downpayment requirements for working- and middle-class families.
• Mortgage brokers, who offered less-credit-worthy home buyers subprime, adjustable rate loans with low initial payments, but exploding interest rates.
• Former Federal Reserve chairman Alan Greenspan, who in 2004, near the peak of the housing bubble, encouraged Americans to take out adjustable rate mortgages.
• Wall Street firms, who paid too little attention to the quality of the risky loans that they bundled into Mortgage Backed Securities (MBS), and issued bonds using those securities as collateral.
• The Bush administration, which failed to provide needed government oversight of the increasingly dicey mortgage-backed securities market.
• An obscure accounting rule called mark-to-market, which can have the paradoxical result of making assets be worth less on paper than they are in reality during times of panic.
• Collective delusion, or a belief on the part of all parties that home prices would keep rising forever, no matter how high or how fast they had already gone up.

The U.S. economy is enormously complicated. Screwing it up takes a great deal of cooperation."

-Robert Kuttner, PART I: "The Bubble Economy," The American Prospect, 9.24.07 , Part II: –Joe Miller & Brooks Jackson "Who Caused the Economic Crisis?" Factcheck.org, 10.1.08. Image: -John Wardell, "Roulette Wheel," Flickr 1.1.06).

Right Under Our Noses: Financial Weapons of Mass Destruction & A Modernized Regulatory Structure...

THE PROBLEMS: Part I

“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?"

Who, indeed!

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

If this is even remotely close to the mark, then we can expect to see more bold ultimatums and actions by both Bernanke and Paulson. We can also expect that those who are getting protection for their investments are the global banks and investment houses, not the American people.

THE IMPLICATIONS:

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.”

A SOLUTION:

“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.

If we bail out our corporate masters with hundreds of billions of tax dollars without instituting draconian market reform and launching criminal prosecution, we will be left to bear the cross of corporate malfeasance. We will pay for corporate crime. We will leave those who robbed us free to plunder.”

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.