Tuesday, December 2, 2008

The Financial Crisis: An Explanation

Amazing that all reports to date have been uniformly erroneous as pertains to what exactly occurred, how it occurred and who were the responsible parties. We keep hearing that this mess in the financial markets is due to mortgage defaults. That's like saying a forest fire was caused by a match; true, perhaps but woefully inadequate for an explanation. An explanation must describe how the match was brought to the location, how it was struck, who carelessly threw a burning match down to the ground thereby starting the conflagration and whether the act was accidental or intended. While article after article states that Freddie Mac and Fannie Mae are the originators of this disaster, we will see, upon a more thorough analysis, that is not true. Such charges against the FMs are diversionary; meant to divert attention away from substrate reality. Much like when reporters ask financial experts what their explanations are, we get the same answers: The government is responsible because of oversight failure and deregulation legislation. The Fed (Federal Reserve) is responsible for policies that created "cheap credit". Freddie Mac and Fannie Mae are responsible for their evolving philosophy of extending home ownership to as many Americans as possible.

Again, while those answers have some small measure of truth to them, do they accurately portray the real explanation? In a word, no! I've heard Chicago School advocates go so far as to claim the Fed has been responsible for every economic crisis, including the Great Depression, thereby laying blame upon the United States government; usually with much side-talk of Liberal spending practices and exorbitant taxation. Any unbiased look at the Congressional record will prove that any/all attempts at regulation of financial markets has given rise to such hue and cry the only legislation that passes concerns deregulation of those markets. In fact, the main cause of the current financial debacle stems from Credit Default Swaps, (CDS) "…invented in 1997 by a team working for JPMorgan Chase. Credit Default Swaps became legal, and illegal to regulate, with the Commodity Futures Modernization Act of 2000. They were introduced and rushed through congress as a companion bill, the last day before the Christmas holiday. It was never debated in the House or the Senate. The bill was 11,000 pages long. Less than a week after it was passed by congress, President Clinton signed it into Public Law (106-554) on December 21, 2000." Obviously, this major legislation was never even read by those passing it into law. As stated previously, up to $62 Trillion dollars has been invested in CDS which is said to be more than three times the combined worth of all economies (as measured by GDP; Gross Domestic Product which is the sum total of all goods and services) on Earth. These complex financial instruments were then bundled and sold; they are a significant part of nearly all portfolios worldwide. The value of these portfolios is now ambiguous as the value supposedly held in CDS is essentially worthless. This ambiguity in holdings is what has prompted the severe credit crunch as investors hold onto the money they do have; not knowing how much they are worth, people are not willing to risk any further investment.

While CDS are often compared to insurance like instruments for home and automobile, there is a huge difference: Such insurance policies involve loss of material assets that one owns. CDS were issued on suppositions of what might occur; like a business folding or mortgage defaulting. According to Time.com CDS "promise to cover losses on certain securities in the event of a default. They typically apply to municipal bonds, corporate debt and mortgage securities and are sold by banks, hedge funds and others. The buyer of the credit default insurance pays premiums over a period of time in return for peace of mind, knowing that losses will be covered if a default happens. It's supposed to work similarly to someone taking out home insurance to protect against losses from fire and theft…Except that it doesn't. Banks and insurance companies are regulated; the credit swaps market is not. As a result, contracts can be traded—or swapped –from investor to investor without anyone overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults. The instruments can be bought and sold from both ends – the insured and the insurer." These instruments padded portfolios even as they padded banks' ledgers with value that was hypothetical. But such value added gave the impression that more and more gains were accruing thereby enticing more and more investors to invest their money.

Do you see what I see? Ever hear of pyramid/Ponzi schemes? It's when money promised one investor can only come from ever-expanding the investor base to pay off those already invested. As you no doubt can figure out, the actual investments don't bring in enough money; it's the new investor money that purchases more leveraged instruments that add to the "growth" of an investment firm which serves to bring in even more new investor money. Such a scheme works as long as new investors offer a constant stream of revenue. However, as soon as new investors don't pump capital into the scheme, it collapses. This constitutes felonious activity prosecutable in a court of law. Yet, not word one as to anyone being so charged. Funny how "white collar" criminals never seem to get jacked up like regular folk caught with their hand in the cookie jar. Stealing crumbs? Go to jail. Fuck up a worldwide financial system? No golden parachute for you. Of course, some of those people responsible for the mess are now being tapped to solve the problem. When you consider that they probably should go to prison, being asked to work for only paltry government pay is supposed to be punishment enough? Need more? Already there are abuses using the bailout money which has prompted Congressman Barney Frank to state, "Any use of these funds for any purpose other than lending--for bonuses, for severance pay, for dividends, for acquisitions of other institutions, etc.--is a violation of the act."

Which brings me to the near uniform "promise" coming from Obama and other Congressional leaders that CEOs will not be getting any bonus money from the Treasury's Troubled Asset Relief Program. As if such bonuses/golden parachutes are at all the issue. It's meant to soothe the anger vis-à-vis public sentiment and calls for a revengeful response. Much like the "earmarks" issue brought up again and again during the campaign with most Americans against such "wasteful" spending when, in actuality, such perks amount to just $20 billion dollars in a $3 Trillion budget; or accounting for less than a fraction of one percent. But, we hear daily pledges against letting CEOs have a bonus package. This is not an endorsement for allowing those perks, but rather, a word of warning since the news media's uniform excuse for never giving adequate context to news stories is that space/time constraints don't allow for such detail, one must then ask themselves if wasting such precious space/time on pointless points of discussion isn't subterfuge?

Sure the collapse may have begun with defaulting mortgages whereby those holders of CDS wanted to collect their insurance money and the insurers had nowhere near enough cash to settle up; a scenario that multiplied across the face of the planet. But, it is the suspect nature of the CDS platform that lacks stability, not the mortgage market. Nationally less than six percent of prime mortgages are in default; approximately ten percent in Alt-A mortgages and about 16 percent in the infamous subprime mortgages. To consider the preceding percentages in a more positive (and informative) light, 94 percent of prime mortgages are still being paid; 90 percent of Alt-A mortgages are still being paid; 84 percent of subprime mortgages are still being paid. One should now see that mortgage defaults aren't the main problem. Creative thievery by a greedy financial sector is and has been the problem. To blame the FMs is ludicrous as combined the FMs hold about 20 percent of defaulted mortgages; many of these having been originated elsewhere, bundled with CDS and sold to the FMs. A common gripe from the Chicago School cadre is that they shouldn't be held accountable because the FMs offered such affordable rates and access to mortgages that the rest of the mortgage market players (commercial banks and mortgage lenders) were at a disadvantage, so of course, they were forced to compete by offering even better rates and shoddy due diligence as regards background checks which are undertaken to assure the people taking out these mortgages were making enough money to pay them off. These other mortgage market players then bundled the suspect mortgages with CDS and sold them to FMs. Now these same mortgage market players decry the Federal government for having attempted to expand the "ownership society" to include regular people with modest incomes. How is that wrong-headed? No one can dispute such ownership feeds the economy via multiplier effect (every house needs constant maintenance as well as house wares, etc.). And, every house has its nooks and crannies to cram with trinket-talismen (or what is called "fetish consumerism" that comprises as much as two-thirds of the U.S. economy). And, woe unto he that stands in the way of this particular expression of Savage Capitalism.

The actuality of this financial debacle is that the American Congress/Senate acquiesced to kneeling at the altar of deregulation thereby allowing Free Marketeers to game a system that was already totally in their favor. You see, the centuries-old mainstay of Capitalism or, a reasonable rate of return on one's investment, has since the era of Reagan been replaced with a what the market will bear philosophy. In such a climate, no perverse scheme of extortion is too much. Profits continued accruing to the very few at the very top. And, as has been now witnessed, once such extortive schemes collapse, the costs are to be shouldered by the people; regular folk by the millions now indebted through several generations to come.

Which brings us to President-elect Obama's campaign promises regarding rebuilding America's infrastructure, retooling its manufacturing base, funneling more money into the education system, not to mention the tax cut promised to 95 percent of American workers earning less than $250,000 a year. Not going to happen. Impossible in light of the massive outlays for the financial bailout which fattens an already too fat budget deficit (the National Debt interest alone at $451 Billion a year). It won't be long before we read about China's refusal to invest any more money in America (which has been a large part of deficit funding) because of fear that such loans will never be paid back. That will require huge sacrifices from the people starting with massive loss of jobs. Those lucky enough to keep their jobs will be forced to endure wage diminishment, benefit give-backs, continued inadequate health coverage, etc. etc. Retirement funds will evaporate. Social Security will wither and die. The safety net will unravel.

This scenario is a repeat of worldwide catastrophes detailed in "The Shock Doctrine: The Rise of Disaster Capitalism" by Naomi Klein. The American empire has peaked and is now in decline. The American people will soon learn how much of the world survives day-to-day without hope of any improvement in their lives. As has the Third World, Americans will now pay for the profligate ways of a tiny few. And, should we rise up in anger? Like the unfortunate masses have already experienced, we'll be put down by brute force of arms.

Buckle up, people. It's going to be one long bumpy ride to the other side.