DAILY BUSINESS REPORT - Financial Updates, International Markets and Business News
January 31, 2012
European Bailout Infographic: Presenting The Truckloads Of Cash Needed To Rescue The Insolvent PIIGS
...No, literally truckloads. Our friends at demonocracy.info have been kind enough to put together an infographic that explains the European bailout in simple, visual terms, that even the most innocent of FTL truckers can grasp without much exertion, for the simple reason that it shows all the bailouts amounts in terms of trucks of cash. And here is the kicker: one would need a 13 lane highway, filled with trucks bumper to bumper, stretching for about 3 kilometers to represent the €2.91 trillion in total amounts owed by the PIIGS and their citizens (whether voluntarily or not... actually make that involuntarily) to Europe's largest banks. What is most frightening is what is not shown: just how it is that the world's central banks are keeping all of these banks propped up. Because sooner or later all this money will be discovered to have been fatally misallocated. Then the real bailout cost will become all too evident, and just like in the US, it will be in the double digit trillions. Which means the metaphorical highway of trucks full of cash will stretch on for kilometers and kilometers and so on (or miles, for the naive US-based truckers). But since that day is in the future, there is no reason to worry about it.
January 30, 2012
The Lowdown on Obama-economics
Economic fairness is impossible: an oxymoron. Since economic activities are inherently varied and often competitive and since one size doesn't fit all and not everyone can win in a competition, no such thing as fairness is possible unless it simply means no one may be prevented from taking part. Certainly, however, the outcome will most likely be very different for different participants.
The sort of fairness and equality President Obama and his supporters are after may be achieved around a family or fraternity dinner table or in a last will and testament where goods are being distributed among family members who each expect the fulfillment of an implied promise from elders to receive a "fair share" of the wealth left to them. "Fair" here makes sense since the idea is that no one is going to get much less or more than another. But no such expectation makes any sense throughout a country! The government owns nothing and can thus leave nothing to the citizenry without engaging in massive redistribution of wealth it doesn't have any authority to distribute or redistribute.
When fairness is demanded, it implies that the government does have the authority to assign winners and losers in the economic sphere, as if we still lived in a monarchy awaiting the decision of the king as to who will be the beneficiary of his largess. All the subjects can hope they will receive a fair share of the wealth of the country.
But in a free country, with the principle of private property rights as the law of the land, the king or government has no business engaging in wealth distribution so the issue of fairness is entirely moot. It's a dream and where attempted, it leads to a police state. All that Mr. Obama needs to do to appreciate this is to read George Orwell's Animal Farm, a wonderful parable about what happens when equality is demanded and government tries to produce it. He might also check out the late Robert Nozick's famous Wilt Chamberlain example, from this book Anarchy, State, and Utopia (1973) where he shows that when goodies are fairly distributed among people they will turn right around and rearrange it all so the "fair" distribution is completely upset.
Or if he wants real life cases from which to take lessons, Obama & Co. might remember the Soviet Union and investigate how things are panning out in that heavenly egalitarian country, North Korea. They could perhaps consider that in Cuba the rulers are finally realizing the futility of the socialist-egalitarian ideal and are making changes to turn the place into more and more of a free-market system.
Still, there will always be those who want to level the economy. The main reason is the misguided conviction that we are, after all, in the same boat, just as are the children in a family. But the government isn't like our parents who have made a promise to care for all their children. We aren't the children of Mr. Obama and his administration! To try to serve us all with all the benefits that parents owe to their offspring would be futile and invites totalitarianism.
Parents, after all, own their resources and owe some of it to their children; this is not the case with governments and the citizenry. They don't own anything at all without confiscating it. At most they may do this up to what is needed for administering the laws of the land − providing the citizenry with national defense and a sound legal system and its maintenance. Even some of this can be achieved without much government management. After all, who is the government but other citizens who have been hired to do a rather limited job in the country? It is up to the citizenry to secure for themselves economic growth, solvency, innovation, investment, etc. To attempt anything more would involve the government in tasks that free citizens aren't entitled to.
Sadly, Obama & Co. see the country as it if were some club or team where everyone is part of it and needs the same treatment as everyone else. But a country is not a club or a team − those are the results of free men and women coming together voluntarily for a great variety of purposes. The government of such free men and women must not get involved with what the clubs are embarking upon, be it business, athletics, education, entertainment or whatever else peaceful such folks will embark upon. Like the proverbial cop on the beat, the government isn't there to pick the goals and tasks of those whom they serve in a limited capacity of securing their rights. It's there to keep the peace. That is all!
The sort of fairness and equality President Obama and his supporters are after may be achieved around a family or fraternity dinner table or in a last will and testament where goods are being distributed among family members who each expect the fulfillment of an implied promise from elders to receive a "fair share" of the wealth left to them. "Fair" here makes sense since the idea is that no one is going to get much less or more than another. But no such expectation makes any sense throughout a country! The government owns nothing and can thus leave nothing to the citizenry without engaging in massive redistribution of wealth it doesn't have any authority to distribute or redistribute.
When fairness is demanded, it implies that the government does have the authority to assign winners and losers in the economic sphere, as if we still lived in a monarchy awaiting the decision of the king as to who will be the beneficiary of his largess. All the subjects can hope they will receive a fair share of the wealth of the country.
But in a free country, with the principle of private property rights as the law of the land, the king or government has no business engaging in wealth distribution so the issue of fairness is entirely moot. It's a dream and where attempted, it leads to a police state. All that Mr. Obama needs to do to appreciate this is to read George Orwell's Animal Farm, a wonderful parable about what happens when equality is demanded and government tries to produce it. He might also check out the late Robert Nozick's famous Wilt Chamberlain example, from this book Anarchy, State, and Utopia (1973) where he shows that when goodies are fairly distributed among people they will turn right around and rearrange it all so the "fair" distribution is completely upset.
Or if he wants real life cases from which to take lessons, Obama & Co. might remember the Soviet Union and investigate how things are panning out in that heavenly egalitarian country, North Korea. They could perhaps consider that in Cuba the rulers are finally realizing the futility of the socialist-egalitarian ideal and are making changes to turn the place into more and more of a free-market system.
Still, there will always be those who want to level the economy. The main reason is the misguided conviction that we are, after all, in the same boat, just as are the children in a family. But the government isn't like our parents who have made a promise to care for all their children. We aren't the children of Mr. Obama and his administration! To try to serve us all with all the benefits that parents owe to their offspring would be futile and invites totalitarianism.
Parents, after all, own their resources and owe some of it to their children; this is not the case with governments and the citizenry. They don't own anything at all without confiscating it. At most they may do this up to what is needed for administering the laws of the land − providing the citizenry with national defense and a sound legal system and its maintenance. Even some of this can be achieved without much government management. After all, who is the government but other citizens who have been hired to do a rather limited job in the country? It is up to the citizenry to secure for themselves economic growth, solvency, innovation, investment, etc. To attempt anything more would involve the government in tasks that free citizens aren't entitled to.
Sadly, Obama & Co. see the country as it if were some club or team where everyone is part of it and needs the same treatment as everyone else. But a country is not a club or a team − those are the results of free men and women coming together voluntarily for a great variety of purposes. The government of such free men and women must not get involved with what the clubs are embarking upon, be it business, athletics, education, entertainment or whatever else peaceful such folks will embark upon. Like the proverbial cop on the beat, the government isn't there to pick the goals and tasks of those whom they serve in a limited capacity of securing their rights. It's there to keep the peace. That is all!
January 29, 2012
Financial Illiteracy of Those Who Mock Conspiracy Theorists
From Social Psychological and Personality Science (SPPS), a journal from the independent publisher Sage Publications, comes an article that has predictably seen wide distribution on the Internet. It implies that those who believe in globalist conspiracy theories are illogical – even downright nutty.
The article is entitled "Dead and Alive: Beliefs in Contradictory Conspiracy Theories" and the thesis of the article is that people who believe in conspiracy theories eventually become so immersed in them and so mesmerized that they do not realize they are holding contradictory beliefs.
"Conspiracy theories can form a monological belief system: A self-sustaining worldview comprised of a network of mutually supportive beliefs. The present research shows that even mutually incompatible conspiracy theories are positively correlated in endorsement." (SPPS Abstract)
"Conspiratorialists" become so distrustful of "government" and "authority" that they will impute any and every kind of malevolence to them.
Thus it is that people can claim, on the one hand, that Osama bin Laden is "dead" and died years ago, while simultaneously claiming that bin Laden remains alive and that US and Pakistan government authorities are not being truthful about him and his physical state.
Of course, I've never run into anyone, who claims that bin Laden is ALIVE. But it's true that here at the Daily Bell we've run articles explaining that bin Laden probably died years ago. See, for instance, "Osama bin Laden is Dead Again?"
The SPPS article would likely have you believe this is an outrageous conspiracy theory. But given that FOX news ran a report on bin Laden's death in 2001, and given that Pakistan's former president Benazir Bhutto herself claimed that bin Laden died in the early 2000s (supposedly as the result of an assassination), it doesn't seem so far-fetched to speculate that bin Laden didn't die as the result of a US raid in 2011.
But that's almost minor stuff. Articles like this, despite their scientific patina, are deeply illiterate. Why so? Because invariably such articles won't deal with the bedrock financial illiteracy of current economic and political paradigms.
Imagine if the world were based on lies. Well, unfortunately, that's the truth. The lies go far beyond "who shot JFK" or whether the US government was directly or indirectly involved in 9/11.
When one uses the logical framework of Austrian, free-market analysis to analyze the Way the World Works in the modern age, one inevitably comes to the conclusion that modern society is built around fundamental untruths.
The first one is economic: It is the idea that central bankers can efficiently and effectively set the price of money. They cannot.
Every time central bankers decide on how much money to print or where short interest rates should be, the decisions are "fixing" prices – and price-fixing never works. Price-fixing distorts economies and causes a wealth shift from those who create it to those who don't and may not know what to do with it. Over time, aggressively mis-priced money causes first recessions and then depressions.
The second lie is that laws and regulations are necessary and that they can save society from "anarchy." In fact, anarchy is only the absence of government. That's the real definition. And absence of government does not necessarily imply "chaos." Just as setting interest rates fixes the price of money, so every law and regulation is a price fix as well, preventing someone from doing something within the context of the marketplace. This also constitutes a wealth transfer.
One can have a perfectly adequate and satisfying society without formal government, certainly without the kinds of intrusive and murderous governments we've got today. History is full of examples of societies that flourished with at least minimal government, especially societies where power truly flowed from the bottom up.
The third lie is that government is essential for purposes of defense and defending its citizens. But a quick survey of modern wars shows a disturbing tendency of governments – especially certain Western governments – to foment the very wars that citizens believe they're being protected from.
War is the "health of the state" – the way that those in power consolidate their hold while punishing their enemies using phony pretexts having to do with "treason" and "leaking classified information." Sound familiar?
It is what we call the Internet Reformation that has gradually shed light on the fundamental untruths permeating modern society in both the developed and developing world.
The Internet, like the Gutenberg Press before it, is a revolutionary device that has allowed people access to information that was hitherto denied or covered up, especially in the 20th century when the power elite's control over society was perhaps at its apex.
A conspiracy likely DOES exist. The Internet easily reveals not just facts that illuminate it, but also PATTERNS that show the same command-and-control strategies implemented throughout history, over and over.
It is easy, unfortunately, to mock those who believe in so-called "conspiracy theories" because the truth of what has occurred in this weary world is so extreme and shocking that most people simply cannot believe it. What truly horrifies us becomes a target for mockery. It's a defense mechanism.
Here's the seeming hard truth: A tiny group of Anglosphere banking families controlling most if not all of the world's major central banks have used the trillions to which they have access in order to foment what can be called a "New World Order."
This tiny group of intergenerational plotters and their enablers and associates have apparently built a seamless matrix of control around the entire globe to implement their schemes. They are building world government and are putting in place its building blocks.
What is it about the UN, IMF, World Bank, International Criminal Court, World Health Organization and hundreds of others lesser known globalist facilities that people who deny or decry modern "conspiracy theory" don't understand?
An entire gamut of globalist entities has been superimposed on the world in the past 75 years. Most recently − only this past week, in fact − the US military held a formal exercise over the skies of Los Angeles using the same black helicopters that conspiracy theorists were mocked for mentioning not a decade ago.
But the biggest issue by far – bigger than even the establishment of the facilities of the New World Order – is the fundamental illiteracy of those who choose to support modern society as it is today and as it has evolved over the past 100 years.
While human societies have always been based on fairly bizarre rituals, it is safe to say that the current crop of behind-the-scenes leaders have raised statist insanity to a new level.
Every part of modern society, from its basic economic building blocks to its liturgical belief in dysfunctional "laws and regulations" to its deep-seated reverence for the manipulated destruction of war, is questionable on a factual basis.
The reality of modern society is increasingly pathological – and the ones with the pathology are those who lead the rest of us along using paradigms that are evidently and obviously dishonest and dysfunctional.
Articles that mock the looniness of "conspiratorialists" need to deal with the fundamental economic and sociopolitical dishonesty of their own assumptions. They should begin by admitting the evident and obvious logical fallacies of the "modern" society they celebrate.
I'm not holding my breath.
The article is entitled "Dead and Alive: Beliefs in Contradictory Conspiracy Theories" and the thesis of the article is that people who believe in conspiracy theories eventually become so immersed in them and so mesmerized that they do not realize they are holding contradictory beliefs.
"Conspiracy theories can form a monological belief system: A self-sustaining worldview comprised of a network of mutually supportive beliefs. The present research shows that even mutually incompatible conspiracy theories are positively correlated in endorsement." (SPPS Abstract)
"Conspiratorialists" become so distrustful of "government" and "authority" that they will impute any and every kind of malevolence to them.
Thus it is that people can claim, on the one hand, that Osama bin Laden is "dead" and died years ago, while simultaneously claiming that bin Laden remains alive and that US and Pakistan government authorities are not being truthful about him and his physical state.
Of course, I've never run into anyone, who claims that bin Laden is ALIVE. But it's true that here at the Daily Bell we've run articles explaining that bin Laden probably died years ago. See, for instance, "Osama bin Laden is Dead Again?"
The SPPS article would likely have you believe this is an outrageous conspiracy theory. But given that FOX news ran a report on bin Laden's death in 2001, and given that Pakistan's former president Benazir Bhutto herself claimed that bin Laden died in the early 2000s (supposedly as the result of an assassination), it doesn't seem so far-fetched to speculate that bin Laden didn't die as the result of a US raid in 2011.
But that's almost minor stuff. Articles like this, despite their scientific patina, are deeply illiterate. Why so? Because invariably such articles won't deal with the bedrock financial illiteracy of current economic and political paradigms.
Imagine if the world were based on lies. Well, unfortunately, that's the truth. The lies go far beyond "who shot JFK" or whether the US government was directly or indirectly involved in 9/11.
When one uses the logical framework of Austrian, free-market analysis to analyze the Way the World Works in the modern age, one inevitably comes to the conclusion that modern society is built around fundamental untruths.
The first one is economic: It is the idea that central bankers can efficiently and effectively set the price of money. They cannot.
Every time central bankers decide on how much money to print or where short interest rates should be, the decisions are "fixing" prices – and price-fixing never works. Price-fixing distorts economies and causes a wealth shift from those who create it to those who don't and may not know what to do with it. Over time, aggressively mis-priced money causes first recessions and then depressions.
The second lie is that laws and regulations are necessary and that they can save society from "anarchy." In fact, anarchy is only the absence of government. That's the real definition. And absence of government does not necessarily imply "chaos." Just as setting interest rates fixes the price of money, so every law and regulation is a price fix as well, preventing someone from doing something within the context of the marketplace. This also constitutes a wealth transfer.
One can have a perfectly adequate and satisfying society without formal government, certainly without the kinds of intrusive and murderous governments we've got today. History is full of examples of societies that flourished with at least minimal government, especially societies where power truly flowed from the bottom up.
The third lie is that government is essential for purposes of defense and defending its citizens. But a quick survey of modern wars shows a disturbing tendency of governments – especially certain Western governments – to foment the very wars that citizens believe they're being protected from.
War is the "health of the state" – the way that those in power consolidate their hold while punishing their enemies using phony pretexts having to do with "treason" and "leaking classified information." Sound familiar?
It is what we call the Internet Reformation that has gradually shed light on the fundamental untruths permeating modern society in both the developed and developing world.
The Internet, like the Gutenberg Press before it, is a revolutionary device that has allowed people access to information that was hitherto denied or covered up, especially in the 20th century when the power elite's control over society was perhaps at its apex.
A conspiracy likely DOES exist. The Internet easily reveals not just facts that illuminate it, but also PATTERNS that show the same command-and-control strategies implemented throughout history, over and over.
It is easy, unfortunately, to mock those who believe in so-called "conspiracy theories" because the truth of what has occurred in this weary world is so extreme and shocking that most people simply cannot believe it. What truly horrifies us becomes a target for mockery. It's a defense mechanism.
Here's the seeming hard truth: A tiny group of Anglosphere banking families controlling most if not all of the world's major central banks have used the trillions to which they have access in order to foment what can be called a "New World Order."
This tiny group of intergenerational plotters and their enablers and associates have apparently built a seamless matrix of control around the entire globe to implement their schemes. They are building world government and are putting in place its building blocks.
What is it about the UN, IMF, World Bank, International Criminal Court, World Health Organization and hundreds of others lesser known globalist facilities that people who deny or decry modern "conspiracy theory" don't understand?
An entire gamut of globalist entities has been superimposed on the world in the past 75 years. Most recently − only this past week, in fact − the US military held a formal exercise over the skies of Los Angeles using the same black helicopters that conspiracy theorists were mocked for mentioning not a decade ago.
But the biggest issue by far – bigger than even the establishment of the facilities of the New World Order – is the fundamental illiteracy of those who choose to support modern society as it is today and as it has evolved over the past 100 years.
While human societies have always been based on fairly bizarre rituals, it is safe to say that the current crop of behind-the-scenes leaders have raised statist insanity to a new level.
Every part of modern society, from its basic economic building blocks to its liturgical belief in dysfunctional "laws and regulations" to its deep-seated reverence for the manipulated destruction of war, is questionable on a factual basis.
The reality of modern society is increasingly pathological – and the ones with the pathology are those who lead the rest of us along using paradigms that are evidently and obviously dishonest and dysfunctional.
Articles that mock the looniness of "conspiratorialists" need to deal with the fundamental economic and sociopolitical dishonesty of their own assumptions. They should begin by admitting the evident and obvious logical fallacies of the "modern" society they celebrate.
I'm not holding my breath.
January 28, 2012
Western Policymakers Are Doing The Exact Opposite Of What South Korea And Indonesia Did Right
There is a delicious irony in the world of economic policy at the moment.
Back in 1997 and 1998 I had a ringside seat to the Asian financial crisis from my trading desk in Seoul. When everything collapsed, the policy prescriptions from the World Bank and IMF for Asia’s sick economies was to:
1. HIKE interest rates,
2. CUT government spending,
3. Further deregulate, liberalize, and open their economies to foreign investment to attract capital;
4. And let their zombie banks FAIL.
Though, they experienced brutal recessions after swallowing this tough medicine, the two countries which carried out these policies to the fullest extent: South Korea, and Indonesia, are today among the most successful and dynamic economies in Asia, and the WORLD.
Since emerging from recession in 2000, Indonesia has enjoyed more than a decade of fast, uninterrupted economic growth. In fact, one emerging markets funds manager told me this week that Jakarta today is “far too modern” to interest him now. It has already “emerged.”
South Korea also emerged bigger, better, and stronger from the crisis 14 years ago. On my last trip there in late 2010 ahead of the G20 meeting in Seoul, I was astounded how far it had come since I’d last been there in 2003.
I remember having a chat with my cab driver and telling him it really looked to me as though Korea had reached “developed country status.” Becoming a “seon-jin-guk” as they call it in Korean was always one of the burning desires of Korean politicians, bureaucrats, business people, and ordinary citizens alike.
My cabbie was far too modest and said, “No. We still have a long way to go,” as he waved my visa card in front of a payment gadget mounted on his dashboard that instantly deducted the fare and had me on my way in about 5 seconds flat, without having to fumble around for change or sign anything.
South Korea today is the most wired country on the planet. So good are their technology companies, spearheaded by Samsung Electronics, they even have Apple running scared.
I recently retired my Blackberry. The replacement won’t be an iPhone. It’ll be Samsung’s Galaxy S2. All my friends who have them say they’re, “Way better.”
Bottom line — Indonesia and South Korea “reset” their systems back in the late 1990s and have emerged stronger and more dynamic than ever.
The Asian crisis, back then was brought on by the same things that led to the current crisis in Europe and the US (and the one I believe is coming to China): Too much cheap money. Too much borrowing by people who couldn’t afford it, to buy non-productive assets. And an insanely leveraged banking system run amuck.
Today, the same Western policymakers whose advice got Indonesia and South Korea quickly back on the rails are giving the EXACT OPPOSITE prescriptions for their own economies.
They’ve CUT interest rates to near ZERO. Governments have SPENT trillions of borrowed money that they have no hope of ever repaying on ill-advised “stimulus.”
They’ve BAILED OUT nearly all the brain-dead banks, keeping them on life support in a coma. Protectionist rhetoric is building up, and more onerous regulations are being ushered in.
This is what Japan did after its 1980s bubble. And look at them now. They’re stuck in a time warp, and the Japanese economy remains in a funk.
It doesn’t take a genius to see that if they persist with their current approach, Europe and America are going to end up exactly like Japan. And places such as South Korea, and even Indonesia, are eventually going to leave them in the dust.
Back in 1997 and 1998 I had a ringside seat to the Asian financial crisis from my trading desk in Seoul. When everything collapsed, the policy prescriptions from the World Bank and IMF for Asia’s sick economies was to:
1. HIKE interest rates,
2. CUT government spending,
3. Further deregulate, liberalize, and open their economies to foreign investment to attract capital;
4. And let their zombie banks FAIL.
Though, they experienced brutal recessions after swallowing this tough medicine, the two countries which carried out these policies to the fullest extent: South Korea, and Indonesia, are today among the most successful and dynamic economies in Asia, and the WORLD.
Since emerging from recession in 2000, Indonesia has enjoyed more than a decade of fast, uninterrupted economic growth. In fact, one emerging markets funds manager told me this week that Jakarta today is “far too modern” to interest him now. It has already “emerged.”
South Korea also emerged bigger, better, and stronger from the crisis 14 years ago. On my last trip there in late 2010 ahead of the G20 meeting in Seoul, I was astounded how far it had come since I’d last been there in 2003.
I remember having a chat with my cab driver and telling him it really looked to me as though Korea had reached “developed country status.” Becoming a “seon-jin-guk” as they call it in Korean was always one of the burning desires of Korean politicians, bureaucrats, business people, and ordinary citizens alike.
My cabbie was far too modest and said, “No. We still have a long way to go,” as he waved my visa card in front of a payment gadget mounted on his dashboard that instantly deducted the fare and had me on my way in about 5 seconds flat, without having to fumble around for change or sign anything.
South Korea today is the most wired country on the planet. So good are their technology companies, spearheaded by Samsung Electronics, they even have Apple running scared.
I recently retired my Blackberry. The replacement won’t be an iPhone. It’ll be Samsung’s Galaxy S2. All my friends who have them say they’re, “Way better.”
Bottom line — Indonesia and South Korea “reset” their systems back in the late 1990s and have emerged stronger and more dynamic than ever.
The Asian crisis, back then was brought on by the same things that led to the current crisis in Europe and the US (and the one I believe is coming to China): Too much cheap money. Too much borrowing by people who couldn’t afford it, to buy non-productive assets. And an insanely leveraged banking system run amuck.
Today, the same Western policymakers whose advice got Indonesia and South Korea quickly back on the rails are giving the EXACT OPPOSITE prescriptions for their own economies.
They’ve CUT interest rates to near ZERO. Governments have SPENT trillions of borrowed money that they have no hope of ever repaying on ill-advised “stimulus.”
They’ve BAILED OUT nearly all the brain-dead banks, keeping them on life support in a coma. Protectionist rhetoric is building up, and more onerous regulations are being ushered in.
This is what Japan did after its 1980s bubble. And look at them now. They’re stuck in a time warp, and the Japanese economy remains in a funk.
It doesn’t take a genius to see that if they persist with their current approach, Europe and America are going to end up exactly like Japan. And places such as South Korea, and even Indonesia, are eventually going to leave them in the dust.
January 27, 2012
Michael Hudson: Banks Weren’t Meant to Be Like This
The inherently symbiotic relationship between banks and governments recently has been reversed. In medieval times, wealthy bankers lent to kings and princes as their major customers. But now it is the banks that are needy, relying on governments for funding – capped by the post-2008 bailouts to save them from going bankrupt from their bad private-sector loans and gambles.
Yet the banks now browbeat governments – not by having ready cash but by threatening to go bust and drag the economy down with them if they are not given control of public tax policy, spending and planning. The process has gone furthest in the United States. Joseph Stiglitz characterizes the Obama administration’s vast transfer of money and pubic debt to the banks as a “privatizing of gains and the socializing of losses. It is a ‘partnership’ in which one partner robs the other.” Prof. Bill Black describes banks as becoming criminogenic and innovating “control fraud.” High finance has corrupted regulatory agencies, falsified account-keeping by “mark to model” trickery, and financed the campaigns of its supporters to disable public oversight. The effect is to leave banks in control of how the economy’s allocates its credit and resources.
If there is any silver lining to today’s debt crisis, it is that the present situation and trends cannot continue. So this is not only an opportunity to restructure banking; we have little choice. The urgent issue is who will control the economy: governments, or the financial sector and monopolies with which it has made an alliance.
Fortunately, it is not necessary to re-invent the wheel. Already a century ago the outlines of a productive industrial banking system were well understood. But recent bank lobbying has been remarkably successful in distracting attention away from classical analyses of how to shape the financial and tax system to best promote economic growth – by public checks on bank privileges.
How Banks Broke The Social Compact, Promoting Their Own Special Interests
People used to know what banks did. Bankers took deposits and lent them out, paying short-term depositors less than they charged for risky or less liquid loans. The risk was borne by bankers, not depositors or the government. But today, bank loans are made increasingly to speculators in recklessly large amounts for quick in-and-out trading. Financial crashes have become deeper and affect a wider swath of the population as debt pyramiding has soared and credit quality plunged into the toxic category of “liars’ loans.”
The first step toward today’s mutual interdependence between high finance and government was for central banks to act as lenders of last resort to mitigate the liquidity crises that periodically resulted from the banks’ privilege of credit creation. In due course governments also provided public deposit insurance, recognizing the need to mobilize and recycle savings into capital investment as the Industrial Revolution gained momentum. In exchange for this support, they regulated banks as public utilities.
Over time, banks have sought to disable this regulatory oversight, even to the point of decriminalizing fraud. Sponsoring an ideological attack on government, they accuse public bureaucracies of “distorting” free markets (by which they mean markets free for predatory behavior). The financial sector is now making its move to concentrate planning in its own hands.
The problem is that the financial time frame is notoriously short-term and often self-destructive. And inasmuch as the banking system’s product is debt, its business plan tends to be extractive and predatory, leaving economies high-cost. This is why checks and balances are needed, along with regulatory oversight to ensure fair dealing. Dismantling public attempts to steer banking to promote economic growth (rather than merely to make bankers rich) has permitted banks to turn into something nobody anticipated. Their major customers are other financial institutions, insurance and real estate – the FIRE sector, not industrial firms. Debt leveraging by real estate and monopolies, arbitrage speculators, hedge funds and corporate raiders inflates asset prices on credit. The effect of creating “balance sheet wealth” in this way is to load down the “real” production-and-consumption economy with debt and related rentier charges, adding more to the cost of living and doing business than rising productivity reduces production costs.
Since 2008, public bailouts have taken bad loans off the banks’ balance sheet at enormous taxpayer expense – some $13 trillion in the United States, and proportionally higher in Ireland and other economies now being subjected to austerity to pay for “free market” deregulation. Bankers are holding economies hostage, threatening a monetary crash if they do not get more bailouts and nearly free central bank credit, and more mortgage and other loan guarantees for their casino-like game. The resulting “too big to fail” policy means making governments too weak to fight back.
The process that began with central bank support thus has turned into broad government guarantees against bank insolvency. The largest banks have made so many reckless loans that they have become wards of the state. Yet they have become powerful enough to capture lawmakers to act as their facilitators. The popular media and even academic economic theorists have been mobilized to pose as experts in an attempt to convince the public that financial policy is best left to technocrats – of the banks’ own choosing, as if there is no alternative policy but for governments to subsidize a financial free lunch and crown bankers as society’s rulers.
The Bubble Economy and its austerity aftermath could not have occurred without the banking sector’s success in weakening public regulation, capturing national treasuries and even disabling law enforcement. Must governments surrender to this power grab? If not, who should bear the losses run up by a financial system that has become dysfunctional? If taxpayers have to pay, their economy will become high-cost and uncompetitive – and a financial oligarchy will rule.
The Present Debt Quandary
The endgame in times past was to write down bad debts. That meant losses for banks and investors. But today’s debt overhead is being kept in place – shifting bad loans off bank balance sheets to become public debts owed by taxpayers to save banks and their creditors from loss. Governments have given banks newly minted bonds or central bank credit in exchange for junk mortgages and bad gambles – without re-structuring the financial system to create a more stable, less debt-ridden economy. The pretense is that these bailouts will enable banks to lend enough to revive the economy by enough to pay its debts.
Seeing the handwriting on the wall, bankers are taking as much bailout money as they can get, and running, using the money to buy as much tangible property and ownership rights as they can while their lobbyists keep the public subsidy faucet running.
The pretense is that debt-strapped economies can resume business-as-usual growth by borrowing their way out of debt. But a quarter of U.S. real estate already is in negative equity – worth less than the mortgages attached to it – and the property market is still shrinking, so banks are not lending except with public Federal Housing Administration guarantees to cover whatever losses they may suffer. In any event, it already is mathematically impossible to carry today’s debt overhead without imposing austerity, debt deflation and depression.
This is not how banking was supposed to evolve. If governments are to underwrite bank loans, they may as well be doing the lending in the first place – and receiving the gains. Indeed, since 2008 the over-indebted economy’s crash led governments to become the major shareholders of the largest and most troubled banks – Citibank in the United States, Anglo-Irish Bank in Ireland, and Britain’s Royal Bank of Scotland. Yet rather than taking this opportunity to run these banks as public utilities and lower their charges for credit-card services – or most important of all, to stop their lending to speculators and gamblers – governments left these banks operating as part of the “casino capitalism” that has become their business plan.
There is no natural reason for matters to be like this. Relations between banks and government used to be the reverse. In 1307, France’s Philip IV (“The Fair”) set the tone by seizing the Knights Templars’ wealth, arresting them and putting many to death – not on financial charges, but on the accusation of devil-worshipping and satanic sexual practices. In 1344 the Peruzzi bank went broke, followed by the Bardi by making unsecured loans to Edward III of England and other monarchs who died or defaulted. Many subsequent banks had to suffer losses on loans gone bad to real estate or financial speculators.
By contrast, now the U.S., British, Irish and Latvian governments have taken bad bank loans onto their national balance sheets, imposing a heavy burden on taxpayers – while letting bankers cash out with immense wealth. These “cash for trash” swaps have turned the mortgage crisis and general debt collapse into a fiscal problem. Shifting the new public bailout debts onto the non-financial economy threaten to increase the cost of living and doing business. This is the result of the economy’s failure to distinguish productive from unproductive loans and debts. It helps explain why nations now are facing financial austerity and debt peonage instead of the leisure economy promised so eagerly by technological optimists a century ago.
So we are brought back to the question of what the proper role of banks should be. This issue was discussed exhaustively prior to World War I. It is even more urgent today.
How Classical Economists Hoped to Modernize Banks as Agents of Industrial Capitalism
Britain was the home of the Industrial Revolution, but there was little long-term lending to finance investment in factories or other means of production. British and Dutch merchant banking was to extend short-term credit on the basis of collateral such as real property or sales contracts for merchandise shipped (“receivables”). Buoyed by this trade financing, merchant bankers were successful enough to maintain long-established short-term funding practices. This meant that James Watt and other innovators were obliged to raise investment money from their families and friends rather than from banks.
It was the French and Germans who moved banking into the industrial stage to help their nations catch up. In France, the Saint-Simonians described the need to create an industrial credit system aimed at funding means of production. In effect, the Saint-Simonians proposed to restructure banks along lines akin to a mutual fund. A start was made with the Crédit Mobilier, founded by the Péreire Brothers in 1852. Their aim was to shift the banking and financial system away from debt financing at interest toward equity lending, taking returns in the form of dividends that would rise or decline in keeping with the debtor’s business fortunes. By giving businesses leeway to cut back dividends when sales and profits decline, profit-sharing agreements avoid the problem that interest must be paid willy-nilly. If an interest payment is missed, the debtor may be forced into bankruptcy and creditors can foreclose. It was to avoid this favoritism for creditors regardless of the debtor’s ability to pay that prompted Mohammed to ban interest under Islamic law.
Attracting reformers ranging from socialists to investment bankers, the Saint-Simonians won government backing for their policies under France’s Third Empire. Their approach inspired Marx as well as industrialists in Germany and protectionists in the United States and England. The common denominator of this broad spectrum was recognition that an efficient banking system was needed to finance the industry on which a strong national state and military power depended.
Germany Develops an Industrial Banking System
It was above all in Germany that long-term financing found its expression in the Reichsbank and other large industrial banks as part of the “holy trinity” of banking, industry and government planning under Bismarck’s “state socialism.” German banks made a virtue of necessity. British banks “derived the greater part of their funds from the depositors,” and steered these savings and business deposits into mercantile trade financing. This forced domestic firms to finance most new investment out of their own earnings. By contrast, Germany’s “lack of capital … forced industry to turn to the banks for assistance,” noted the financial historian George Edwards. “A considerable proportion of the funds of the German banks came not from the deposits of customers but from the capital subscribed by the proprietors themselves. As a result, German banks “stressed investment operations and were formed not so much for receiving deposits and granting loans but rather for supplying the investment requirements of industry.”
When the Great War broke out in 1914, Germany’s rapid victories were widely viewed as reflecting the superior efficiency of its financial system. To some observers the war appeared as a struggle between rival forms of financial organization. At issue was not only who would rule Europe, but whether the continent would have laissez faire or a more state-socialist economy.
In 1915, shortly after fighting broke out, the Christian Socialist priest-politician Friedrich Naumann published Mitteleuropa, describing how Germany recognized more than any other nation that industrial technology needed long term financing and government support. His book inspired Prof. H. S. Foxwell in England to draw on his arguments in two remarkable essays published in the Economic Journal in September and December 1917: “The Nature of the Industrial Struggle,” and “The Financing of Industry and Trade.” He endorsed Naumann’s contention that “the old individualistic capitalism, of what he calls the English type, is giving way to the new, more impersonal, group form; to the disciplined scientific capitalism he claims as German.”
This was necessarily a group undertaking, with the emerging tripartite integration of industry, banking and government, with finance being “undoubtedly the main cause of the success of modern German enterprise,” Foxwell concluded (p. 514). German bank staffs included industrial experts who were forging industrial policy into a science. And in America, Thorstein Veblen’s The Engineers and the Price System (1921) voiced the new industrial philosophy calling for bankers and government planners to become engineers in shaping credit markets.
Foxwell warned that British steel, automotive, capital equipment and other heavy industry was becoming obsolete largely because its bankers failed to perceive the need to promote equity investment and extend long term credit. They based their loan decisions not on the new production and revenue their lending might create, but simply on what collateral they could liquidate in the event of default: inventories of unsold goods, real estate, and money due on bills for goods sold and awaiting payment from customers. And rather than investing in the shares of the companies that their loans supposedly were building up, they paid out most of their earnings as dividends – and urged companies to do the same. This short time horizon forced business to remain liquid rather than having leeway to pursue long term strategy.
German banks, by contrast, paid out dividends (and expected such dividends from their clients) at only half the rate of British banks, choosing to retain earnings as capital reserves and invest them largely in the stocks of their industrial clients. Viewing these companies as allies rather than merely as customers from whom to make as large a profit as quickly as possible, German bank officials sat on their boards, and helped expand their business by extending loans to foreign governments on condition that their clients be named the chief suppliers in major public investments. Germany viewed the laws of history as favoring national planning to organize the financing of heavy industry, and gave its bankers a voice in formulating international diplomacy, making them “the principal instrument in the extension of her foreign trade and political power.”
A similar contrast existed in the stock market. British brokers were no more up to the task of financing manufacturing in its early stages than were its banks. The nation had taken an early lead by forming Crown corporations such as the East India Company, the Bank of England and even the South Sea Company. Despite the collapse of the South Sea Bubble in 1720, the run-up of share prices from 1715 to 1720 in these joint-stock monopolies established London’s stock market as a popular investment vehicle, for Dutch and other foreigners as well as for British investors. But the market was dominated by railroads, canals and large public utilities. Industrial firms were not major issuers of stock.
In any case, after earning their commissions on one issue, British stockbrokers were notorious for moving on to the next without much concern for what happened to the investors who had bought the earlier securities. “As soon as he has contrived to get his issue quoted at a premium and his underwriters have unloaded at a profit,” complained Foxwell, “his enterprise ceases. ‘To him,’ as the Times says, ‘a successful flotation is of more importance than a sound venture.’”
Much the same was true in the United States. Its merchant heroes were individualistic traders and political insiders often operating on the edge of the law to gain their fortunes by stock-market manipulation, railroad politicking for land giveaways, and insurance companies, mining and natural resource extraction. America’s wealth-seeking spirit found its epitome in Thomas Edison’s hit-or-miss method of invention, coupled with a high degree of litigiousness to obtain patent and monopoly rights.
In sum, neither British nor American banking or stock markets planned for the future. Their time frame was short, and they preferred rent-extracting projects to industrial innovation. Most banks favored large real estate borrowers, railroads and public utilities whose income streams easily could be forecast. Only after manufacturing companies grew fairly large did they obtain significant bank and stock market credit.
What is remarkable is that this is the tradition of banking and high finance that has emerged victorious throughout the world. The explanation is primarily the military victory of the United States, Britain and their Allies in the Great War and a generation later, in World War II.
The Regression Toward Burdensome Unproductive Debts After World War I
The development of industrial credit led economists to distinguish between productive and unproductive lending. A productive loan provides borrowers with resources to trade or invest at a profit sufficient to pay back the loan and its interest charge. An unproductive loan must be paid out of income earned elsewhere. Governments must pay war loans out of tax revenues. Consumers must pay loans out of income they earn at a job – or by selling assets. These debt payments divert revenue away from being spent on consumption and investment, so the economy shrinks. This traditionally has led to crises that wipe out debts, above all those that are unproductive.
In the aftermath of World War I the economies of Europe’s victorious and defeated nations alike were dominated by postwar arms and reparations debts. These inter-governmental debts were to pay for weapons (by the Allies when the United States unexpectedly demanded that they pay for the arms they had bought before America’s entry into the war), and for the destruction of property (by the Axis), not new means of production. Yet to the extent that they were inter-governmental, these debts were more intractable than debts to private bankers and bondholders. Despite the fact that governments in principle are sovereign and hence can annul debts owed to private creditors, the defeated Axis governments were in no position to do this.
And among the Allies, Britain led the capitulation to U.S. arms billing, captive to the creditor ideology that “a debt is a debt” and must be paid regardless of what this entails in practice or even whether the debt in fact can be paid. Confronted with America’s demand for payment, the Allies turned to Germany to make them whole. After taking its liquid assets and major natural resources, they insisted that it squeeze out payments by taxing its economy. No attempt was made to calculate just how Germany was to do this – or most important, how it was to convert this domestic revenue (the “budgetary problem”) into hard currency or gold. Despite the fact that banking had focused on international credit and currency transfers since the 12th century, there was a broad denial of what John Maynard Keynes identified as a foreign exchange transfer problem.
Never before had there been an obligation of such enormous magnitude. Nevertheless, all of Germany’s political parties and government agencies sought to devise ways to tax the economy to raise the sums being demanded. Taxes, however, are levied in a nation’s own currency. The only way to pay the Allies was for the Reichsbank to take this fiscal revenue and throw it onto the foreign exchange markets to obtain the sterling and other hard currency to pay. Britain, France and the other recipients then paid this money on their Inter-Ally debts to the United States.
Adam Smith pointed out that no government ever had paid down its public debt. But creditors always have been reluctant to acknowledge that debtors are unable to pay. Ever since David Ricardo’s lobbying for their perspective in Britain’s Bullion debates, creditors have found it their self-interest to promote a doctrinaire blind spot, insisting that debts of any magnitude could be paid. They resist acknowledging a distinction between raising funds domestically (by running a budget surplus) and obtaining the foreign exchange to pay foreign-currency debt. Furthermore, despite the evident fact that austerity cutbacks on consumption and investment can only be extractive, creditor-oriented economists refused to recognize that debts cannot be paid by shrinking the economy. Or that foreign debts and other international payments cannot be paid in domestic currency without lowering the exchange rate.
The more domestic currency Germany sought to convert, the further its exchange rate was driven down against the dollar and other gold-based currencies. This obliged Germans to pay much more for imports. The collapse of the exchange rate was the source of hyperinflation, not an increase in domestic money creation as today’s creditor-sponsored monetarist economists insist. In vain Keynes pointed to the specific structure of Germany’s balance of payments and asked creditors to specify just how many German exports they were willing to take, and to explain how domestic currency could be converted into foreign exchange without collapsing the exchange rate and causing price inflation.
Tragically, Ricardian tunnel vision won Allied government backing. Bertil Ohlin and Jacques Rueff claimed that economies receiving German payments would recycle their inflows to Germany and other debt-paying countries by buying their imports. If income adjustments did not keep exchange rates and prices stable, then Germany’s falling exchange rate would make its exports sufficiently more attractive to enable it to earn the revenue to pay.
This is the logic that the International Monetary Fund followed half a century later in insisting that Third World countries remit foreign earnings and even permit flight capital as well as pay their foreign debts. It is the neoliberal stance now demanding austerity for Greece, Ireland, Italy and other Eurozone economies.
Bank lobbyists claim that the European Central Bank will risk spurring domestic wage and price inflation of it does what central banks were founded to do: finance budget deficits. Europe’s financial institutions are given a monopoly right to perform this electronic task – and to receive interest for what a real central bank could create on its own computer keyboard.
But why it is less inflationary for commercial banks to finance budget deficits than for central banks to do this? The bank lending that has inflated a global financial bubble since the 1980s has left as its legacy a debt overhead that can no more be supported today than Germany was able to carry its reparations debt in the 1920s. Would government credit have so recklessly inflated asset prices?
How Debt Creation Has Fueled Asset-Price Inflation Since The 1980s
Banking in recent decades has not followed the productive lines that early economic futurists expected. As noted above, instead of financing tangible investment to expand production and innovation, most loans are made against collateral, with interest to be paid out of what borrowers can make elsewhere. Despite being unproductive in the classical sense, it was remunerative for debtors from 1980 until 2008 – not by investing the loan proceeds to expand economic activity, but by riding the wave of asset-price inflation. Mortgage credit enabled borrowers to bid up property prices, drawing speculators and new customers into the market in the expectation that prices would continue to rise. But hothouse credit infusions meant additional debt service, which ended up shrinking the market for goods and services.
Under normal conditions the effect would have been for rents to decline, with property prices following suit, leading to mortgage defaults. But banks postponed the collapse into negative equity by lowering their lending standards, providing enough new credit to keep on inflating prices. This averted a collapse of their speculative mortgage and stock market lending. It was inflationary – but it was inflating asset prices, not commodity prices or wages. Two decades of asset price inflation enabled speculators, homeowners and commercial investors to borrow the interest falling due and still make a capital gain.
This hope for a price gain made winning bidders willing to pay lenders all the current income – making banks the ultimate and major rentier income recipients. The process of inflating asset prices by easing credit terms and lowering the interest rate was self-feeding. But it also was self-terminating, because raising the multiple by which a given real estate rent or business income can be “capitalized” into bank loans increased the economy’s debt overhead.
Securities markets became part of this problem. Rising stock and bond prices made pension funds pay more to purchase a retirement income – so “pension fund capitalism” was coming undone. So was the industrial economy itself. Instead of raising new equity financing for companies, the stock market became a vehicle for corporate buyouts. Raiders borrowed to buy out stockholders, loading down companies with debt. The most successful looters left them bankrupt shells. And when creditors turned their economic gains from this process into political power to shift the tax burden onto wage earners and industry, this raised the cost of living and doing business – by more than technology was able to lower prices.
The EU Rejects Central Bank Money Creation, Leaving Deficit Financing to the Banks
Article 123 of the Lisbon Treaty forbids the ECB or other central banks to lend to government. But central banks were created specifically – to finance government deficits. The EU has rolled back history to the way things were three hundred years ago, before the Bank of England was created. Reserving the task of credit creation for commercial banks, it leaves governments without a central bank to finance the public spending needed to avert depression and widespread financial collapse.
So the plan has backfired. When “hard money” policy makers limited central bank power, they assumed that public debts would be risk-free. Obliging budget deficits to be financed by private creditors seemed to offer a bonanza: being able to collect interest for creating electronic credit that governments can create themselves. But now, European governments need credit to balance their budget or face default. So banks now want a central bank to create the money to bail them out for the bad loans they have made.
For starters, the ECB’s €489 billion in three-year loans at 1% interest gives banks a free lunch arbitrage opportunity (the “carry trade”) to buy Greek and Spanish bonds yielding a higher rate. The policy of buying government bonds in the open market – after banks first have bought them at a lower issue price – gives the banks a quick and easy trading gain.
How are these giveaways less inflationary than for central banks to directly finance budget deficits and roll over government debts? Is the aim of giving banks easy gains simply to provide them with resources to resume the Bubble Economy lending that led to today’s debt overhead in the first place?
Conclusion
Governments can create new credit electronically on their own computer keyboards as easily as commercial banks can. And unlike banks, their spending is expected to serve a broad social purpose, to be determined democratically. When commercial banks gain policy control over governments and central banks, they tend to support their own remunerative policy of creating asset-inflationary credit – leaving the clean-up costs to be solved by a post-bubble austerity. This makes the debt overhead even harder to pay – indeed, impossible.
So we are brought back to the policy issue of how public money creation to finance budget deficits differs from issuing government bonds for banks to buy. Is not the latter option a convoluted way to finance such deficits – at a needless interest charge? When governments monetize their budget deficits, they do not have to pay bondholders.
I have heard bankers argue that governments need an honest broker to decide whether a loan or public spending policy is responsible. To date their advice has not promoted productive credit. Yet they now are attempting to compensate for the financial crisis by telling debtor governments to sell off property in their public domain. This “solution” relies on the myth that privatization is more efficient and will lower the cost of basic infrastructure services. Yet it involves paying interest to the buyers of rent-extraction rights, higher executive salaries, stock options and other financial fees.
Most cost savings are achieved by shifting to non-unionized labor, and typically end up being paid to the privatizers, their bankers and bondholders, not passed on to the public. And bankers back price deregulation, enabling privatizers to raise access charges. This makes the economy higher cost and hence less competitive – just the opposite of what is promised.
Banking has moved so far away from funding industrial growth and economic development that it now benefits primarily at the economy’s expense in a predator and extractive way, not by making productive loans. This is now the great problem confronting our time. Banks now lend mainly to other financial institutions, hedge funds, corporate raiders, insurance companies and real estate, and engage in their own speculation in foreign currency, interest-rate arbitrage, and computer-driven trading programs. Industrial firms bypass the banking system by financing new capital investment out of their own retained earnings, and meet their liquidity needs by issuing their own commercial paper directly. Yet to keep the bank casino winning, global bankers now want governments not only to bail them out but to enable them to renew their failed business plan – and to keep the present debts in place so that creditors will not have to take a loss.
This wish means that society should lose, and even suffer depression. We are dealing here not only with greed, but with outright antisocial behavior and hostility.
Europe thus has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy. History provides a wealth of examples illustrating the dangers of capitulating to bankers, and also for how to restructure banking along more productive lines. The underlying questions are clear enough:
* Have banks outlived their historical role, or can they be restructured to finance productive capital investment rather than simply inflate asset prices?
* Would a public option provide less costly and better directed credit?
* Why not promote economic recovery by writing down debts to reflect the ability to pay, rather than relinquishing more wealth to an increasingly aggressive creditor class?
Solving the Eurozone’s financial problem can be made much easier by the tax reforms that classical economists advocated to complement their financial reforms. To free consumers and employers from taxation, they proposed to levy the burden on the “unearned increment” of land and natural resource rent, monopoly rent and financial privilege. The guiding principle was that property rights in the earth, monopolies and other ownership privileges have no direct cost of production, and hence can be taxed without reducing their supply or raising their price, which is set in the market. Removing the tax deductibility for interest is the other key reform that is needed.
A rent tax holds down housing prices and those of basic infrastructure services, whose untaxed revenue tends to be capitalized into bank loans and paid out in the form of interest charges. Additionally, land and natural resource rents – along with interest – are the easiest to tax, because they are highly visible and their value is easy to assess.
Pressure to narrow existing budget deficits offers a timely opportunity to rationalize the tax systems of Greece and other PIIGS countries in which the wealthy avoid paying their fair share of taxes. The political problem blocking this classical fiscal policy is that it “interferes” with the rent-extracting free lunches that banks seek to lend against. So they act as lobbyists for untaxing real estate and monopolies (and themselves as well). Despite the financial sector’s desire to see governments remain sufficiently solvent to pay bondholders, it has subsidized an enormous public relations apparatus and academic junk economics to oppose the tax policies that can close the fiscal gap in the fairest way.
It is too early to forecast whether banks or governments will emerge victorious from today’s crisis. As economies polarize between debtors and creditors, planning is shifting out of public hands into those of bankers. The easiest way for them to keep this power is to block a true central bank or strong public sector from interfering with their monopoly of credit creation. The counter is for central banks and governments to act as they were intended to, by providing a public option for credit creation.
Yet the banks now browbeat governments – not by having ready cash but by threatening to go bust and drag the economy down with them if they are not given control of public tax policy, spending and planning. The process has gone furthest in the United States. Joseph Stiglitz characterizes the Obama administration’s vast transfer of money and pubic debt to the banks as a “privatizing of gains and the socializing of losses. It is a ‘partnership’ in which one partner robs the other.” Prof. Bill Black describes banks as becoming criminogenic and innovating “control fraud.” High finance has corrupted regulatory agencies, falsified account-keeping by “mark to model” trickery, and financed the campaigns of its supporters to disable public oversight. The effect is to leave banks in control of how the economy’s allocates its credit and resources.
If there is any silver lining to today’s debt crisis, it is that the present situation and trends cannot continue. So this is not only an opportunity to restructure banking; we have little choice. The urgent issue is who will control the economy: governments, or the financial sector and monopolies with which it has made an alliance.
Fortunately, it is not necessary to re-invent the wheel. Already a century ago the outlines of a productive industrial banking system were well understood. But recent bank lobbying has been remarkably successful in distracting attention away from classical analyses of how to shape the financial and tax system to best promote economic growth – by public checks on bank privileges.
How Banks Broke The Social Compact, Promoting Their Own Special Interests
People used to know what banks did. Bankers took deposits and lent them out, paying short-term depositors less than they charged for risky or less liquid loans. The risk was borne by bankers, not depositors or the government. But today, bank loans are made increasingly to speculators in recklessly large amounts for quick in-and-out trading. Financial crashes have become deeper and affect a wider swath of the population as debt pyramiding has soared and credit quality plunged into the toxic category of “liars’ loans.”
The first step toward today’s mutual interdependence between high finance and government was for central banks to act as lenders of last resort to mitigate the liquidity crises that periodically resulted from the banks’ privilege of credit creation. In due course governments also provided public deposit insurance, recognizing the need to mobilize and recycle savings into capital investment as the Industrial Revolution gained momentum. In exchange for this support, they regulated banks as public utilities.
Over time, banks have sought to disable this regulatory oversight, even to the point of decriminalizing fraud. Sponsoring an ideological attack on government, they accuse public bureaucracies of “distorting” free markets (by which they mean markets free for predatory behavior). The financial sector is now making its move to concentrate planning in its own hands.
The problem is that the financial time frame is notoriously short-term and often self-destructive. And inasmuch as the banking system’s product is debt, its business plan tends to be extractive and predatory, leaving economies high-cost. This is why checks and balances are needed, along with regulatory oversight to ensure fair dealing. Dismantling public attempts to steer banking to promote economic growth (rather than merely to make bankers rich) has permitted banks to turn into something nobody anticipated. Their major customers are other financial institutions, insurance and real estate – the FIRE sector, not industrial firms. Debt leveraging by real estate and monopolies, arbitrage speculators, hedge funds and corporate raiders inflates asset prices on credit. The effect of creating “balance sheet wealth” in this way is to load down the “real” production-and-consumption economy with debt and related rentier charges, adding more to the cost of living and doing business than rising productivity reduces production costs.
Since 2008, public bailouts have taken bad loans off the banks’ balance sheet at enormous taxpayer expense – some $13 trillion in the United States, and proportionally higher in Ireland and other economies now being subjected to austerity to pay for “free market” deregulation. Bankers are holding economies hostage, threatening a monetary crash if they do not get more bailouts and nearly free central bank credit, and more mortgage and other loan guarantees for their casino-like game. The resulting “too big to fail” policy means making governments too weak to fight back.
The process that began with central bank support thus has turned into broad government guarantees against bank insolvency. The largest banks have made so many reckless loans that they have become wards of the state. Yet they have become powerful enough to capture lawmakers to act as their facilitators. The popular media and even academic economic theorists have been mobilized to pose as experts in an attempt to convince the public that financial policy is best left to technocrats – of the banks’ own choosing, as if there is no alternative policy but for governments to subsidize a financial free lunch and crown bankers as society’s rulers.
The Bubble Economy and its austerity aftermath could not have occurred without the banking sector’s success in weakening public regulation, capturing national treasuries and even disabling law enforcement. Must governments surrender to this power grab? If not, who should bear the losses run up by a financial system that has become dysfunctional? If taxpayers have to pay, their economy will become high-cost and uncompetitive – and a financial oligarchy will rule.
The Present Debt Quandary
The endgame in times past was to write down bad debts. That meant losses for banks and investors. But today’s debt overhead is being kept in place – shifting bad loans off bank balance sheets to become public debts owed by taxpayers to save banks and their creditors from loss. Governments have given banks newly minted bonds or central bank credit in exchange for junk mortgages and bad gambles – without re-structuring the financial system to create a more stable, less debt-ridden economy. The pretense is that these bailouts will enable banks to lend enough to revive the economy by enough to pay its debts.
Seeing the handwriting on the wall, bankers are taking as much bailout money as they can get, and running, using the money to buy as much tangible property and ownership rights as they can while their lobbyists keep the public subsidy faucet running.
The pretense is that debt-strapped economies can resume business-as-usual growth by borrowing their way out of debt. But a quarter of U.S. real estate already is in negative equity – worth less than the mortgages attached to it – and the property market is still shrinking, so banks are not lending except with public Federal Housing Administration guarantees to cover whatever losses they may suffer. In any event, it already is mathematically impossible to carry today’s debt overhead without imposing austerity, debt deflation and depression.
This is not how banking was supposed to evolve. If governments are to underwrite bank loans, they may as well be doing the lending in the first place – and receiving the gains. Indeed, since 2008 the over-indebted economy’s crash led governments to become the major shareholders of the largest and most troubled banks – Citibank in the United States, Anglo-Irish Bank in Ireland, and Britain’s Royal Bank of Scotland. Yet rather than taking this opportunity to run these banks as public utilities and lower their charges for credit-card services – or most important of all, to stop their lending to speculators and gamblers – governments left these banks operating as part of the “casino capitalism” that has become their business plan.
There is no natural reason for matters to be like this. Relations between banks and government used to be the reverse. In 1307, France’s Philip IV (“The Fair”) set the tone by seizing the Knights Templars’ wealth, arresting them and putting many to death – not on financial charges, but on the accusation of devil-worshipping and satanic sexual practices. In 1344 the Peruzzi bank went broke, followed by the Bardi by making unsecured loans to Edward III of England and other monarchs who died or defaulted. Many subsequent banks had to suffer losses on loans gone bad to real estate or financial speculators.
By contrast, now the U.S., British, Irish and Latvian governments have taken bad bank loans onto their national balance sheets, imposing a heavy burden on taxpayers – while letting bankers cash out with immense wealth. These “cash for trash” swaps have turned the mortgage crisis and general debt collapse into a fiscal problem. Shifting the new public bailout debts onto the non-financial economy threaten to increase the cost of living and doing business. This is the result of the economy’s failure to distinguish productive from unproductive loans and debts. It helps explain why nations now are facing financial austerity and debt peonage instead of the leisure economy promised so eagerly by technological optimists a century ago.
So we are brought back to the question of what the proper role of banks should be. This issue was discussed exhaustively prior to World War I. It is even more urgent today.
How Classical Economists Hoped to Modernize Banks as Agents of Industrial Capitalism
Britain was the home of the Industrial Revolution, but there was little long-term lending to finance investment in factories or other means of production. British and Dutch merchant banking was to extend short-term credit on the basis of collateral such as real property or sales contracts for merchandise shipped (“receivables”). Buoyed by this trade financing, merchant bankers were successful enough to maintain long-established short-term funding practices. This meant that James Watt and other innovators were obliged to raise investment money from their families and friends rather than from banks.
It was the French and Germans who moved banking into the industrial stage to help their nations catch up. In France, the Saint-Simonians described the need to create an industrial credit system aimed at funding means of production. In effect, the Saint-Simonians proposed to restructure banks along lines akin to a mutual fund. A start was made with the Crédit Mobilier, founded by the Péreire Brothers in 1852. Their aim was to shift the banking and financial system away from debt financing at interest toward equity lending, taking returns in the form of dividends that would rise or decline in keeping with the debtor’s business fortunes. By giving businesses leeway to cut back dividends when sales and profits decline, profit-sharing agreements avoid the problem that interest must be paid willy-nilly. If an interest payment is missed, the debtor may be forced into bankruptcy and creditors can foreclose. It was to avoid this favoritism for creditors regardless of the debtor’s ability to pay that prompted Mohammed to ban interest under Islamic law.
Attracting reformers ranging from socialists to investment bankers, the Saint-Simonians won government backing for their policies under France’s Third Empire. Their approach inspired Marx as well as industrialists in Germany and protectionists in the United States and England. The common denominator of this broad spectrum was recognition that an efficient banking system was needed to finance the industry on which a strong national state and military power depended.
Germany Develops an Industrial Banking System
It was above all in Germany that long-term financing found its expression in the Reichsbank and other large industrial banks as part of the “holy trinity” of banking, industry and government planning under Bismarck’s “state socialism.” German banks made a virtue of necessity. British banks “derived the greater part of their funds from the depositors,” and steered these savings and business deposits into mercantile trade financing. This forced domestic firms to finance most new investment out of their own earnings. By contrast, Germany’s “lack of capital … forced industry to turn to the banks for assistance,” noted the financial historian George Edwards. “A considerable proportion of the funds of the German banks came not from the deposits of customers but from the capital subscribed by the proprietors themselves. As a result, German banks “stressed investment operations and were formed not so much for receiving deposits and granting loans but rather for supplying the investment requirements of industry.”
When the Great War broke out in 1914, Germany’s rapid victories were widely viewed as reflecting the superior efficiency of its financial system. To some observers the war appeared as a struggle between rival forms of financial organization. At issue was not only who would rule Europe, but whether the continent would have laissez faire or a more state-socialist economy.
In 1915, shortly after fighting broke out, the Christian Socialist priest-politician Friedrich Naumann published Mitteleuropa, describing how Germany recognized more than any other nation that industrial technology needed long term financing and government support. His book inspired Prof. H. S. Foxwell in England to draw on his arguments in two remarkable essays published in the Economic Journal in September and December 1917: “The Nature of the Industrial Struggle,” and “The Financing of Industry and Trade.” He endorsed Naumann’s contention that “the old individualistic capitalism, of what he calls the English type, is giving way to the new, more impersonal, group form; to the disciplined scientific capitalism he claims as German.”
This was necessarily a group undertaking, with the emerging tripartite integration of industry, banking and government, with finance being “undoubtedly the main cause of the success of modern German enterprise,” Foxwell concluded (p. 514). German bank staffs included industrial experts who were forging industrial policy into a science. And in America, Thorstein Veblen’s The Engineers and the Price System (1921) voiced the new industrial philosophy calling for bankers and government planners to become engineers in shaping credit markets.
Foxwell warned that British steel, automotive, capital equipment and other heavy industry was becoming obsolete largely because its bankers failed to perceive the need to promote equity investment and extend long term credit. They based their loan decisions not on the new production and revenue their lending might create, but simply on what collateral they could liquidate in the event of default: inventories of unsold goods, real estate, and money due on bills for goods sold and awaiting payment from customers. And rather than investing in the shares of the companies that their loans supposedly were building up, they paid out most of their earnings as dividends – and urged companies to do the same. This short time horizon forced business to remain liquid rather than having leeway to pursue long term strategy.
German banks, by contrast, paid out dividends (and expected such dividends from their clients) at only half the rate of British banks, choosing to retain earnings as capital reserves and invest them largely in the stocks of their industrial clients. Viewing these companies as allies rather than merely as customers from whom to make as large a profit as quickly as possible, German bank officials sat on their boards, and helped expand their business by extending loans to foreign governments on condition that their clients be named the chief suppliers in major public investments. Germany viewed the laws of history as favoring national planning to organize the financing of heavy industry, and gave its bankers a voice in formulating international diplomacy, making them “the principal instrument in the extension of her foreign trade and political power.”
A similar contrast existed in the stock market. British brokers were no more up to the task of financing manufacturing in its early stages than were its banks. The nation had taken an early lead by forming Crown corporations such as the East India Company, the Bank of England and even the South Sea Company. Despite the collapse of the South Sea Bubble in 1720, the run-up of share prices from 1715 to 1720 in these joint-stock monopolies established London’s stock market as a popular investment vehicle, for Dutch and other foreigners as well as for British investors. But the market was dominated by railroads, canals and large public utilities. Industrial firms were not major issuers of stock.
In any case, after earning their commissions on one issue, British stockbrokers were notorious for moving on to the next without much concern for what happened to the investors who had bought the earlier securities. “As soon as he has contrived to get his issue quoted at a premium and his underwriters have unloaded at a profit,” complained Foxwell, “his enterprise ceases. ‘To him,’ as the Times says, ‘a successful flotation is of more importance than a sound venture.’”
Much the same was true in the United States. Its merchant heroes were individualistic traders and political insiders often operating on the edge of the law to gain their fortunes by stock-market manipulation, railroad politicking for land giveaways, and insurance companies, mining and natural resource extraction. America’s wealth-seeking spirit found its epitome in Thomas Edison’s hit-or-miss method of invention, coupled with a high degree of litigiousness to obtain patent and monopoly rights.
In sum, neither British nor American banking or stock markets planned for the future. Their time frame was short, and they preferred rent-extracting projects to industrial innovation. Most banks favored large real estate borrowers, railroads and public utilities whose income streams easily could be forecast. Only after manufacturing companies grew fairly large did they obtain significant bank and stock market credit.
What is remarkable is that this is the tradition of banking and high finance that has emerged victorious throughout the world. The explanation is primarily the military victory of the United States, Britain and their Allies in the Great War and a generation later, in World War II.
The Regression Toward Burdensome Unproductive Debts After World War I
The development of industrial credit led economists to distinguish between productive and unproductive lending. A productive loan provides borrowers with resources to trade or invest at a profit sufficient to pay back the loan and its interest charge. An unproductive loan must be paid out of income earned elsewhere. Governments must pay war loans out of tax revenues. Consumers must pay loans out of income they earn at a job – or by selling assets. These debt payments divert revenue away from being spent on consumption and investment, so the economy shrinks. This traditionally has led to crises that wipe out debts, above all those that are unproductive.
In the aftermath of World War I the economies of Europe’s victorious and defeated nations alike were dominated by postwar arms and reparations debts. These inter-governmental debts were to pay for weapons (by the Allies when the United States unexpectedly demanded that they pay for the arms they had bought before America’s entry into the war), and for the destruction of property (by the Axis), not new means of production. Yet to the extent that they were inter-governmental, these debts were more intractable than debts to private bankers and bondholders. Despite the fact that governments in principle are sovereign and hence can annul debts owed to private creditors, the defeated Axis governments were in no position to do this.
And among the Allies, Britain led the capitulation to U.S. arms billing, captive to the creditor ideology that “a debt is a debt” and must be paid regardless of what this entails in practice or even whether the debt in fact can be paid. Confronted with America’s demand for payment, the Allies turned to Germany to make them whole. After taking its liquid assets and major natural resources, they insisted that it squeeze out payments by taxing its economy. No attempt was made to calculate just how Germany was to do this – or most important, how it was to convert this domestic revenue (the “budgetary problem”) into hard currency or gold. Despite the fact that banking had focused on international credit and currency transfers since the 12th century, there was a broad denial of what John Maynard Keynes identified as a foreign exchange transfer problem.
Never before had there been an obligation of such enormous magnitude. Nevertheless, all of Germany’s political parties and government agencies sought to devise ways to tax the economy to raise the sums being demanded. Taxes, however, are levied in a nation’s own currency. The only way to pay the Allies was for the Reichsbank to take this fiscal revenue and throw it onto the foreign exchange markets to obtain the sterling and other hard currency to pay. Britain, France and the other recipients then paid this money on their Inter-Ally debts to the United States.
Adam Smith pointed out that no government ever had paid down its public debt. But creditors always have been reluctant to acknowledge that debtors are unable to pay. Ever since David Ricardo’s lobbying for their perspective in Britain’s Bullion debates, creditors have found it their self-interest to promote a doctrinaire blind spot, insisting that debts of any magnitude could be paid. They resist acknowledging a distinction between raising funds domestically (by running a budget surplus) and obtaining the foreign exchange to pay foreign-currency debt. Furthermore, despite the evident fact that austerity cutbacks on consumption and investment can only be extractive, creditor-oriented economists refused to recognize that debts cannot be paid by shrinking the economy. Or that foreign debts and other international payments cannot be paid in domestic currency without lowering the exchange rate.
The more domestic currency Germany sought to convert, the further its exchange rate was driven down against the dollar and other gold-based currencies. This obliged Germans to pay much more for imports. The collapse of the exchange rate was the source of hyperinflation, not an increase in domestic money creation as today’s creditor-sponsored monetarist economists insist. In vain Keynes pointed to the specific structure of Germany’s balance of payments and asked creditors to specify just how many German exports they were willing to take, and to explain how domestic currency could be converted into foreign exchange without collapsing the exchange rate and causing price inflation.
Tragically, Ricardian tunnel vision won Allied government backing. Bertil Ohlin and Jacques Rueff claimed that economies receiving German payments would recycle their inflows to Germany and other debt-paying countries by buying their imports. If income adjustments did not keep exchange rates and prices stable, then Germany’s falling exchange rate would make its exports sufficiently more attractive to enable it to earn the revenue to pay.
This is the logic that the International Monetary Fund followed half a century later in insisting that Third World countries remit foreign earnings and even permit flight capital as well as pay their foreign debts. It is the neoliberal stance now demanding austerity for Greece, Ireland, Italy and other Eurozone economies.
Bank lobbyists claim that the European Central Bank will risk spurring domestic wage and price inflation of it does what central banks were founded to do: finance budget deficits. Europe’s financial institutions are given a monopoly right to perform this electronic task – and to receive interest for what a real central bank could create on its own computer keyboard.
But why it is less inflationary for commercial banks to finance budget deficits than for central banks to do this? The bank lending that has inflated a global financial bubble since the 1980s has left as its legacy a debt overhead that can no more be supported today than Germany was able to carry its reparations debt in the 1920s. Would government credit have so recklessly inflated asset prices?
How Debt Creation Has Fueled Asset-Price Inflation Since The 1980s
Banking in recent decades has not followed the productive lines that early economic futurists expected. As noted above, instead of financing tangible investment to expand production and innovation, most loans are made against collateral, with interest to be paid out of what borrowers can make elsewhere. Despite being unproductive in the classical sense, it was remunerative for debtors from 1980 until 2008 – not by investing the loan proceeds to expand economic activity, but by riding the wave of asset-price inflation. Mortgage credit enabled borrowers to bid up property prices, drawing speculators and new customers into the market in the expectation that prices would continue to rise. But hothouse credit infusions meant additional debt service, which ended up shrinking the market for goods and services.
Under normal conditions the effect would have been for rents to decline, with property prices following suit, leading to mortgage defaults. But banks postponed the collapse into negative equity by lowering their lending standards, providing enough new credit to keep on inflating prices. This averted a collapse of their speculative mortgage and stock market lending. It was inflationary – but it was inflating asset prices, not commodity prices or wages. Two decades of asset price inflation enabled speculators, homeowners and commercial investors to borrow the interest falling due and still make a capital gain.
This hope for a price gain made winning bidders willing to pay lenders all the current income – making banks the ultimate and major rentier income recipients. The process of inflating asset prices by easing credit terms and lowering the interest rate was self-feeding. But it also was self-terminating, because raising the multiple by which a given real estate rent or business income can be “capitalized” into bank loans increased the economy’s debt overhead.
Securities markets became part of this problem. Rising stock and bond prices made pension funds pay more to purchase a retirement income – so “pension fund capitalism” was coming undone. So was the industrial economy itself. Instead of raising new equity financing for companies, the stock market became a vehicle for corporate buyouts. Raiders borrowed to buy out stockholders, loading down companies with debt. The most successful looters left them bankrupt shells. And when creditors turned their economic gains from this process into political power to shift the tax burden onto wage earners and industry, this raised the cost of living and doing business – by more than technology was able to lower prices.
The EU Rejects Central Bank Money Creation, Leaving Deficit Financing to the Banks
Article 123 of the Lisbon Treaty forbids the ECB or other central banks to lend to government. But central banks were created specifically – to finance government deficits. The EU has rolled back history to the way things were three hundred years ago, before the Bank of England was created. Reserving the task of credit creation for commercial banks, it leaves governments without a central bank to finance the public spending needed to avert depression and widespread financial collapse.
So the plan has backfired. When “hard money” policy makers limited central bank power, they assumed that public debts would be risk-free. Obliging budget deficits to be financed by private creditors seemed to offer a bonanza: being able to collect interest for creating electronic credit that governments can create themselves. But now, European governments need credit to balance their budget or face default. So banks now want a central bank to create the money to bail them out for the bad loans they have made.
For starters, the ECB’s €489 billion in three-year loans at 1% interest gives banks a free lunch arbitrage opportunity (the “carry trade”) to buy Greek and Spanish bonds yielding a higher rate. The policy of buying government bonds in the open market – after banks first have bought them at a lower issue price – gives the banks a quick and easy trading gain.
How are these giveaways less inflationary than for central banks to directly finance budget deficits and roll over government debts? Is the aim of giving banks easy gains simply to provide them with resources to resume the Bubble Economy lending that led to today’s debt overhead in the first place?
Conclusion
Governments can create new credit electronically on their own computer keyboards as easily as commercial banks can. And unlike banks, their spending is expected to serve a broad social purpose, to be determined democratically. When commercial banks gain policy control over governments and central banks, they tend to support their own remunerative policy of creating asset-inflationary credit – leaving the clean-up costs to be solved by a post-bubble austerity. This makes the debt overhead even harder to pay – indeed, impossible.
So we are brought back to the policy issue of how public money creation to finance budget deficits differs from issuing government bonds for banks to buy. Is not the latter option a convoluted way to finance such deficits – at a needless interest charge? When governments monetize their budget deficits, they do not have to pay bondholders.
I have heard bankers argue that governments need an honest broker to decide whether a loan or public spending policy is responsible. To date their advice has not promoted productive credit. Yet they now are attempting to compensate for the financial crisis by telling debtor governments to sell off property in their public domain. This “solution” relies on the myth that privatization is more efficient and will lower the cost of basic infrastructure services. Yet it involves paying interest to the buyers of rent-extraction rights, higher executive salaries, stock options and other financial fees.
Most cost savings are achieved by shifting to non-unionized labor, and typically end up being paid to the privatizers, their bankers and bondholders, not passed on to the public. And bankers back price deregulation, enabling privatizers to raise access charges. This makes the economy higher cost and hence less competitive – just the opposite of what is promised.
Banking has moved so far away from funding industrial growth and economic development that it now benefits primarily at the economy’s expense in a predator and extractive way, not by making productive loans. This is now the great problem confronting our time. Banks now lend mainly to other financial institutions, hedge funds, corporate raiders, insurance companies and real estate, and engage in their own speculation in foreign currency, interest-rate arbitrage, and computer-driven trading programs. Industrial firms bypass the banking system by financing new capital investment out of their own retained earnings, and meet their liquidity needs by issuing their own commercial paper directly. Yet to keep the bank casino winning, global bankers now want governments not only to bail them out but to enable them to renew their failed business plan – and to keep the present debts in place so that creditors will not have to take a loss.
This wish means that society should lose, and even suffer depression. We are dealing here not only with greed, but with outright antisocial behavior and hostility.
Europe thus has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy. History provides a wealth of examples illustrating the dangers of capitulating to bankers, and also for how to restructure banking along more productive lines. The underlying questions are clear enough:
* Have banks outlived their historical role, or can they be restructured to finance productive capital investment rather than simply inflate asset prices?
* Would a public option provide less costly and better directed credit?
* Why not promote economic recovery by writing down debts to reflect the ability to pay, rather than relinquishing more wealth to an increasingly aggressive creditor class?
Solving the Eurozone’s financial problem can be made much easier by the tax reforms that classical economists advocated to complement their financial reforms. To free consumers and employers from taxation, they proposed to levy the burden on the “unearned increment” of land and natural resource rent, monopoly rent and financial privilege. The guiding principle was that property rights in the earth, monopolies and other ownership privileges have no direct cost of production, and hence can be taxed without reducing their supply or raising their price, which is set in the market. Removing the tax deductibility for interest is the other key reform that is needed.
A rent tax holds down housing prices and those of basic infrastructure services, whose untaxed revenue tends to be capitalized into bank loans and paid out in the form of interest charges. Additionally, land and natural resource rents – along with interest – are the easiest to tax, because they are highly visible and their value is easy to assess.
Pressure to narrow existing budget deficits offers a timely opportunity to rationalize the tax systems of Greece and other PIIGS countries in which the wealthy avoid paying their fair share of taxes. The political problem blocking this classical fiscal policy is that it “interferes” with the rent-extracting free lunches that banks seek to lend against. So they act as lobbyists for untaxing real estate and monopolies (and themselves as well). Despite the financial sector’s desire to see governments remain sufficiently solvent to pay bondholders, it has subsidized an enormous public relations apparatus and academic junk economics to oppose the tax policies that can close the fiscal gap in the fairest way.
It is too early to forecast whether banks or governments will emerge victorious from today’s crisis. As economies polarize between debtors and creditors, planning is shifting out of public hands into those of bankers. The easiest way for them to keep this power is to block a true central bank or strong public sector from interfering with their monopoly of credit creation. The counter is for central banks and governments to act as they were intended to, by providing a public option for credit creation.
January 26, 2012
Fred Feldkamp: Agenda Items for Lame Duck Congress to Fix the US Economy
In this issue of The Institutional Risk Analyst, IRA Vice Chairman Christopher Whalen reviews some reader comments and press reports further to last week's missive, "Can Pent Up Supply Overcome Systemic Inaction?," as well as some earlier contributions.
Our friend Fred Feldkamp wrote a long comment last week on why the Fed should do QE3 to help the mortgage sector.
"If implemented, the proposed QE 3 uses the Fed's power to create a "riskless arbitrage" to narrow the spread between long-term (10-year) Treasurys and long-term fixed rate mortgages. A relative reduction in Treasury bonds held by the Fed pushes long-term Treasury rates up (at 1.8%, the 10-year was at record low rates) while a mortgage QE 3 will stabilize long term mortgage rates, keep them from rising rapidly or actually push them lower," Fed argues.
We are less sanguine about the efficacy of further Fed intervention in the bond market via QE3, especially given the cartel behavior of the large banks and housing agencies in refusing to refinance the bottom third of the US mortgage market - a mere 25-35 million households. But Fred offers some hope here in his three final recommendations of action items for the immediate post-election period at the end of 2012:
"So, what's left to do if the Fed succeeds with a QE 3?
A) Restore the power of non-banks to do well-structured securitizations (under SEC '40 Act Rule 3a-7) that access money market funds for short term funding on a demonstrably safe basis by properly amending '40 Act Rule 2a-7 to allow well-structured pools of "current assets" the access they had before the ludicrous 1998 amendments to Rule 2a-7 that created the bank "monopoly" of money market funds which eventually generated the 2008 "uber-crisis."
B) Allow long-term rates to rise relative to short-term rates (within limits of course) until new investment vehicles are created by financiers that profit by creating private sector "riskless arbitrages" ...
C) Fix the Bankruptcy Code so lenders rights are preserved by the "indubitable equivalent" of their current first mortgage liens and allow bankruptcy judges to wipe out the rest of the unrecoverable mortgages--even if that requires the receivership of several major entities under the "Orderly Liquidation Authority" of Dodd-Frank.
Get everything ready so Congress can adopt necessary changes during a "lame duck" post-election session (allowing the next Congress to "blame" the current Congress when facing inevitable criticisms). Those changes will create the "fresh start" that the nation (and the world) need in 2013."
We completely agree with Fred that fixing the 2005 bankruptcy "reform" legislation, which has effectively placed second lien holders ahead of first liens in the mortgage market, must be a national priority. When a borrower files bankruptcy, everything but the first lien mortgage should go, then the Court should see if that aspect of the borrower's estate can be salvaged.
As we've noted in The IRA, the 2005 bankruptcy reform law turns the entire world on its head and forces first lien investors to take losses before second liens -- precisely what the large banks desired. Just as WalMart (WMT) pushed the Durbin Amendment to the Dodd-Frank law in order to sipohon more profits out of banks via lower ATM interchange fees, the big banks have used bankruptcy reform in 2005 to protect half a trillion in worthless second lien exposures on residential homes. In both examples, consumers and the US economy are the losers.
As one senior banker told The IRA: "Dick Durbin is the Senator from WalMart, plain and simple. The Durbin amendment pushes down what banks are allowed to charge for clearing ATM transactions, arguably below the cost of providing the service. WalMart has pocketed billions in profits via lower point-of-sale transaction costs. None of that money will go to consumers. And banks must now raise fees on other services to compensate. The whole point of ATM cards is to help consumers avoid debt, but now you will see vendors pushing the use of credit cards instead of ATM cards."
In terms of our comment advocating a reorganization of Bank of America, "Should the Courts Appoint an Equitable Receiver for Bank of America?," Henny Sender of the Financial Times reported on January 19th:
"Wherever he goes, Brian Moynihan cannot escape the question. Investors, analysts and industry rivals all want to know whether the Bank of America chief executive will seek bankruptcy protection for Countrywide, the mortgage provider that his group bought near the top of the market. In public, he has responded carefully. Annual results released yesterday passed without direct mention of plans for the home loans unit. At a conference last month, Mr Moynihan said only: "We look at all options for Countrywide."
But interviews conducted by the Financial Times reveal that he has been rather more forthcoming in private. More than a year ago, Mr Moynihan confided to a Wall Street chief executive that if he did not kill Countrywide by placing it in bankruptcy proceedings, he feared the mortgage unit would kill the bank, this executive says. Last September, on the sidelines of the International Monetary Fund/World Bank meetings in Washington, Mr Moynihan told one investor that a filing would be complicated but he did not dismiss the possibility. "If it were simple, we would have already done it," he said, according to a participant in the conversation."
Of course, we continue to believe that the strategy of filing Countrywide or the Rescap subsidiary of Ally Financial is not a viable strategy, but as one veteran lawyer told us several years ago with respect to Bank of America, it makes an interesting negotiating strategy.
In this regard, we must note that Global law firm White & Case LLP announced January 9th that it is representing a group of bondholders, including institutional holders and secondary holders, with more than $800 million of secured bonds from Rescap. Gerard Uzzi of White & Case, who is representing the group, stated: "Ally, Ally Bank and Rescap are too intertwined to be easily unwound. A forced Rescap filing would be a big mistake and create significant litigation against Ally."
Ditto Gerard. That is why the parent of Bank of America or the parent of Rescap must file and seek the protection of the Bankruptcy Court for the entire group a la Lehman Brothers. As we have noted over the past four years of fun and games with the folks at Bank of America with respect to Countrywide, you cannot file bankruptcy for the affiliate of a bank holding company because the creditors will immediately attack the parent company. Period, end of story.
In our December 20, 2011 comment, "Leland Miller: The Crisis Ahead for China's Policy Banks," we suggested that China's version of Fannie Mae and Freddie Mac poses a threat to the country's financial health.
But a reader named Richard in CT writes: "Re-read Leland Miller's article in Dec 20 IRA. Not sure 'crisis' is the right word. Seems more simply a burdensome load."
Our friend Fred Feldkamp wrote a long comment last week on why the Fed should do QE3 to help the mortgage sector.
"If implemented, the proposed QE 3 uses the Fed's power to create a "riskless arbitrage" to narrow the spread between long-term (10-year) Treasurys and long-term fixed rate mortgages. A relative reduction in Treasury bonds held by the Fed pushes long-term Treasury rates up (at 1.8%, the 10-year was at record low rates) while a mortgage QE 3 will stabilize long term mortgage rates, keep them from rising rapidly or actually push them lower," Fed argues.
We are less sanguine about the efficacy of further Fed intervention in the bond market via QE3, especially given the cartel behavior of the large banks and housing agencies in refusing to refinance the bottom third of the US mortgage market - a mere 25-35 million households. But Fred offers some hope here in his three final recommendations of action items for the immediate post-election period at the end of 2012:
"So, what's left to do if the Fed succeeds with a QE 3?
A) Restore the power of non-banks to do well-structured securitizations (under SEC '40 Act Rule 3a-7) that access money market funds for short term funding on a demonstrably safe basis by properly amending '40 Act Rule 2a-7 to allow well-structured pools of "current assets" the access they had before the ludicrous 1998 amendments to Rule 2a-7 that created the bank "monopoly" of money market funds which eventually generated the 2008 "uber-crisis."
B) Allow long-term rates to rise relative to short-term rates (within limits of course) until new investment vehicles are created by financiers that profit by creating private sector "riskless arbitrages" ...
C) Fix the Bankruptcy Code so lenders rights are preserved by the "indubitable equivalent" of their current first mortgage liens and allow bankruptcy judges to wipe out the rest of the unrecoverable mortgages--even if that requires the receivership of several major entities under the "Orderly Liquidation Authority" of Dodd-Frank.
Get everything ready so Congress can adopt necessary changes during a "lame duck" post-election session (allowing the next Congress to "blame" the current Congress when facing inevitable criticisms). Those changes will create the "fresh start" that the nation (and the world) need in 2013."
We completely agree with Fred that fixing the 2005 bankruptcy "reform" legislation, which has effectively placed second lien holders ahead of first liens in the mortgage market, must be a national priority. When a borrower files bankruptcy, everything but the first lien mortgage should go, then the Court should see if that aspect of the borrower's estate can be salvaged.
As we've noted in The IRA, the 2005 bankruptcy reform law turns the entire world on its head and forces first lien investors to take losses before second liens -- precisely what the large banks desired. Just as WalMart (WMT) pushed the Durbin Amendment to the Dodd-Frank law in order to sipohon more profits out of banks via lower ATM interchange fees, the big banks have used bankruptcy reform in 2005 to protect half a trillion in worthless second lien exposures on residential homes. In both examples, consumers and the US economy are the losers.
As one senior banker told The IRA: "Dick Durbin is the Senator from WalMart, plain and simple. The Durbin amendment pushes down what banks are allowed to charge for clearing ATM transactions, arguably below the cost of providing the service. WalMart has pocketed billions in profits via lower point-of-sale transaction costs. None of that money will go to consumers. And banks must now raise fees on other services to compensate. The whole point of ATM cards is to help consumers avoid debt, but now you will see vendors pushing the use of credit cards instead of ATM cards."
In terms of our comment advocating a reorganization of Bank of America, "Should the Courts Appoint an Equitable Receiver for Bank of America?," Henny Sender of the Financial Times reported on January 19th:
"Wherever he goes, Brian Moynihan cannot escape the question. Investors, analysts and industry rivals all want to know whether the Bank of America chief executive will seek bankruptcy protection for Countrywide, the mortgage provider that his group bought near the top of the market. In public, he has responded carefully. Annual results released yesterday passed without direct mention of plans for the home loans unit. At a conference last month, Mr Moynihan said only: "We look at all options for Countrywide."
But interviews conducted by the Financial Times reveal that he has been rather more forthcoming in private. More than a year ago, Mr Moynihan confided to a Wall Street chief executive that if he did not kill Countrywide by placing it in bankruptcy proceedings, he feared the mortgage unit would kill the bank, this executive says. Last September, on the sidelines of the International Monetary Fund/World Bank meetings in Washington, Mr Moynihan told one investor that a filing would be complicated but he did not dismiss the possibility. "If it were simple, we would have already done it," he said, according to a participant in the conversation."
Of course, we continue to believe that the strategy of filing Countrywide or the Rescap subsidiary of Ally Financial is not a viable strategy, but as one veteran lawyer told us several years ago with respect to Bank of America, it makes an interesting negotiating strategy.
In this regard, we must note that Global law firm White & Case LLP announced January 9th that it is representing a group of bondholders, including institutional holders and secondary holders, with more than $800 million of secured bonds from Rescap. Gerard Uzzi of White & Case, who is representing the group, stated: "Ally, Ally Bank and Rescap are too intertwined to be easily unwound. A forced Rescap filing would be a big mistake and create significant litigation against Ally."
Ditto Gerard. That is why the parent of Bank of America or the parent of Rescap must file and seek the protection of the Bankruptcy Court for the entire group a la Lehman Brothers. As we have noted over the past four years of fun and games with the folks at Bank of America with respect to Countrywide, you cannot file bankruptcy for the affiliate of a bank holding company because the creditors will immediately attack the parent company. Period, end of story.
In our December 20, 2011 comment, "Leland Miller: The Crisis Ahead for China's Policy Banks," we suggested that China's version of Fannie Mae and Freddie Mac poses a threat to the country's financial health.
But a reader named Richard in CT writes: "Re-read Leland Miller's article in Dec 20 IRA. Not sure 'crisis' is the right word. Seems more simply a burdensome load."
January 25, 2012
Are George Soros, The IMF And The World Bank Purposely Trying To Scare The Living Daylights Out Of Us?
Over the past couple of weeks, George Soros, the IMF and the World Bank have all issued incredibly chilling warnings about the possibility of an impending economic collapse. Considering the power and the influence that Soros, the IMF and the World Bank all have over the global financial system, this is very alarming. So are they purposely trying to scare the living daylights out of us? Soros is even warning of riots in the streets of America. Unfortunately, way too often top global leaders say something in public because they want to "push" events in a certain direction. Do George Soros and officials at the IMF and World Bank hope to prevent a worldwide financial collapse by making these statements, or are other agendas at work? We may never know. But one thing is for sure - many of the top financial officials in the world are using language that is downright "apocalyptic", and that is not a good sign for the rest of 2012.
Right now, George Soros is saying things that he has never said before. Just check out what George Soros recently told Newsweek....
“I am not here to cheer you up. The situation is about as serious and difficult as I’ve experienced in my career,” Soros tells Newsweek. “We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”
Later on in that same article, Soros is quoted as saying that we could soon see the U.S. government using "strong-arm tactics" to crack down on rioting in the streets of major U.S. cities....
As anger rises, riots on the streets of American cities are inevitable. “Yes, yes, yes,” he says, almost gleefully. The response to the unrest could be more damaging than the violence itself. “It will be an excuse for cracking down and using strong-arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained, which would be a break with the tradition of the United States.”
It almost sounds like George Soros is anticipating the same kind of a breakdown of society that many survivalists and preppers are getting ready for.
So how bad are things going to get?
Well, George Soros is publicly warning that the coming financial crisis could end up being even worse than 2008. Just check out the following quotes from him that appeared in a recent Businessweek article....
Billionaire investor George Soros said Europe’s sovereign-debt woes are “more serious” than the financial crisis of 2008 and that the world faces the prospect of a “vicious circle” of deflation.
“We have a more dangerous situation now than in 2008,” Soros, 81, said in response to a question at an event in the southern Indian city of Bangalore today. “The crisis in Europe is more serious than the crash of 2008.”
But George Soros is not the only one issuing these kinds of warnings.
Once again, the head of the IMF, Christine Lagarde, has made a speech in which she openly warned that we are heading for a repeat of the "1930s".
She told an audience in Berlin on Monday that the globe is facing "a 1930s moment, in which inaction, insularity and rigid ideology combine to cause a collapse in global demand".
During the speech she called for a trillion more dollars to support financially troubled governments, and she made the following statement....
"It is not about saving any one country or region. It is about saving the world from a downward economic spiral."
As I wrote about the other day, the World Bank has also been using apocalyptic language about the global financial situation. In a shocking new report, the World Bank revised GDP growth estimates for 2012 downward very sharply, it warned that Europe could be facing financial collapse at any time, and it instructed the rest of the world to "prepare for the worst."
The lead author of the report, Andrew Burns, said that the "importance of contingency planning cannot be stressed enough" and that if there is a major financial crisis in Europe the entire globe will be deeply affected....
"An escalation of the crisis would spare no-one. Developed- and developing-country growth rates could fall by as much or more than in 2008/09."
So should we be alarmed that George Soros, the IMF and the World Bank are all proclaiming that a financial nightmare could be just around the corner?
Of course we should be.
Whether their motives are pure or not, they are telling the truth about the global financial situation in this case. As I have written about so frequently, there are a whole host of signs that indicate that we could be on the verge of a major global recession.
A lot of folks in the investment world are warning that hard times are about to hit us as well. For example, the following is what legendary investor Joseph Granville recently told Bloomberg Television....
Joseph Granville, whose “sell everything” call in 1981 sparked a decline in U.S. stocks, said the Dow Jones Industrial Average (INDU) will drop toward 8,000 this year because of waning momentum and volume.
“Volume precedes prices,” Granville, 88, a technical analyst who has been publishing the Granville Market Letter from Kansas City, Missouri for about 50 years, said in an interview on “Street Smart” on Bloomberg Television. “You are seeing much lower volume. That tells you that prices are going to go much lower, much lower than most people think possible and very few people have projected.”
Considering all of the warnings out there, it only seems prudent to prepare for the worst.
But unfortunately, a lot of people are just going to leave their holdings sitting out there like a dead duck, and they are going to be absolutely devastated by the coming financial tsunami.
Those that believe that the United States can somehow escape the coming financial storm don't really know what they are talking about.
In fact, there was very troubling news for the U.S. dollar just the other day. It was announced that India will start paying for its oil from Iran in a currency other than U.S. dollars.
But this is just another sign that the rest of the world is starting to reject the U.S. dollar. For decades, the U.S. dollar has been the reserve currency of the world and this has given us a tremendous advantage. Unfortunately for us, that is now changing.
U.S. newspapers are not talking about what is going on, but mainstream newspapers in Europe are. Right now, some of the biggest countries in the world are working on plans to quit using U.S. dollars for the buying and selling of oil.
The following comes from a recent article in The Independent....
In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.
The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
This is a very big deal, and if this gets pulled off it is going to have devastating consequences for the U.S. dollar and for the U.S. economy.
But of course when it comes to troubles for the U.S. financial system, there are a whole host of issues that could be talked about.
An environment for a "perfect storm" is developing, and most Americans have absolutely no idea what is about to happen.
Fortunately, there are some researchers out there that are working hard to sound the alarm bells. For example, the following quote comes from a recent interview with Gerald Celente....
I believe that we have to watch out for something along the lines of an economic martial law. The European system is in collapse. The financial system in the United States is just as tenuous, if not more, and I believe they will not admit there will be a financial crash but rather they will use a geo-political issue to get the people in a state of fear and hysteria whereby they'll then call a bank holiday or devaluation of the currency, or a hyperinflation of the currency, and blame it on somebody else.
It would be wise to listen to what experts such as Gerald Celente are saying.
Now is the time to take stock of where you are at and to make plans for the coming year.
Just because things have "always" been a certain way does not mean that they will continue to be that way.
Just because certain things have "always" worked in the past does not mean that they will continue to work in the future.
Our world is experiencing fundamental changes. It is changing at a faster pace than we have ever seen before. The way that we all live our lives five or ten years from now will be vastly different from how we live our lives today.
This will be a very challenging time to be alive, but it is also going to be a very exciting time to be alive.
So what do all of you think is going to happen in 2012?
Right now, George Soros is saying things that he has never said before. Just check out what George Soros recently told Newsweek....
“I am not here to cheer you up. The situation is about as serious and difficult as I’ve experienced in my career,” Soros tells Newsweek. “We are facing an extremely difficult time, comparable in many ways to the 1930s, the Great Depression. We are facing now a general retrenchment in the developed world, which threatens to put us in a decade of more stagnation, or worse. The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”
Later on in that same article, Soros is quoted as saying that we could soon see the U.S. government using "strong-arm tactics" to crack down on rioting in the streets of major U.S. cities....
As anger rises, riots on the streets of American cities are inevitable. “Yes, yes, yes,” he says, almost gleefully. The response to the unrest could be more damaging than the violence itself. “It will be an excuse for cracking down and using strong-arm tactics to maintain law and order, which, carried to an extreme, could bring about a repressive political system, a society where individual liberty is much more constrained, which would be a break with the tradition of the United States.”
It almost sounds like George Soros is anticipating the same kind of a breakdown of society that many survivalists and preppers are getting ready for.
So how bad are things going to get?
Well, George Soros is publicly warning that the coming financial crisis could end up being even worse than 2008. Just check out the following quotes from him that appeared in a recent Businessweek article....
Billionaire investor George Soros said Europe’s sovereign-debt woes are “more serious” than the financial crisis of 2008 and that the world faces the prospect of a “vicious circle” of deflation.
“We have a more dangerous situation now than in 2008,” Soros, 81, said in response to a question at an event in the southern Indian city of Bangalore today. “The crisis in Europe is more serious than the crash of 2008.”
But George Soros is not the only one issuing these kinds of warnings.
Once again, the head of the IMF, Christine Lagarde, has made a speech in which she openly warned that we are heading for a repeat of the "1930s".
She told an audience in Berlin on Monday that the globe is facing "a 1930s moment, in which inaction, insularity and rigid ideology combine to cause a collapse in global demand".
During the speech she called for a trillion more dollars to support financially troubled governments, and she made the following statement....
"It is not about saving any one country or region. It is about saving the world from a downward economic spiral."
As I wrote about the other day, the World Bank has also been using apocalyptic language about the global financial situation. In a shocking new report, the World Bank revised GDP growth estimates for 2012 downward very sharply, it warned that Europe could be facing financial collapse at any time, and it instructed the rest of the world to "prepare for the worst."
The lead author of the report, Andrew Burns, said that the "importance of contingency planning cannot be stressed enough" and that if there is a major financial crisis in Europe the entire globe will be deeply affected....
"An escalation of the crisis would spare no-one. Developed- and developing-country growth rates could fall by as much or more than in 2008/09."
So should we be alarmed that George Soros, the IMF and the World Bank are all proclaiming that a financial nightmare could be just around the corner?
Of course we should be.
Whether their motives are pure or not, they are telling the truth about the global financial situation in this case. As I have written about so frequently, there are a whole host of signs that indicate that we could be on the verge of a major global recession.
A lot of folks in the investment world are warning that hard times are about to hit us as well. For example, the following is what legendary investor Joseph Granville recently told Bloomberg Television....
Joseph Granville, whose “sell everything” call in 1981 sparked a decline in U.S. stocks, said the Dow Jones Industrial Average (INDU) will drop toward 8,000 this year because of waning momentum and volume.
“Volume precedes prices,” Granville, 88, a technical analyst who has been publishing the Granville Market Letter from Kansas City, Missouri for about 50 years, said in an interview on “Street Smart” on Bloomberg Television. “You are seeing much lower volume. That tells you that prices are going to go much lower, much lower than most people think possible and very few people have projected.”
Considering all of the warnings out there, it only seems prudent to prepare for the worst.
But unfortunately, a lot of people are just going to leave their holdings sitting out there like a dead duck, and they are going to be absolutely devastated by the coming financial tsunami.
Those that believe that the United States can somehow escape the coming financial storm don't really know what they are talking about.
In fact, there was very troubling news for the U.S. dollar just the other day. It was announced that India will start paying for its oil from Iran in a currency other than U.S. dollars.
But this is just another sign that the rest of the world is starting to reject the U.S. dollar. For decades, the U.S. dollar has been the reserve currency of the world and this has given us a tremendous advantage. Unfortunately for us, that is now changing.
U.S. newspapers are not talking about what is going on, but mainstream newspapers in Europe are. Right now, some of the biggest countries in the world are working on plans to quit using U.S. dollars for the buying and selling of oil.
The following comes from a recent article in The Independent....
In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar.
Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars.
The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years.
This is a very big deal, and if this gets pulled off it is going to have devastating consequences for the U.S. dollar and for the U.S. economy.
But of course when it comes to troubles for the U.S. financial system, there are a whole host of issues that could be talked about.
An environment for a "perfect storm" is developing, and most Americans have absolutely no idea what is about to happen.
Fortunately, there are some researchers out there that are working hard to sound the alarm bells. For example, the following quote comes from a recent interview with Gerald Celente....
I believe that we have to watch out for something along the lines of an economic martial law. The European system is in collapse. The financial system in the United States is just as tenuous, if not more, and I believe they will not admit there will be a financial crash but rather they will use a geo-political issue to get the people in a state of fear and hysteria whereby they'll then call a bank holiday or devaluation of the currency, or a hyperinflation of the currency, and blame it on somebody else.
It would be wise to listen to what experts such as Gerald Celente are saying.
Now is the time to take stock of where you are at and to make plans for the coming year.
Just because things have "always" been a certain way does not mean that they will continue to be that way.
Just because certain things have "always" worked in the past does not mean that they will continue to work in the future.
Our world is experiencing fundamental changes. It is changing at a faster pace than we have ever seen before. The way that we all live our lives five or ten years from now will be vastly different from how we live our lives today.
This will be a very challenging time to be alive, but it is also going to be a very exciting time to be alive.
So what do all of you think is going to happen in 2012?
January 24, 2012
More Evidence that JP Morgan Stuck the Knife in MF Global
The death of MF Global and JP Morgan’s role in its demise is starting to look like a beauty contest between Cinderalla’s ugly sisters. As much as most market savvy observers are convinced that there is no explanation for how MF Global made $1.2 billion in customer funds go poof that could exculpate the firm, JP Morgan’s conduct isn’t looking too pretty either.
Reader Michael C sent a link to a Reuters investigative piece on the MF Global collapse, and it’s a doozy. While in proper journalistic form it is careful about reaching firm conclusions on a post mortem that is still underway, the pattern it has uncovered is not surprising to those of us who are onto JP Morgan. As many, including this blogger, have pointed out, it was JP Morgan that did in the doomed Lehman by withhold $7 billion of cash and collateral. And we’ve written how it used one of its best private clients, billionaire investor and industrialist Len Blavatnik, as a stuffee for toxic subprime debt in summer 2007, when every financial firm was desperate to offload US housing dreck.
The short form of the Reuters story is that JP Morgan, by virtue of being both a lender to MF Global as well as clearing its trades, has a big information advantage and could see how distressed the firm was. MF Global drew down the full amount of a newly-syndicated $1.3 billion credit facility, a huge warning sign.
The Reuters story makes clear that JP Morgan went into “possession is 9/10ths of the law” mode, calling for full compliance with transaction procedures when normal business practice was to be more forgiving. The New York bank offers up the excuse that it lost money to MF Global, but that is not the issue. Any creditor to a bankrupt company will lose money. The issue is whether JP Morgan did anything irregular or impermissible to cut its losses, which in this case appears to have come in no small measure out of the hides of customers.
The story is worth reading in full, but this incident gives a picture of the sort of behavior JP Morgan was engaged in:
MF Global also decided to sell $1.3 billion of IOUs known as commercial paper. The short-term debt was part of some $7 billion of securities the firm sold that week. But this sale was critical, people familiar with the situation said, because MF Global had used customer funds to invest in the short-term debt and now badly needed to liquidate the IOUs and move cash into the customer accounts to meet their demands. The investments in the IOUs were allowed by industry regulations, these people said.
For help, Corzine turned to his old employer, Goldman Sachs, which specializes in trading the short-term paper. Corzine phoned Goldman President Gary Cohn to ask him to buy the IOUs, offering a slight discount, according to people familiar with the situation.
Cohn agreed, and Goldman traders made the purchases, these people said. Because it needed the cash immediately, MF Global sought to settle the deal that day, according to Corzine’s testimony in Congress.
JPMorgan, in its role as middleman, was able to control the speed with which MF Global’s asset sales were processed, according to people familiar with the situation.
Two people familiar with the transaction say that JPMorgan was slow to process the trade…It remains unclear exactly whether cash from the sale was ultimately routed to MF Global.
This was not a time of generalized market stress. Goldman was clearly good for the trade. JP Morgan hanging on the money had nothing to do with that trade and everything to do with it trying to lower its credit exposure. I don’t know why there isn’t more noise about how this situation illustrates the dangers of having a bank be both a major clearing firm and a lender (ex via clearing exposures) to the same customers. Either JP Morgan should hive off its clearing business or there needs to be much stricter regulation about these conflicts of interest.
It’s also pretty clear that a lot of customer money is sitting at JP Morgan, but JP Morgan will argue in bankruptcy court that it should not have to disgorge it (it almost doesn’t matter what the facts are, JP Morgan will lawyer up to make the case). Unfortunately, since most of the counterparties hurt don’t have the political clout of TBTF bank, JP Morgan is unlikely to take a reputational hit anywhere close to what it might deserve.
Reader Michael C sent a link to a Reuters investigative piece on the MF Global collapse, and it’s a doozy. While in proper journalistic form it is careful about reaching firm conclusions on a post mortem that is still underway, the pattern it has uncovered is not surprising to those of us who are onto JP Morgan. As many, including this blogger, have pointed out, it was JP Morgan that did in the doomed Lehman by withhold $7 billion of cash and collateral. And we’ve written how it used one of its best private clients, billionaire investor and industrialist Len Blavatnik, as a stuffee for toxic subprime debt in summer 2007, when every financial firm was desperate to offload US housing dreck.
The short form of the Reuters story is that JP Morgan, by virtue of being both a lender to MF Global as well as clearing its trades, has a big information advantage and could see how distressed the firm was. MF Global drew down the full amount of a newly-syndicated $1.3 billion credit facility, a huge warning sign.
The Reuters story makes clear that JP Morgan went into “possession is 9/10ths of the law” mode, calling for full compliance with transaction procedures when normal business practice was to be more forgiving. The New York bank offers up the excuse that it lost money to MF Global, but that is not the issue. Any creditor to a bankrupt company will lose money. The issue is whether JP Morgan did anything irregular or impermissible to cut its losses, which in this case appears to have come in no small measure out of the hides of customers.
The story is worth reading in full, but this incident gives a picture of the sort of behavior JP Morgan was engaged in:
MF Global also decided to sell $1.3 billion of IOUs known as commercial paper. The short-term debt was part of some $7 billion of securities the firm sold that week. But this sale was critical, people familiar with the situation said, because MF Global had used customer funds to invest in the short-term debt and now badly needed to liquidate the IOUs and move cash into the customer accounts to meet their demands. The investments in the IOUs were allowed by industry regulations, these people said.
For help, Corzine turned to his old employer, Goldman Sachs, which specializes in trading the short-term paper. Corzine phoned Goldman President Gary Cohn to ask him to buy the IOUs, offering a slight discount, according to people familiar with the situation.
Cohn agreed, and Goldman traders made the purchases, these people said. Because it needed the cash immediately, MF Global sought to settle the deal that day, according to Corzine’s testimony in Congress.
JPMorgan, in its role as middleman, was able to control the speed with which MF Global’s asset sales were processed, according to people familiar with the situation.
Two people familiar with the transaction say that JPMorgan was slow to process the trade…It remains unclear exactly whether cash from the sale was ultimately routed to MF Global.
This was not a time of generalized market stress. Goldman was clearly good for the trade. JP Morgan hanging on the money had nothing to do with that trade and everything to do with it trying to lower its credit exposure. I don’t know why there isn’t more noise about how this situation illustrates the dangers of having a bank be both a major clearing firm and a lender (ex via clearing exposures) to the same customers. Either JP Morgan should hive off its clearing business or there needs to be much stricter regulation about these conflicts of interest.
It’s also pretty clear that a lot of customer money is sitting at JP Morgan, but JP Morgan will argue in bankruptcy court that it should not have to disgorge it (it almost doesn’t matter what the facts are, JP Morgan will lawyer up to make the case). Unfortunately, since most of the counterparties hurt don’t have the political clout of TBTF bank, JP Morgan is unlikely to take a reputational hit anywhere close to what it might deserve.
January 23, 2012
The Global Elite Are Hiding 18 Trillion Dollars In Offshore Banks
In recent days, the fact that Mitt Romney has millions of dollars parked down in the Cayman Islands has made headlines all over the world. But when it comes to offshore banking, what Mitt Romney is doing is small potatoes. The truth is that the global elite are hiding an almost unbelievable amount of money in offshore banks. According to shocking research done by the IMF, the global elite are holding a total of 18 trillion dollars in offshore banks. And that figure does not even count any money being held in Switzerland. That is a staggering amount of money. Keep in mind that U.S. GDP in 2010 was only 14.58 trillion dollars. So why do the global elite go to such trouble to hide their money in offshore banks? Well, there are two main reasons. One is privacy and the other is low taxation. Privacy is a big issue for those that are involved in illegal enterprises such as drug running, but the biggest reason why people move money into offshore banks is in order to avoid taxes. Some set up bank accounts in foreign nations because they want to legally minimize their taxes and others set up bank accounts in foreign nations because they want to illegally avoid taxes. You would be absolutely amazed at what some large corporations and wealthy individuals do to get out of paying taxes. Unfortunately, the vast majority of the rest of us don't have the resources or the knowledge to play these games, so we get taxed into oblivion.
So why do they call it "offshore banking"?
Well, the term originally developed because the banks on the Channel Islands were "offshore" from the United Kingdom. Most "offshore banks" are still located on islands today. The Cayman Islands, Bermuda, the Bahamas, and the Isle of Man are examples of this. Other "offshore banking centers" such as Monaco are actually not "offshore" at all, but the term applies to them anyway.
Traditionally, these offshore banking centers have been very attractive to both criminals and to the global elite because they would not tell anyone (including governments) about the money that anyone had parked there.
These days some governments (particularly the U.S. government) are trying to change this, but we certainly will not see the end of offshore banking any time soon.
The amount of money that goes through these offshore banks is absolutely astounding.
It has been estimated that 80 percent of all international banking transactions take place through these offshore banks. $1.4 trillion is being held in offshore banks in the Cayman Islands alone.
One article in the Guardian estimated that a third of all the wealth on the entire globe is being held in offshore banks, and others believe that as much as half of all the capital in the world flows through offshore banks at some point.
Obviously, all of this tax avoidance means that governments around the world are missing out on a whole lot of money.
It has been estimated that the U.S. government is missing out on $100 billion a year because of these offshore banks. Others would put that figure significantly higher.
Avoiding taxes is a game that the global elite have mastered. They are playing a whole different ballgame than you and I are. They don't just sit there like idiots and get blasted with taxes. Instead, they hire the best experts and they employ every trick in the book to hold on to as much money as they possibly can.
These days, taking advantage of offshore tax havens is not that complicated to do. The following is from a recent Politico article....
A plausible scenario plays out like this: I hire an accountant. Doing her job, my accountant tells me that if I sign a few legal documents and route my money through a small Caribbean island, I could keep more of my paycheck and pay a lower tax rate. I may have earned my money in the United States, but legally I can claim that it was, in fact, earned in a tax haven.
If it is legal, perhaps more of us should look into this.
After all, if playing these kinds of games is good enough for Mitt Romney, then why isn't it good enough for all the rest of us?
During a campaign stop recently, Romney said the following....
"I can tell you we follow the tax laws"
I certainly believe him when he says that. But it is what he said next that is troubling....
"And if there's an opportunity to save taxes, we like anybody else in this country will follow that opportunity."
I certainly believe him when he says that too.
ABC News recently revealed that Bain Capital has established an astounding 138 different offshore funds in the Cayman Islands.
Something has got to work pretty well to want to do it 138 times.
But Bain Capital was also very busy over in other offshore banking centers as well.
One of the largest shell companies that Bain set up down in the Caribbean was called Sankaty High Yield Asset Investors Ltd. It did not have an office in Bermuda and it had no staff in Bermuda. But it helped clients of Bain Capital avoid a whole lot of taxes.
The following comes from a 2007 Los Angeles Times article....
In Bermuda, Romney served as president and sole shareholder for four years of Sankaty High Yield Asset Investors Ltd. It funneled money into Bain Capital's Sankaty family of hedge funds, which invest in bonds and other debt issued by corporations, as well as bank loans.
Like thousands of similar financial entities, Sankaty maintains no office or staff in Bermuda. Its only presence consists of a nameplate at a lawyer's office in downtown Hamilton, capital of the British island territory.
"It's just a mail drop, essentially," said Marc B. Wolpow, who worked with Romney for nine years at Bain Capital and who set up Sankaty Ltd. in October 1997 without ever visiting Bermuda. "There's no one doing any work down there other than lawyers."
The amount of money being funneled through Sankaty today is absolutely stunning....
Today, Bain Capital manages $60 billion in assets, according to a spokesman. The total includes $23 billion in Sankaty debt and credit funds. Half a dozen Sankaty affiliates now are active in Bermuda, corporate registry records show.
The Sankaty debt hedge funds are organized as partnerships in Delaware that produce taxable business income by investing in fixed-income bonds and other debt instruments. Under tax law, even tax-exempt U.S. institutions may face a 35% tax if they invest directly in such hedge funds. By investing instead through a Bermuda corporation, the taxes are legally blocked, experts say.
Of course all of this is perfectly legal.
So nobody gets into trouble for any of this.
By keeping money offshore, even those managing these kinds of funds can avoid being taxed.
Victor Fleischer, a tax professor at the University of Colorado Law School, recently explained how this works....
"The idea behind some of the Cayman Island strategies was that the income that the fund managers receive for managing the money would be kept offshore in the Cayman Island — and the chief benefit is that you can defer when you recognize that income until a later date and you can reinvest the money from the Cayman islands and none of those reinvested funds get taxed until you bring them back either"
So was Romney doing this?
We may never know unless he shows us his tax returns.
What we do know is that Romney has millions of dollars of his own personal wealth invested in offshore tax havens.
The following comes from ABC News....
In addition to paying the lower tax rate on his investment income, Romney has as much as $8 million invested in at least 12 funds listed on a Cayman Islands registry. Another investment, which Romney reports as being worth between $5 million and $25 million, shows up on securities records as having been domiciled in the Caymans.
But Romney does not just have money invested down in the Cayman Islands. Apparently his money is invested in a whole host of offshore tax havens.
The following quote comes from a Reuters article....
Bain funds in which Romney is invested are scattered from Delaware to the Cayman Islands and Bermuda, Ireland and Hong Kong, according to a Reuters analysis of securities filings.
So is there anything wrong with this?
Well, it depends on how you define "wrong".
What Romney is doing is perfectly legal.
But it also stinks. Washington lawyer Jack Blum recently told ABC News the following about Romney's finances....
"His personal finances are a poster child of what's wrong with the American tax system"
So now we may have a few hints as to why Romney may not want to release his old tax returns.
But as noted above, what Romney is doing is just small potatoes compared to what the ultra-wealthy do.
The U.S. Congress has been trying to clamp down on offshore banking, but the ultra-wealthy are always two or three steps ahead of them.
The ultra-wealthy will go to just about any extreme in order to avoid paying taxes.
In fact, the Washington Post has reported that an increasing number of wealthy individuals are actually deciding to renounce their citizenship rather than face the wrath of the IRS.
The ultra-wealthy aren't really concerned that much with national citizenship anyway. If they want to influence an election, they can have far more influence by donating a few million bucks to a "Super PAC" than they can by casting the few votes that they have.
In a previous article, I described how the ultra-wealthy use offshore banks as a "shadow banking system" that plays by rules that most people don't even know exist....
It is a shadow banking system that most Americans don't know anything about. Most Americans don't have the resources to be able to set up shell companies in half a dozen different countries so that they can "filter" their profits. Most Americans don't know a thing about complicated tax avoidance plans that tax lawyers use such as the "Double Irish" and the "Dutch Sandwich". Most Americans would have no idea how to eventually have most of the money that they make end up in Bermuda so that it can avoid taxes.
Most among the global elite simply do not care that U.S. debt is climbing into the stratosphere. All they care about is keeping as much of their own money in their pockets as they possibly can.
Of course there are always exceptions to this rule. Warren Buffett recently wrote a check to the U.S. Treasury for a little more than $49,000 to help pay off the national debt.
But considering the fact that the U.S. national debt is increasing by more than 100 million dollars an hour, that didn't exactly do much to help.
Our system is deeply broken and the global elite are getting away with bloody murder. Over the decades, they have carefully crafted the rules so that as much wealth as possible is funneled into their pockets, and they have carefully crafted the rules so that as much wealth as possible stays in their pockets.
Of course if we got rid of the personal income tax and the corporate income tax entirely and replaced them with a completely new system we could get rid of all of this game playing once and for all.
But what do you think the odds are of that happening?
So why do they call it "offshore banking"?
Well, the term originally developed because the banks on the Channel Islands were "offshore" from the United Kingdom. Most "offshore banks" are still located on islands today. The Cayman Islands, Bermuda, the Bahamas, and the Isle of Man are examples of this. Other "offshore banking centers" such as Monaco are actually not "offshore" at all, but the term applies to them anyway.
Traditionally, these offshore banking centers have been very attractive to both criminals and to the global elite because they would not tell anyone (including governments) about the money that anyone had parked there.
These days some governments (particularly the U.S. government) are trying to change this, but we certainly will not see the end of offshore banking any time soon.
The amount of money that goes through these offshore banks is absolutely astounding.
It has been estimated that 80 percent of all international banking transactions take place through these offshore banks. $1.4 trillion is being held in offshore banks in the Cayman Islands alone.
One article in the Guardian estimated that a third of all the wealth on the entire globe is being held in offshore banks, and others believe that as much as half of all the capital in the world flows through offshore banks at some point.
Obviously, all of this tax avoidance means that governments around the world are missing out on a whole lot of money.
It has been estimated that the U.S. government is missing out on $100 billion a year because of these offshore banks. Others would put that figure significantly higher.
Avoiding taxes is a game that the global elite have mastered. They are playing a whole different ballgame than you and I are. They don't just sit there like idiots and get blasted with taxes. Instead, they hire the best experts and they employ every trick in the book to hold on to as much money as they possibly can.
These days, taking advantage of offshore tax havens is not that complicated to do. The following is from a recent Politico article....
A plausible scenario plays out like this: I hire an accountant. Doing her job, my accountant tells me that if I sign a few legal documents and route my money through a small Caribbean island, I could keep more of my paycheck and pay a lower tax rate. I may have earned my money in the United States, but legally I can claim that it was, in fact, earned in a tax haven.
If it is legal, perhaps more of us should look into this.
After all, if playing these kinds of games is good enough for Mitt Romney, then why isn't it good enough for all the rest of us?
During a campaign stop recently, Romney said the following....
"I can tell you we follow the tax laws"
I certainly believe him when he says that. But it is what he said next that is troubling....
"And if there's an opportunity to save taxes, we like anybody else in this country will follow that opportunity."
I certainly believe him when he says that too.
ABC News recently revealed that Bain Capital has established an astounding 138 different offshore funds in the Cayman Islands.
Something has got to work pretty well to want to do it 138 times.
But Bain Capital was also very busy over in other offshore banking centers as well.
One of the largest shell companies that Bain set up down in the Caribbean was called Sankaty High Yield Asset Investors Ltd. It did not have an office in Bermuda and it had no staff in Bermuda. But it helped clients of Bain Capital avoid a whole lot of taxes.
The following comes from a 2007 Los Angeles Times article....
In Bermuda, Romney served as president and sole shareholder for four years of Sankaty High Yield Asset Investors Ltd. It funneled money into Bain Capital's Sankaty family of hedge funds, which invest in bonds and other debt issued by corporations, as well as bank loans.
Like thousands of similar financial entities, Sankaty maintains no office or staff in Bermuda. Its only presence consists of a nameplate at a lawyer's office in downtown Hamilton, capital of the British island territory.
"It's just a mail drop, essentially," said Marc B. Wolpow, who worked with Romney for nine years at Bain Capital and who set up Sankaty Ltd. in October 1997 without ever visiting Bermuda. "There's no one doing any work down there other than lawyers."
The amount of money being funneled through Sankaty today is absolutely stunning....
Today, Bain Capital manages $60 billion in assets, according to a spokesman. The total includes $23 billion in Sankaty debt and credit funds. Half a dozen Sankaty affiliates now are active in Bermuda, corporate registry records show.
The Sankaty debt hedge funds are organized as partnerships in Delaware that produce taxable business income by investing in fixed-income bonds and other debt instruments. Under tax law, even tax-exempt U.S. institutions may face a 35% tax if they invest directly in such hedge funds. By investing instead through a Bermuda corporation, the taxes are legally blocked, experts say.
Of course all of this is perfectly legal.
So nobody gets into trouble for any of this.
By keeping money offshore, even those managing these kinds of funds can avoid being taxed.
Victor Fleischer, a tax professor at the University of Colorado Law School, recently explained how this works....
"The idea behind some of the Cayman Island strategies was that the income that the fund managers receive for managing the money would be kept offshore in the Cayman Island — and the chief benefit is that you can defer when you recognize that income until a later date and you can reinvest the money from the Cayman islands and none of those reinvested funds get taxed until you bring them back either"
So was Romney doing this?
We may never know unless he shows us his tax returns.
What we do know is that Romney has millions of dollars of his own personal wealth invested in offshore tax havens.
The following comes from ABC News....
In addition to paying the lower tax rate on his investment income, Romney has as much as $8 million invested in at least 12 funds listed on a Cayman Islands registry. Another investment, which Romney reports as being worth between $5 million and $25 million, shows up on securities records as having been domiciled in the Caymans.
But Romney does not just have money invested down in the Cayman Islands. Apparently his money is invested in a whole host of offshore tax havens.
The following quote comes from a Reuters article....
Bain funds in which Romney is invested are scattered from Delaware to the Cayman Islands and Bermuda, Ireland and Hong Kong, according to a Reuters analysis of securities filings.
So is there anything wrong with this?
Well, it depends on how you define "wrong".
What Romney is doing is perfectly legal.
But it also stinks. Washington lawyer Jack Blum recently told ABC News the following about Romney's finances....
"His personal finances are a poster child of what's wrong with the American tax system"
So now we may have a few hints as to why Romney may not want to release his old tax returns.
But as noted above, what Romney is doing is just small potatoes compared to what the ultra-wealthy do.
The U.S. Congress has been trying to clamp down on offshore banking, but the ultra-wealthy are always two or three steps ahead of them.
The ultra-wealthy will go to just about any extreme in order to avoid paying taxes.
In fact, the Washington Post has reported that an increasing number of wealthy individuals are actually deciding to renounce their citizenship rather than face the wrath of the IRS.
The ultra-wealthy aren't really concerned that much with national citizenship anyway. If they want to influence an election, they can have far more influence by donating a few million bucks to a "Super PAC" than they can by casting the few votes that they have.
In a previous article, I described how the ultra-wealthy use offshore banks as a "shadow banking system" that plays by rules that most people don't even know exist....
It is a shadow banking system that most Americans don't know anything about. Most Americans don't have the resources to be able to set up shell companies in half a dozen different countries so that they can "filter" their profits. Most Americans don't know a thing about complicated tax avoidance plans that tax lawyers use such as the "Double Irish" and the "Dutch Sandwich". Most Americans would have no idea how to eventually have most of the money that they make end up in Bermuda so that it can avoid taxes.
Most among the global elite simply do not care that U.S. debt is climbing into the stratosphere. All they care about is keeping as much of their own money in their pockets as they possibly can.
Of course there are always exceptions to this rule. Warren Buffett recently wrote a check to the U.S. Treasury for a little more than $49,000 to help pay off the national debt.
But considering the fact that the U.S. national debt is increasing by more than 100 million dollars an hour, that didn't exactly do much to help.
Our system is deeply broken and the global elite are getting away with bloody murder. Over the decades, they have carefully crafted the rules so that as much wealth as possible is funneled into their pockets, and they have carefully crafted the rules so that as much wealth as possible stays in their pockets.
Of course if we got rid of the personal income tax and the corporate income tax entirely and replaced them with a completely new system we could get rid of all of this game playing once and for all.
But what do you think the odds are of that happening?
January 22, 2012
Our Morally Bankrupt Government, Justice Edition Part I: Enforcement Against Financial Meltdown Perpetrators
Perhaps the clearest window into a nation’s soul is its criminal justice system. Criminal law is legislated morality: certain acts are so vile, we exile the perpetrators to prison. But not every criminal. America will never have enough resources to catch and prosecute all criminals. As a result many guilty go free without ever being pursued, simply because the government decided spend its limited resources elsewhere. Looking at whom the government prosecutes, therefore, is an easy way to see law enforcers’ priorities in action.
Sadly, when it comes to the Financial Meltdown perpetrators, scrutiny reveals those priorities are deeply distorted. Our law enforcers chose to become the protection detail of our wealthy-beyond-dreaming-crooks-in-chief, while throwing the book at their guilty but less destructive subordinates.
Who should we be prosecuting? Well, there’s Dick Fuld of Lehman; James Cayne of Bear, Stearns; Joseph Cassano of AIGFP; Angelo Mozillo of Countrywide; and E. Stanley O’Neal of Merrill Lynch, just to name a few. There’s also all the bailed out top bankers still in power, such as Lloyd Blankfein, Jamie Dimon, and the meltdown era executives at the other biggest bailout recipients: Citigroup, Bank of America, Wells Fargo, Morgan Stanley. And that’s not an exhaustive list.
As I lay out below, AG Holder and President Obama have abandoned the cherished American principle–the core democratic principle–of equality before the law. That’s a kind of moral corruption that strikes at the heart of our national identity. And as best I can tell–again, the evidence follows–this corruption flows from Treasury Department/Wall Street fear mongering and revolving door conflicts of interest.
Worst of all, our top law enforcers abandoned equality before the law precisely when our democracy desperately needs it. Our only defense against the growing tyranny of the 1%, the only means we have of policing the bounds of their power, is the vigorous and equal enforcement of the law.
The Buck Stops with Holder and Obama
A couple of housekeeping notes first: Many at Justice and in the FBI are ethical and moral people who try very hard to do right by the American people. So even though I use the word “Justice” as in Justice Department throughout, my critique does not apply to the people below the very top. Fundamentally only Attorney General Eric Holder and President Obama are responsible our Department of Justice’s enforcement priorities.
Attorney General Holder runs the show, but President Obama gave him the job, and can fire him at any time. Holder’s enforcement priorities and strategies therefore must reflect Obama’s priorities. I realize that’s a very formal take, but it’s the only defensible one. I don’t care how much who knew about what, how decisions are or were in fact made, or any other framing or excusing of AG Holder & President Obama’s responsibility for our criminal justice priorities. In our democracy the only political control We, the People have on our national criminal enforcement priorities is our vote for President. And an incumbent President’s strongest advertisement of his enforcement priorities is his Attorney General and his record. The buck stops with them, period.
Judging Justice
Another important caveat about this critique: I’m only looking at all things Financial Meltdown. In this part one, I’m looking at the prosecution of perpetrators, bankers and the companies they run. In part two I look at Justice’s defense of our legal system, of the rule of law itself. While Justice is responsible for many other topics–combating terrorism, for example–the Financial Meltdown devastated our economy, deranged our democracy and destroyed trillions of dollars of ordinary Americans’ wealth. So though I’m only grading one subject, it’s not a gotcha quiz. Nor does it say anything about Justice’s performance in those other areas.
Nor am I rigging the test: Justice itself defined the standard for judging it. The Justice Department’s Mission, as spelled out in its “Performance and Accountability Report 2011” is:
“To enforce the law and defend the interests of the United States according to the law, to ensure public safety against threats foreign and domestic, to provide federal leadership in preventing and controlling crime, to seek just punishment for those guilty of unlawful behavior, and to ensure fair and impartial administration of justice for all Americans.
And Justice cites these core values in guiding its mission:
“Equal Justice Under the Law….”Honesty and Integrity….
“Commitment to Excellence….”Respect for the Worth and Dignity of Each Human Being….”
This mission and these values are animated by “Strategic Goals” and the “strategic objectives,” under each (at p. I-2). For Part 1, this is the only strategic goal and objective that matters:
“II Prevent Crime, Enforce Federal Laws, and Represent the Rights and Interests of the American People
…”2.5 Combat public and corporate corruption, fraud, economic crime, and cybercrime.” [I'm not going to talk about cybercrime.]
Giving Credit Due
Let’s start with Justice’s self-assessment (at p. II-15). Basically, Justice thinks it’s doing a great job: ”the FBI obtained the most convictions in the history of its Corporate and Securities Fraud programs” and took down 340 “criminal enterprises engaging in white collar crimes”, hugely exceeding the target of 250. More; Justice reports it won 93% of its criminal prosecutions, including financial frauds and other categories. (at pp. II-17 to -21) That win percentage shows that when Justice puts crooks on trial, the bad guys don’t really stand a chance. Justice is more dominant than the Steel Curtain. Just ask Jeff Skilling, ex-CEO of Enron.
A closer, and still positive look at Justice’s work on all things Financial Fraud comes from the news pages of the Financial Fraud Enforcement Task Force. That task force was set up by President Obama “in November 2009 to hold accountable those who helped bring about the last financial crisis as well as those who would attempt to take advantage of the efforts at economic recovery.”
Highlights from the task force’s 2011 include winning important convictions for bid-rigging that defrauded municipalities; insider trading; executives’ embezzlement from their banks; multiple mortgage fraud schemes; and many other financial crimes. Justice even convicted a major CEO of securities fraud (ex-Duane Reade CEO Anthony Cuti) and took down Lee Bently Farkas, ex-Chairman of Taylor, Bean & Whitaker for bank and securities fraud. Finally, Justice has filed several important civil suits, like one against Deutsche Bank and its mortgage subsidiary MortgageIt, for defrauding HUD.
Those Successes Highlight the Big Failure
So yes, our Justice Department is prosecuting financial fraud on a large scale. But these cases are all against small and medium fish, or at best, are token cases. Why not take on the Great White Sharks, and do system-wide prosecutions? If the excuse is resources, well, that’s a leadership decision, not an insurmountable problem. And the decision is deeply flawed: the failure to target the sharks and clean up fraud systematically has damaged our nation deeply, and leaves it very vulnerable.
Here’s what I mean about small and medium fish: Justice considers 14 people who scammed $47 million using 22 Florida properties a “Large-Scale Mortgage Fraud Conspiracy” and $23 million in fraudulent loans for 44 NY properties a ”Massive Mortgage Fraud Scheme“. If those cases are “large scale” and “massive”, what’s the appropriate superlative to talk about the mortgage fraud conspiracy at Countrywide or WaMu or any of the others? What superlative would Justice use if it convicted their executives? SuperMegaGigantoNormous Fraud?
Similarly, the Financial Fraud Task Force went after mortgage modification scams like this not-quite-a-million dollar California loan modification fraud. The crooks in that case targeted homeowners with letters filled with false promises about modification help, and took the money of homeowners who relied on those representations. Now, those crooks deserve what they got; thanks, Justice, for nailing them. But as Massachusetts AG Martha Coakley and Nevada AG Catherine Cortez Masto’s lawsuits detail, the banks have done similar things themselves. (See Coakley’s suit starting at paragraph 124, and Masto‘s whole complaint.)
That is, the banks made and make numerous representations to homeowners that prove false–most devastatingly, that the foreclosure is on hold while the modification is in process–and they take money based on those representations, called trial payments. Under Massachusetts and Nevada law the banks’ practices are illegally deceptive. How come they’re kosher under federal law but the guy in California deserved jail?
So that’s the small fish/shark problem. And no, the Farkas conviction isn’t sufficient to address the issue. Farkas wasn’t one of the biggest boys. If he were one of many, fine. But on his own it’s not enough to matter.
By critiquing token cases, I mean suits like the one against Deutsche Bank. Deutsche Bank, through MortgageIT, was not the only major bank that defrauded HUD, according to HUD itself. Last May Shahien Nasiripour broke the story on HUD’s internal report essentially indicting Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and Ally Financial for precisely MortgageIT-type claims. Not coincidentally, the Deutsche Bank suit was announced May 3, and Nasiripour’s story hit on May 11–I’ll bet people inside HUD were outraged only Deutsche Bank was charged. Since then only one other defrauding-HUD case has been filed, and it also is relatively small fry: Allied Home Mortgage.
Consider that MortgageIt and Allied Home don’t even rise into the top 25 subprime lenders. When looking at the list, remember that Countrywide and First Franklin/National City/Merrill Lynch are now Bank of America (BofA); Long Beach Mortgage/Washington Mutual and Encore Credit/ECC Capital/Bear Stearns are now part of JPMorgan Chase (JPM); and Wachovia is now part of Wells Fargo (WFC). The liability those banks have surely dwarfs what MortgageIT created for Deutsche Bank or Allied Home created. Since Justice was given the HUD report and its veritable indictments of the biggest banks, why haven’t suits followed? Big, big money’s at stake.
The SEC has taken a similar approach to its CDO cases. Nail each of the big banks for one of dozens of similar securities. Tokenism is just as destructive in that context. Token suits in the face of such widespread wrongdoing have zero deterrent effect.
Recidivism Risk: Why The Failure To Prosecute Matters So Much
Look, AG Holder might say, why are you being so harsh? All the medium and small fry we’ve convicted hurt many people and deserved what they got. Each “token” case is a big deal, a major resources suck, but we’re bringing them anyway.
Well, on the token cases, if MA AG Coakley can sue several big banks at once, so can you. Don’t tell me the Massachusetts AG has more resources than Justice. More: win the cases and they more than pay for themselves. Can you win? Well, consider this case in which private investors beat Citi badly. With facts like those, how could you lose? And there’s similarly damning facts under any part of the Wall Street sidewalk you turn over.
Right now top bankers are so confident no one will prosecute them that they show absolutely no respect for the law. I mean, all the big banks, which means, all the top bankers, have repeatedly violated injunctions they’ve agreed to with the SEC. And why not? As Judge Rakoff noted, the SEC hasn’t enforced a single injunction “against a financial institution for at least the last 10 years.” But it’s more than that; the bankers’ disdain for the law is most clear in the fraudulent documents and the deceptive practices that are part of the banks’ current business model.
New York City hasn’t seen such lawlessness since its murderous 70s, 80s and early 90's. Residents lived in constant fear, and graffiti marring every inch of every subway car reminded everyone that law enforcement had lost control. NYC’s gold-collar crooks are just as brazen now, wreaking economic violence across our planet. And like the subway graffiti, fraudulent documents defacing every inch of our courts and land records show law enforcement’s impotence.
Law enforcers took back the subway by frisking turnstile jumpers, arresting people for outstanding warrants, seizing guns and drugs. That’s important: police and prosecutors didn’t incarcerate little perps, turnstile jumpers. NY incarcerated violent felons by frisking and identifying turnstile jumpers. In addition, NYC visibly reasserted its control by cleaning the graffiti. The government can regain control of Wall Street by vigorous law enforcement against the Great White Sharks and cleaning up document fraud until not a visible trace remains, and the courts and land records are rendered harder to deface.
One key difference between the two crime waves, however, makes thorough prosecution of this gold-collar one crucial. Violent criminals are not easy to deter, because their decision to commit crime is often fueled by drugs and/or rage. Crime reduction comes more from incapacitation than deterrence. With rational people, however, deterrence is possible. All it takes is for the crook to perceive a high likelihood of getting caught and punished. And Wall Streeters are nothing if not rational, at least in the economic sense. Systematic, consistent, and punitive prosecutions of top gold-collar crooks would have a broad deterrent effect. But it has to be the top guys; the next Angelo Mozillo is not deterred by the prosecution of Angelo Rossi.
And frankly, we can’t afford not to deter gold-collar crooks. Wall Street financial frauds suck up so much wealth, nations are brought to their knees. Madoff’s money pile is an ant hill to banksters’ Burj Kalifa.
Is Holder Kowtowing to Geithner?
Part of Justice’s strategic objective is to “Combat public and corporate corruption”. If Justice were serious about achieving this objective it wouldn’t stop until it had incarcerated Darrel Dochow and his former boss, Scott Polakoff, and perhaps Polakoff’s boss too. Who are these people?
Well, they were top regulators at the Office of the Thrift Supervision (OTS). The OTS was a mindbogglingly bad bank regulator. OTS oversaw AIG, Washington Mutual, Countrywide, IndyMac, and BancUnited, to name a few. In fact, the Financial Crisis Inquiry Commission used OTS as a case study in regulatory failure. Dodd-Frank put the agency out of its misery, merging it into the better though still awful OCC.
But I don’t want Dochow and Polakoff prosecuted for mere incompetence. See, these “regulators” allowed (Dochow) and even ordered (Polakoff) banks they oversaw to lie about their financial health. These guys knowingly let the banks under their supervision cook their books. And it’s even worse when you consider Dochow’s history; he was part of the last great banking regulatory failure–the Keating scandal.
And yet Justice has to date declined to prosecute. When Louise Story and Gretchen Morgenson broke the story last November, they reported that the Dochow case had been referred to Justice for prosecution in 2009, so it’s not like Justice hasn’t heard of the situation. So what gives?
Story and Morgenson quoted a Texas law professor explaining that Treasury was blocking the prosecution because OTS was a subdivision of Treasury. If this case went forward, what else would Justice find to prosecute in Treasury’s actions? But if Justice doesn’t prosecute out of deference to Treasury, well, doesn’t that make Treasury and every bank regulator above the law?
There’s nothing inevitable or necessary about Justice’s deference to Treasury. I mean, Attorney General Robert F. Kennedy not only went after the mob, he went after a mobster–Sam Giancana–that had helped elect his brother president. The American people need and deserve an attorney general with that much integrity always, but particularly now.
So that’s where we are on holding the perpetrators of the Financial Meltdown accountable: Small to medium fish incarcerated; big fish and their conspiring regulators not even indicted. Two token cases brought over defrauding the government, but at least five viable cases against bailed-out banks worth many more billions not filed. Add to that dozens of cases brought by the SEC and securities fraud victims that Justice could pick and choose from for targets, but hasn’t. I mean, even if it was something of a joke because he kept his cash, the SEC went after Mozillo.
In all, the record above adds up to the law applied unequally, our economy left at the mercy of banker and regulator recidivism, our Justice system corrupted. But it gets still worse.
Much has been made of a national effort to negotiate with the bailed-out banks over their illegal loan making, servicing and foreclosing practices, their end-run around the public land record system, MERS, and their securities fraud. As the discussions have worn on, it’s become clear that not only is the settlement a hush money effort–look, the banks say, we’ll pay you some billions and you’ll hush up about all the wrong we did–but it’s also now clear that the driver for a quick and dirty settlement is the federal government. At least 14 AGs are so sick of this “law enforcement” charade they’re exploring how best to take effective action together. Why is the Justice doing the bankers’ bidding?
And it’s not just AGs committed to enforcing the law that are realizing Justice is playing for the other team. The FHFA–Fannie & Freddie’s overseer–has also split with Justice. As Nasiripour reported for the Financial Times, FHFA is now working the the NY AG’s office instead of Justice. See, FHFA filed major, evidence-backed lawsuits against all the big banks, but apparently it wants even more negotiating leverage before cutting a deal. (Note to Iowa’s AG Miller, this is how it’s done.)
The NY AG has criminal laws at his disposal, and if the alliance is fruitful, he can use that leverage to get a better deal for FHFA. And the NY AG gets all the documents and evidence FHFA has, simplifying its own enforcement efforts. Yves Smith points out what a slap this alliance is to Justice, since normally it would be the FHFA’s natural ally.
In short, law enforcers serious about enforcing laws and regulators serious about protecting taxpayers are bypassing the Justice department as useless and unhelpful.
So What’s Going On?
I see two basic reasons why Justice has displayed such distorted priorities, and I believe the truth is a combination of both. One possibility is that Secretary Geithner and President Obama’s various Wall Street donors and advisers have convinced AG Holder and President Obama to do this distorted enforcement to avoid another Financial Meltdown. The claim is the Great White Sharks must swim free and their companies be patted on the wrist because the banks’ balance sheets can’t handle the liability, investors can’t handle the uncertainty, and if these guys go to jail, who will run these companies?
But that’s crap. If the banks’ balance sheets can’t handle the liability, liquidate and/or restructure the banks. Since when must we operate in a world with SuperMegaGigantoNormous banks? If Holder and Obama bought this idea, they’ve given in to blackmail.
The other reason doesn’t run through Treasury or Wall Street directly, but from the lawyers that serve them. That is, the revolving door between Justice and the law firm of Covington and Burling meant the people designing the enforcement approach–the Financial Fraud Enforcement Task Force itself– otherwise made their careers and fortunes defending the banks and bankers Justice isn’t prosecuting.
Here’s some highlights, excerpted from my reporting for DailyFinance last Feburary:
AG Holder: Before becoming AG, Holder was a litigation partner at Covington & Burling in its D.C. office for eight years. His practice involved “high stakes civil litigation and white collar criminal defense.” In 2008, immediately before he became AG, Holder was one of six Covington attorneys ranked top in the country in white collar criminal defense.
Assistant AG Lanny Breuer, Head of Justice’s Criminal Division: Just prior to joining Justice, Breuer was co-chair of Covington’s white collar criminal defense department and also an award winner.
James Garland, who joined Justice with Holder but left in 2010: At Justice, Garland
“advised Attorney General Eric Holder on a range of enforcement issues, with an emphasis on criminal…matters, and helped to spearhead the Department’s response to the ongoing economic crisis. He was deeply involved in the creation of President Obama’s Financial Fraud Enforcement Task Force… He worked closely with senior officials at the White House, Main Justice, the U.S. Attorneys’ Offices, and other federal, state, and local enforcement agencies.” [Bold added]
NOTE: the bolded language is no longer in Covington’s bio of Garland. But it was when I wrote the piece last February.
Steve Fagell, who joined Justice with Holder but also left in 2010:
“a member of the Criminal Division’s senior leadership team, [and] a key advisor to Assistant Attorney General Lanny A. Breuer …[Fagell] was integrally involved, for example, in the formulation and communication of Division policy in connection with...corporate and securities fraud, and other forms of financial fraud.…Mr. Fagell also coordinated the Division’s work with the Financial Fraud Enforcement Task Force and the Financial Crisis Inquiry Commission…[Bold added]
And that’s just a piece of the connections between top Justice folks and Covington.
See, our top prosecutor, his top criminal enforcement deputy, and two key architects of Justice’s approach to Financial Meltdown enforcement all worked or now again work for the very people and companies Justice is failing to prosecute. How much of a coincidence can that be?
Robert F. Kennedy must be spinning in his grave.
AG Holder and President Obama, because you have turned our democracy into a de facto aristocracy, I call you morally bankrupt. However, it’s not too late: you can redeem yourselves at any time. Just indict the big boys, prosecute those epitomes of public corruption, ex-regulator Darryl Dochow and his former boss Scott Polakoff, and sue the heck out of all the big banks.
In short, you can redeem yourselves at any time by starting to vigorously and equally enforce the law. Will you?
Sadly, when it comes to the Financial Meltdown perpetrators, scrutiny reveals those priorities are deeply distorted. Our law enforcers chose to become the protection detail of our wealthy-beyond-dreaming-crooks-in-chief, while throwing the book at their guilty but less destructive subordinates.
Who should we be prosecuting? Well, there’s Dick Fuld of Lehman; James Cayne of Bear, Stearns; Joseph Cassano of AIGFP; Angelo Mozillo of Countrywide; and E. Stanley O’Neal of Merrill Lynch, just to name a few. There’s also all the bailed out top bankers still in power, such as Lloyd Blankfein, Jamie Dimon, and the meltdown era executives at the other biggest bailout recipients: Citigroup, Bank of America, Wells Fargo, Morgan Stanley. And that’s not an exhaustive list.
As I lay out below, AG Holder and President Obama have abandoned the cherished American principle–the core democratic principle–of equality before the law. That’s a kind of moral corruption that strikes at the heart of our national identity. And as best I can tell–again, the evidence follows–this corruption flows from Treasury Department/Wall Street fear mongering and revolving door conflicts of interest.
Worst of all, our top law enforcers abandoned equality before the law precisely when our democracy desperately needs it. Our only defense against the growing tyranny of the 1%, the only means we have of policing the bounds of their power, is the vigorous and equal enforcement of the law.
The Buck Stops with Holder and Obama
A couple of housekeeping notes first: Many at Justice and in the FBI are ethical and moral people who try very hard to do right by the American people. So even though I use the word “Justice” as in Justice Department throughout, my critique does not apply to the people below the very top. Fundamentally only Attorney General Eric Holder and President Obama are responsible our Department of Justice’s enforcement priorities.
Attorney General Holder runs the show, but President Obama gave him the job, and can fire him at any time. Holder’s enforcement priorities and strategies therefore must reflect Obama’s priorities. I realize that’s a very formal take, but it’s the only defensible one. I don’t care how much who knew about what, how decisions are or were in fact made, or any other framing or excusing of AG Holder & President Obama’s responsibility for our criminal justice priorities. In our democracy the only political control We, the People have on our national criminal enforcement priorities is our vote for President. And an incumbent President’s strongest advertisement of his enforcement priorities is his Attorney General and his record. The buck stops with them, period.
Judging Justice
Another important caveat about this critique: I’m only looking at all things Financial Meltdown. In this part one, I’m looking at the prosecution of perpetrators, bankers and the companies they run. In part two I look at Justice’s defense of our legal system, of the rule of law itself. While Justice is responsible for many other topics–combating terrorism, for example–the Financial Meltdown devastated our economy, deranged our democracy and destroyed trillions of dollars of ordinary Americans’ wealth. So though I’m only grading one subject, it’s not a gotcha quiz. Nor does it say anything about Justice’s performance in those other areas.
Nor am I rigging the test: Justice itself defined the standard for judging it. The Justice Department’s Mission, as spelled out in its “Performance and Accountability Report 2011” is:
“To enforce the law and defend the interests of the United States according to the law, to ensure public safety against threats foreign and domestic, to provide federal leadership in preventing and controlling crime, to seek just punishment for those guilty of unlawful behavior, and to ensure fair and impartial administration of justice for all Americans.
And Justice cites these core values in guiding its mission:
“Equal Justice Under the Law….”Honesty and Integrity….
“Commitment to Excellence….”Respect for the Worth and Dignity of Each Human Being….”
This mission and these values are animated by “Strategic Goals” and the “strategic objectives,” under each (at p. I-2). For Part 1, this is the only strategic goal and objective that matters:
“II Prevent Crime, Enforce Federal Laws, and Represent the Rights and Interests of the American People
…”2.5 Combat public and corporate corruption, fraud, economic crime, and cybercrime.” [I'm not going to talk about cybercrime.]
Giving Credit Due
Let’s start with Justice’s self-assessment (at p. II-15). Basically, Justice thinks it’s doing a great job: ”the FBI obtained the most convictions in the history of its Corporate and Securities Fraud programs” and took down 340 “criminal enterprises engaging in white collar crimes”, hugely exceeding the target of 250. More; Justice reports it won 93% of its criminal prosecutions, including financial frauds and other categories. (at pp. II-17 to -21) That win percentage shows that when Justice puts crooks on trial, the bad guys don’t really stand a chance. Justice is more dominant than the Steel Curtain. Just ask Jeff Skilling, ex-CEO of Enron.
A closer, and still positive look at Justice’s work on all things Financial Fraud comes from the news pages of the Financial Fraud Enforcement Task Force. That task force was set up by President Obama “in November 2009 to hold accountable those who helped bring about the last financial crisis as well as those who would attempt to take advantage of the efforts at economic recovery.”
Highlights from the task force’s 2011 include winning important convictions for bid-rigging that defrauded municipalities; insider trading; executives’ embezzlement from their banks; multiple mortgage fraud schemes; and many other financial crimes. Justice even convicted a major CEO of securities fraud (ex-Duane Reade CEO Anthony Cuti) and took down Lee Bently Farkas, ex-Chairman of Taylor, Bean & Whitaker for bank and securities fraud. Finally, Justice has filed several important civil suits, like one against Deutsche Bank and its mortgage subsidiary MortgageIt, for defrauding HUD.
Those Successes Highlight the Big Failure
So yes, our Justice Department is prosecuting financial fraud on a large scale. But these cases are all against small and medium fish, or at best, are token cases. Why not take on the Great White Sharks, and do system-wide prosecutions? If the excuse is resources, well, that’s a leadership decision, not an insurmountable problem. And the decision is deeply flawed: the failure to target the sharks and clean up fraud systematically has damaged our nation deeply, and leaves it very vulnerable.
Here’s what I mean about small and medium fish: Justice considers 14 people who scammed $47 million using 22 Florida properties a “Large-Scale Mortgage Fraud Conspiracy” and $23 million in fraudulent loans for 44 NY properties a ”Massive Mortgage Fraud Scheme“. If those cases are “large scale” and “massive”, what’s the appropriate superlative to talk about the mortgage fraud conspiracy at Countrywide or WaMu or any of the others? What superlative would Justice use if it convicted their executives? SuperMegaGigantoNormous Fraud?
Similarly, the Financial Fraud Task Force went after mortgage modification scams like this not-quite-a-million dollar California loan modification fraud. The crooks in that case targeted homeowners with letters filled with false promises about modification help, and took the money of homeowners who relied on those representations. Now, those crooks deserve what they got; thanks, Justice, for nailing them. But as Massachusetts AG Martha Coakley and Nevada AG Catherine Cortez Masto’s lawsuits detail, the banks have done similar things themselves. (See Coakley’s suit starting at paragraph 124, and Masto‘s whole complaint.)
That is, the banks made and make numerous representations to homeowners that prove false–most devastatingly, that the foreclosure is on hold while the modification is in process–and they take money based on those representations, called trial payments. Under Massachusetts and Nevada law the banks’ practices are illegally deceptive. How come they’re kosher under federal law but the guy in California deserved jail?
So that’s the small fish/shark problem. And no, the Farkas conviction isn’t sufficient to address the issue. Farkas wasn’t one of the biggest boys. If he were one of many, fine. But on his own it’s not enough to matter.
By critiquing token cases, I mean suits like the one against Deutsche Bank. Deutsche Bank, through MortgageIT, was not the only major bank that defrauded HUD, according to HUD itself. Last May Shahien Nasiripour broke the story on HUD’s internal report essentially indicting Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and Ally Financial for precisely MortgageIT-type claims. Not coincidentally, the Deutsche Bank suit was announced May 3, and Nasiripour’s story hit on May 11–I’ll bet people inside HUD were outraged only Deutsche Bank was charged. Since then only one other defrauding-HUD case has been filed, and it also is relatively small fry: Allied Home Mortgage.
Consider that MortgageIt and Allied Home don’t even rise into the top 25 subprime lenders. When looking at the list, remember that Countrywide and First Franklin/National City/Merrill Lynch are now Bank of America (BofA); Long Beach Mortgage/Washington Mutual and Encore Credit/ECC Capital/Bear Stearns are now part of JPMorgan Chase (JPM); and Wachovia is now part of Wells Fargo (WFC). The liability those banks have surely dwarfs what MortgageIT created for Deutsche Bank or Allied Home created. Since Justice was given the HUD report and its veritable indictments of the biggest banks, why haven’t suits followed? Big, big money’s at stake.
The SEC has taken a similar approach to its CDO cases. Nail each of the big banks for one of dozens of similar securities. Tokenism is just as destructive in that context. Token suits in the face of such widespread wrongdoing have zero deterrent effect.
Recidivism Risk: Why The Failure To Prosecute Matters So Much
Look, AG Holder might say, why are you being so harsh? All the medium and small fry we’ve convicted hurt many people and deserved what they got. Each “token” case is a big deal, a major resources suck, but we’re bringing them anyway.
Well, on the token cases, if MA AG Coakley can sue several big banks at once, so can you. Don’t tell me the Massachusetts AG has more resources than Justice. More: win the cases and they more than pay for themselves. Can you win? Well, consider this case in which private investors beat Citi badly. With facts like those, how could you lose? And there’s similarly damning facts under any part of the Wall Street sidewalk you turn over.
Right now top bankers are so confident no one will prosecute them that they show absolutely no respect for the law. I mean, all the big banks, which means, all the top bankers, have repeatedly violated injunctions they’ve agreed to with the SEC. And why not? As Judge Rakoff noted, the SEC hasn’t enforced a single injunction “against a financial institution for at least the last 10 years.” But it’s more than that; the bankers’ disdain for the law is most clear in the fraudulent documents and the deceptive practices that are part of the banks’ current business model.
New York City hasn’t seen such lawlessness since its murderous 70s, 80s and early 90's. Residents lived in constant fear, and graffiti marring every inch of every subway car reminded everyone that law enforcement had lost control. NYC’s gold-collar crooks are just as brazen now, wreaking economic violence across our planet. And like the subway graffiti, fraudulent documents defacing every inch of our courts and land records show law enforcement’s impotence.
Law enforcers took back the subway by frisking turnstile jumpers, arresting people for outstanding warrants, seizing guns and drugs. That’s important: police and prosecutors didn’t incarcerate little perps, turnstile jumpers. NY incarcerated violent felons by frisking and identifying turnstile jumpers. In addition, NYC visibly reasserted its control by cleaning the graffiti. The government can regain control of Wall Street by vigorous law enforcement against the Great White Sharks and cleaning up document fraud until not a visible trace remains, and the courts and land records are rendered harder to deface.
One key difference between the two crime waves, however, makes thorough prosecution of this gold-collar one crucial. Violent criminals are not easy to deter, because their decision to commit crime is often fueled by drugs and/or rage. Crime reduction comes more from incapacitation than deterrence. With rational people, however, deterrence is possible. All it takes is for the crook to perceive a high likelihood of getting caught and punished. And Wall Streeters are nothing if not rational, at least in the economic sense. Systematic, consistent, and punitive prosecutions of top gold-collar crooks would have a broad deterrent effect. But it has to be the top guys; the next Angelo Mozillo is not deterred by the prosecution of Angelo Rossi.
And frankly, we can’t afford not to deter gold-collar crooks. Wall Street financial frauds suck up so much wealth, nations are brought to their knees. Madoff’s money pile is an ant hill to banksters’ Burj Kalifa.
Is Holder Kowtowing to Geithner?
Part of Justice’s strategic objective is to “Combat public and corporate corruption”. If Justice were serious about achieving this objective it wouldn’t stop until it had incarcerated Darrel Dochow and his former boss, Scott Polakoff, and perhaps Polakoff’s boss too. Who are these people?
Well, they were top regulators at the Office of the Thrift Supervision (OTS). The OTS was a mindbogglingly bad bank regulator. OTS oversaw AIG, Washington Mutual, Countrywide, IndyMac, and BancUnited, to name a few. In fact, the Financial Crisis Inquiry Commission used OTS as a case study in regulatory failure. Dodd-Frank put the agency out of its misery, merging it into the better though still awful OCC.
But I don’t want Dochow and Polakoff prosecuted for mere incompetence. See, these “regulators” allowed (Dochow) and even ordered (Polakoff) banks they oversaw to lie about their financial health. These guys knowingly let the banks under their supervision cook their books. And it’s even worse when you consider Dochow’s history; he was part of the last great banking regulatory failure–the Keating scandal.
And yet Justice has to date declined to prosecute. When Louise Story and Gretchen Morgenson broke the story last November, they reported that the Dochow case had been referred to Justice for prosecution in 2009, so it’s not like Justice hasn’t heard of the situation. So what gives?
Story and Morgenson quoted a Texas law professor explaining that Treasury was blocking the prosecution because OTS was a subdivision of Treasury. If this case went forward, what else would Justice find to prosecute in Treasury’s actions? But if Justice doesn’t prosecute out of deference to Treasury, well, doesn’t that make Treasury and every bank regulator above the law?
There’s nothing inevitable or necessary about Justice’s deference to Treasury. I mean, Attorney General Robert F. Kennedy not only went after the mob, he went after a mobster–Sam Giancana–that had helped elect his brother president. The American people need and deserve an attorney general with that much integrity always, but particularly now.
So that’s where we are on holding the perpetrators of the Financial Meltdown accountable: Small to medium fish incarcerated; big fish and their conspiring regulators not even indicted. Two token cases brought over defrauding the government, but at least five viable cases against bailed-out banks worth many more billions not filed. Add to that dozens of cases brought by the SEC and securities fraud victims that Justice could pick and choose from for targets, but hasn’t. I mean, even if it was something of a joke because he kept his cash, the SEC went after Mozillo.
In all, the record above adds up to the law applied unequally, our economy left at the mercy of banker and regulator recidivism, our Justice system corrupted. But it gets still worse.
Much has been made of a national effort to negotiate with the bailed-out banks over their illegal loan making, servicing and foreclosing practices, their end-run around the public land record system, MERS, and their securities fraud. As the discussions have worn on, it’s become clear that not only is the settlement a hush money effort–look, the banks say, we’ll pay you some billions and you’ll hush up about all the wrong we did–but it’s also now clear that the driver for a quick and dirty settlement is the federal government. At least 14 AGs are so sick of this “law enforcement” charade they’re exploring how best to take effective action together. Why is the Justice doing the bankers’ bidding?
And it’s not just AGs committed to enforcing the law that are realizing Justice is playing for the other team. The FHFA–Fannie & Freddie’s overseer–has also split with Justice. As Nasiripour reported for the Financial Times, FHFA is now working the the NY AG’s office instead of Justice. See, FHFA filed major, evidence-backed lawsuits against all the big banks, but apparently it wants even more negotiating leverage before cutting a deal. (Note to Iowa’s AG Miller, this is how it’s done.)
The NY AG has criminal laws at his disposal, and if the alliance is fruitful, he can use that leverage to get a better deal for FHFA. And the NY AG gets all the documents and evidence FHFA has, simplifying its own enforcement efforts. Yves Smith points out what a slap this alliance is to Justice, since normally it would be the FHFA’s natural ally.
In short, law enforcers serious about enforcing laws and regulators serious about protecting taxpayers are bypassing the Justice department as useless and unhelpful.
So What’s Going On?
I see two basic reasons why Justice has displayed such distorted priorities, and I believe the truth is a combination of both. One possibility is that Secretary Geithner and President Obama’s various Wall Street donors and advisers have convinced AG Holder and President Obama to do this distorted enforcement to avoid another Financial Meltdown. The claim is the Great White Sharks must swim free and their companies be patted on the wrist because the banks’ balance sheets can’t handle the liability, investors can’t handle the uncertainty, and if these guys go to jail, who will run these companies?
But that’s crap. If the banks’ balance sheets can’t handle the liability, liquidate and/or restructure the banks. Since when must we operate in a world with SuperMegaGigantoNormous banks? If Holder and Obama bought this idea, they’ve given in to blackmail.
The other reason doesn’t run through Treasury or Wall Street directly, but from the lawyers that serve them. That is, the revolving door between Justice and the law firm of Covington and Burling meant the people designing the enforcement approach–the Financial Fraud Enforcement Task Force itself– otherwise made their careers and fortunes defending the banks and bankers Justice isn’t prosecuting.
Here’s some highlights, excerpted from my reporting for DailyFinance last Feburary:
AG Holder: Before becoming AG, Holder was a litigation partner at Covington & Burling in its D.C. office for eight years. His practice involved “high stakes civil litigation and white collar criminal defense.” In 2008, immediately before he became AG, Holder was one of six Covington attorneys ranked top in the country in white collar criminal defense.
Assistant AG Lanny Breuer, Head of Justice’s Criminal Division: Just prior to joining Justice, Breuer was co-chair of Covington’s white collar criminal defense department and also an award winner.
James Garland, who joined Justice with Holder but left in 2010: At Justice, Garland
“advised Attorney General Eric Holder on a range of enforcement issues, with an emphasis on criminal…matters, and helped to spearhead the Department’s response to the ongoing economic crisis. He was deeply involved in the creation of President Obama’s Financial Fraud Enforcement Task Force… He worked closely with senior officials at the White House, Main Justice, the U.S. Attorneys’ Offices, and other federal, state, and local enforcement agencies.” [Bold added]
NOTE: the bolded language is no longer in Covington’s bio of Garland. But it was when I wrote the piece last February.
Steve Fagell, who joined Justice with Holder but also left in 2010:
“a member of the Criminal Division’s senior leadership team, [and] a key advisor to Assistant Attorney General Lanny A. Breuer …[Fagell] was integrally involved, for example, in the formulation and communication of Division policy in connection with...corporate and securities fraud, and other forms of financial fraud.…Mr. Fagell also coordinated the Division’s work with the Financial Fraud Enforcement Task Force and the Financial Crisis Inquiry Commission…[Bold added]
And that’s just a piece of the connections between top Justice folks and Covington.
See, our top prosecutor, his top criminal enforcement deputy, and two key architects of Justice’s approach to Financial Meltdown enforcement all worked or now again work for the very people and companies Justice is failing to prosecute. How much of a coincidence can that be?
Robert F. Kennedy must be spinning in his grave.
AG Holder and President Obama, because you have turned our democracy into a de facto aristocracy, I call you morally bankrupt. However, it’s not too late: you can redeem yourselves at any time. Just indict the big boys, prosecute those epitomes of public corruption, ex-regulator Darryl Dochow and his former boss Scott Polakoff, and sue the heck out of all the big banks.
In short, you can redeem yourselves at any time by starting to vigorously and equally enforce the law. Will you?
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