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How Do I Fleece Thee? Let Me Count the Ways.

Published by marco on

Updated by marco on

So, suddenly everyone cares about macro-economics. Suddenly, we’ve upgraded our interest in the magic, money-making machine—this financial Perpetuum Mobile—from non-existent to frantic. For the longest time, very few of us cared exactly how it worked or why. No one bothered to ask why it was a given that investing in the market made sense—be it through funds, pensions or directly[1]—that’s why it’s called a given. (Duh.) We ignored clear signs that some were making out like bandits—and likely at our expense—because we were doing quite well ourselves and didn’t have to do much but sit back and enjoy the ride. Magic’s awesome when it goes your way.

Well, kaboom. Now that the magic’s gone, it’s time to take a closer look at the underpinnings of this massive fraud called international—nay, globalized—finance. Economists (and avid dilettantes) worth their salt were crying foul years ago; for example, the article Wanna Bet? by yours truly in January 2007 (earthli News) made the following prediction:

“As international politics dominates policy debate, it drowns out the creaking of the international monetary system as it sags under the strain. Throw energy market volatity into the mix, as well as the long, slow demise of the dollar and at least two more years of the Bush doctrine, and it’s a true recipe for disaster. The fuse is lit—and we don’t know how long it is or how fast it burns, but we do know that there is a whole helluva lot of explosives on the other end.”

As Stephen Colbert is fond of saying, “I called it!”

Description of the Problem

 Simplified descriptions are a dime a dozen, but accepting a simplification because it’s easier is a big part of the reason the powers-that-be were able to keep us supporting their economic habit for so long. To understand something as big and hairy as the global economy, you’ve got to get down in the trenches. To that end, there’s an excellent video called Money as Debt by Bob Bossin & Paul Grignon (Google Video) (47min.) that provides a great introduction to the past, present and possible future of our monetary system. It covers advantages, disadvantages and gaping loopholes.[2] The article The Bailout Round II: Adult Version? by Dean Baker (Talking Points Memo) presents a good summary, doing the heavy lifting for us:

“The United States is in a recession and facing the worst financial crisis in almost 80 years because the folks currently in charge were out to lunch. […] They allowed an $8 trillion housing bubble ($110,000 for every homeowner) to grow unchecked. … The main cause of the economy’s weakness is not insolvent banks and lack of credit; it’s the loss of $4 trillion to $5 trillion in housing equity as a result of the bubble’s partial deflation. Families used their equity to support their consumption in the years from 2002 to 2007, as the savings rate fell to almost zero… families can no longer sustain their levels of consumption… banks won’t lend to these families is that they no longer have home equity to serve as collateral…. And house prices are not going to come back….”

As to what can be done—what is normally done—the paper Understanding the Three Ways of Dealing with Financial Crises by Brad DeLong (Grasping Reality), though not particularly well-edited, offers an understandable description of the mechanisms available for financial market control. It’s accompanied by graphics, which nicely illustrate the effects of the different measures. At the end, he makes what, in light of recent events, can only be considered a reasonable prediction:

“I don’t believe that after this the price of risk will ever again become a free-market price, just as after the Great Depression the short-term price of liquidity–the short term interest rate–ever became a free-market price. The federal government, in one form or another, is going to be in the business of insuring debt securities against steep declines in value. Securities that are not so insured will simply not be traded. What Fannie Mae did for “conforming” home loans, the Treasury or some other government agency will do for derivative securities. It will offer insurance, charge for that insurance, and supervise and oversee financiers much more strictly.”

Assuming that there’s anything left to oversee, of course.

A later interview ended on a more upbeat note; from The Mercury News Interview by Brad DeLong on October 02, 2008 (Grasping Reality) offered concrete regulatory measures for a future derivatives markets:

“The first step would be to say you can’t trade a derivative security without trading it through an organized derivative exchange. That is to centralize the market and make it transparent for finance, to re-regulate it in a bunch of different ways. The second thing is to say if you are a high-end financial professional or you are getting a high income from anybody, that you have to take a great deal of that income in the form of long-term stock in whatever company is paying you[3]. (emphasis added)”

So that, in a nutshell, is the problem. The solution? Well, time will tell, but England got the ball rolling over the weekend and the rest of Europe happily fell in line. The U.S. is following—albeit reluctantly—in their footsteps as well. The solution was evident from the beginning, but a false dedication to a screwed-up ideology prevented the governments of the world from implementing it until it was nearly too late. Dean Baker outlined the basic details weeks ago:

“How do we go about getting the banks in order? Almost every economist I know rejects the Paulson approach and argues instead for directly injecting capital into the banks. The taxpayers give them the money and then we own some, or all, of the bank. (That’s what Warren Buffet did with Goldman Sachs.) […] If Secretary Paulson constructed a package that was centered around buying direct equity stakes in the banks, he could quickly garner large majority support in both houses. Better yet, Congress could just construct its own package centered on buying equity stakes and send it to President Bush. If he balks, we can just threaten him with stories about the Great Depression.”

Weeks later, it is almost exactly that plan that is swinging into action (and on the back of which the DJIA rocketed up almost 1000 points).

Who’s Not to Blame

There’s a tremendous amount of information floating around, trying to encapsulate the disaster in a nutshell, to break it down into bite-size chunks or sound-bites. The Republicans, ever fond of facile, easily digested and politically flattering interpretations—and never ones to shy away from twisting wildly in order to pin the blame on a favorite scapegoat—are aiming straight at Fannie Mae, Freddie Mac and (here comes the favorite scapegoat) … poor people.

The article, Subprime Suspects by Daniel Gross (Slate), covers this specious theory in more detail (and he’s understandably pissed):

“Let me get this straight. Investment banks and insurance companies run by centimillionaires blow up, and it’s the fault of Jimmy Carter, Bill Clinton, and poor minorities? […] As Barry Ritholtz notes in this fine rant, the CRA didn’t force mortgage companies to offer loans for no money down, or to throw underwriting standards out the window, or to encourage mortgage brokers to aggressively seek out new markets. Nor did the CRA force the credit-rating agencies to slap high-grade ratings on packages of subprime debt.”

There’s a wonderful expression in America that goes, “don’t piss on my leg and tell me it’s raining”. Anyone who believes the argument that government supervision of Fannie Mae and Freddie Mac—and their obligations through the CRA (the Community Reinvestment Act)—is what brought them down is deluding themselves. Yes, the companies were gutted from the inside out; this video, Exposing Fannie Mae and Freddie Mac by Daryl Montgomery (YouTube) is a fascinating look at corporate malfeasance, wherein we learn that these banks were leveraged at a rate of 70 to 1[4] before being absorbed into the gut of the government.

Gross continues with this defense:

“Third, lending money to poor people and minorities isn’t inherently risky. There’s plenty of evidence that in fact it’s not that risky at all. That’s what we’ve learned from several decades of microlending programs, at home and abroad, with their very high repayment rates. […] On the other hand, lending money recklessly to obscenely rich white guys […] can be really risky. In fact, it’s even more risky, since they have a lot more borrowing capacity.”

The poor generally don’t need a lot of money—they can’t even conceive of borrowing the kind of money that’s causing our current economic troubles. Only the truly criminally devious would think of borrowing billions, then betting it all on shaky gambles in the hopes of winning the lottery. In the end, the poor might default on their mortgage, but only very rarely and with almost zero deleterious effect on the national economy, to say nothing of the global one. When big-time investors lose at the craps tables, their clients lose, their backers lose, but they themselves don’t. They generally still earn big salaries and compensation packages and are back in the morning, bright-eyed and bushy-tailed, ready to hit the tables again.

It seems the Republicans either grew tired of blaming Clinton for the economy or finally realized that no one was buying it. But that good, old, Democratic scapegoat, Jimmy Carter, never gets tired of shouldering blame. The CRA was passed on his watch—and some would say, good for him—so it’s clearly his fault that a high-flying economy thirty years after he left office is crashing and burning.[5]

The irresponsible homeowners, who all tried to move to neighborhoods above their station, have also earned their fair share of opprobrium. Are they to blame for the bad mortgages? Or were they perhaps hoodwinked by a whole chain of people eager to generate more and more and more debt to sell further up the food-chain? The hungry maw of the rational free market demanded more, so they provided. Mortgage Industry Bankrupts Black America by Kai Wright (The Nation) offers much, much more detail about those “irresponsible homeowners” the affluent like to blame for this debacle.

What is to blame

Arnold Schwarzenegger Economics & Socialism − Free To Choose (YouTube)As usual, an overly simplified world-view is to blame. It’s the economic equivalent of “you’re either with us or against us”, with the economy being either a free market—with “free” tending to connote “free lunch” for the “new rulers of the world” (as put so nicely by John Pilger in his book of the same name)—or a socialist wasteland, like Russia had. Do you want what Russia had? Huh? Huh? Huh? Decades of lackluster life followed by a catastrophic crash?[6] No? Then, shut your mouth and get out of the way, while your betters go about the business of making money out of nothing.

Better yet, let Ah-nuld explain everything (see video to the right).

Counting the Ways

The article The Wall Street Model: Unintelligent Design by Pam Martens (CounterPunch) offers a very succinct and illuminating analysis of how the system works or rather, doesn’t. One of the problems at the core of the model is that it depends, in large part, on getting monkeys (in this case, brokers) to claw their way over each other and beat one another about the head to gain every little advantage. Free marketers claim this mechanism efficiently optimizes financial gain, but, outside of the classroom, people exercise no moral restraint and rip every loophole wide open in their desire to “win”. The game is rigged and there is no winning, only more striving and more risk and more stress and sinking to ever-deeper depths. We, the oblivious, may be in The Matrix, but the alpha-monkeys are no happier being strapped to a hamster wheel.[7] Worse still, the system seems to run only for the benefit of the system and the brokers, not the millions of small investors show actually provide the stake for the game.

“[…] imagine a business model that bases remuneration to brokers on how much money they make for their Wall Street employer and not one dime for how well their customers’ portfolios perform. A Wall Street broker receives remuneration that rises from approximately 30 to 50 per cent of the gross commission based on their cumulative trading commissions with zero regard to how well the clients’ accounts have done. There is no acknowledged internal mechanism in any of the major Wall Street firms to gauge the overall success of the accounts the broker is managing. […] Brokers put their clients “safe money” in these unsuitable investments because their Wall Street employer dangled a seductive financial inducement. […] In other words, the financial incentive has created an artificial demand [for inconceivably bad paper].”

The system is designed, as the title says “unintelligently”, because it has implicit feedback loops that lead to extremely undesirable, highly unstable and long-term untenable conditions. But, is “unintelligent” the right description? The system works just splendidly for some—namely, the people that designed it in the first place. The notion that the system is unintelligent is a misnomer because it’s based on the wrong precepts: we assume that the economy is there for the benefit of all. This is blinkered, naive thinking. It is there for the benefit of those in control of it. We are unintelligent for supporting it and allowing the investors to proceed by personal fiat. They are winning; they have, indeed, won. The game is over and there is only a mess to clean up. We have lost. They will retire—having perhaps paid perhaps minimal fines for their “accounting frauds”—to their villas in whichever balmy clime they choose. We, and ensuing generations, will only see the grindstone as it presses painfully against our noses.

We can, at best, hope to have some influence in how the next game is played, which is why we must now pay attention instead of succumbing to anger, retribution, resignation or outright depression.

Forget Blame. What About Punishment?

 We’ve all heard of the sub-prime debt that had been “misclassified”[8] as AAA paper. Oopsie. Well, this is only one case of misclassification; it is standard practice to put lipstick on a pig by simply re-labeling things. Otherwise known as “lying about the content and quality of your securities in order to move them at a higher price than any sane person would otherwise pay”. Otherwise known as fraud when a poor person does it. Investment banks cheerfully perpetrated these acts because they “so despised the low-paying Treasuries that they replaced Treasuries with Freddie Mac and Fannie Mae paper in mutual funds bearing the name ‘U.S. Government Fund.’” Isn’t that cool? They slapped a Mercedes logo on a Yugo and got away with it. As standard practice.

This is criminal. If it is not criminal, then it should be. Even a critic like Pam Marten can only muster up enough bile to call the practice “misleading”. You know what? So are con-men. And, even when such a practice is not technically illegal[9], it is clearly structured in a way that it will be misused and generate the wrong results—where “wrong” means beneficial to only the few that generated the results, but deeply harmful to the majority of other people in the society. It’s why we even have laws and a civilization and a government—remember? Murder is illegal not because it’s not beneficial to the person murdering (they presumably profit from the act), but because, if everyone did it, society would be unbearable and eventually fail. That also used to be the reason we hated con-men instead of admiring, envying and promoting them.

So, we have policies that encourage bad behavior, like the notion that investors have no obligations to the firms in which they’ve invested. The inevitable consequence of that is that, as Martens puts it:

“[t]here is no longer any incentive on Wall Street to bring about initial public offerings of only companies that will stand the test of time and create new jobs and new markets to make America strong and globally competitive. There is only an incentive to collect the underwriting fee and cash out quickly on private equity stakes.”

There is no avoiding the outcome; the policies and structure of the system make its current shape inevitable, resulting in a culture of firms that don’t do anything but profit from fluctuations that generate tremendous amounts of money from thin air. But you can eat neither thin air nor money and neither one amounts to actual, physical value.

The fallout/collapse playing out in the last few weeks is an inevitable consequence of a system that has been increasingly gamed over decades. We, as people, just don’t really care enough to stop it—mostly because there is so much wealth to go around, we were able to ignore the egregious thefts perpetrated by our heralded financial con-men. As mentioned above, why are practices that seem so inherently immoral and unethical not also illegal? Or, if they are, why are the crimes not prosecuted?

Let’s examine first what happens when a normal citizen commits a crime in the normal, public, outside world: they get arrested, their name goes on public record, they get a public trial and they go to public jail. Crimes in the financial world are prosecuted within their own system by “arbitrators”—a system designed by the financiers themselves and rubber-stamped by an obsequious Congress willing to profit from the crooked model:

“…arbitrators do not have to follow the law, or legal precedent, or write a reasoned decision, or pull arbitrators from a large unbiased pool as is done in jury selection. Industry insiders routinely serve over and over again.”

That’s why the article, America’s Own Kleptocracy by Michael Hudson (CounterPunch), can only say that the “heads [of Fannie Mae and Freddie Mac] had been removed for accounting fraud” (emphasis added) and that “Maurice Greenberg already had been removed a few years back for accounting fraud” (emphasis added); financial executives at that level don’t actually get prosecuted or punished for their crimes. What do you think you live? Some law-and-order paradise like Pakistan?[10]

Trillions Upon Trillions

The obvious question is: can the financial collapse be stopped at all? Is the pumping of hundreds of billions of dollars into these failing, crooked banks helping the economy in a significant way? Or is it just a stop-gap measure, meant to keep things afloat—after a fashion—until after the elections? The recent figures might sound like a lot of money, but the real monster is “Credit Default Swaps (CDS) with over $60 trillion now owed through secret contracts in an unregulated market”; the quality of paper traded there is at best currently unknown and most likely unknowable. The amount of debt is, at best, a ballpark guess. Some have put the figure closer to $300 trillion.

Compared to these kinds of numbers, the implosion of the housing market, with its mere trillions, seems like peanuts. It comes as no surprise, however, that the masters of the market and their political lackies would continue to blame all of their woes on that instead of revealing their hugely dishonest—and, by all rights, illegal—money-making schemes. The schemes that benefit the brokers and their firms, but leave the actual investors and holders of portfolios (i.e. the people that actually invested the cold, hard cash into that market) holding all the risk. This system has to be dismantled and a saner one put in place. There is currently no difference between the US and Zimbabwe on that account. We just pretend that our system is fancier, but that’s only because we all believe the myth of American exceptionalism.

Even taking AIG as an example, the housing market was only tangential to its downfall.[11] The reason the housing market is such a convenient scapegoat is that the mortgages in it—the debt—comprised a large part of the available capital in the U.S. financial system. With a tremendous amount of wealth flowing in via pension funds and mutual funds, investors were always looking for a better place—read: more profitable, but still with manageable risk—to put all that wealth. These mortgages, billed as they were as AAA paper, seemed like the ideal place to safely cash in. Honestly, though? This is not just the case of investors and their companies inadvertently making bad gambles; they knew that there couldn’t be that much good paper in the market, but they bought in because they all figured that they would be the ones to cash out first, before the faith in that market collapsed.[12] And, because they all knew that they would get massive commisions (especially compared to investing in boring, old, low-yield T-Bills) regardless of how their investments actually performed. And, because everybody else was doing it[13], you either ran with the big dogs or stayed on the porch.

So, back to AIG. They didn’t do any of that. Instead, they sold investment insurance to investors doing that, picking up “a teeny tiny commission […] for a policy promising to pay if, say, the $11 trillion U.S. mortgage market should ‘stumble’”. The next, logical step was to automate this process, so that requests for such insurance could be granted automatically by computers and the fee for that insurance automatically cashed, dozens of times per second. On the other side, the investors also used machines to automate their strategies, so that they could make commissions of “a thousand million-dollar gambles in the course of a few minutes”, all automatically insured by AIG. This automation continued to invest based on razor-thin probabilities, none of which accounted for what any person would have immediately seen: that the quality of the paper—the mortgages and other debt—had declined considerably and couldn’t possibly be as valuable as indicated. The algorithm has no way of discerning between safe debt and ridiculously unsafe debt marked as safe debt. The machine, like the HAL 9000, doesn’t understand lying.

But that didn’t matter, because the investors got their cut, AIG got theirs and, because, more often than not, faith kept the bubble alive, things worked out. Until they didn’t. Which every damned one of the people involved knew would happen someday. But, they did it anyway, because there was no downside, no punishment for losing the savings of millions of Americans via losses in dozens of markets, in which supposedly “safe” money-markets, mutual funds and pensions are invested. It is no different from the person who invests in a pyramid scheme because he knows he’s not the last sucker in line—those schemes work just great for the first handful of people invested in them.

Isn’t that a Hedge Fund?

And, just to be clear, these are not wealth-creation schemes in the classic sense: they are basically hedge funds and “[a] hedge fund does not make money by producing goods and services. It does not advance funds to buy real assets or even lend money.” One of the massive problems is that investment banks that were investing in more traditional ways saw the ridiculous amounts of being made by hedge funds and moved as quickly as they could to similar business models. However, hedge fund participants must usually sign a paper indicating that they are rich enough to lose everything invested in that fund before they are allowed to participate. The extreme risk is up-front. Investments in much lower-risk instruments do not at all satisfy that requirement, which makes it all the more criminal when that money ends up being managed as a hedge fund anyway. Here is a brief description from Michael Hudson of how hedge funds work:

“[A hedge fund] borrows huge sums to leverage its bet with nearly free credit. Its managers are not industrial engineers but mathematicians who program computers to make cross-bets or “straddles” on which way interest rates, currency exchange rates, stock or bond prices may move – or the prices for packaged bank mortgages. The packaged loans may be sound or they may be junk. It doesn’t matter. All that matters is making money in a marketplace where most trades last only a few seconds. What creates the gains is the price fibrillation – volatility. […] This kind of transaction may make fortunes, but it is not “wealth creation” in the form that most people recognize.”

One obvious question that comes to mind is: if so much money was made by all involved parties, then where did it go? If someone makes mad cash for five years, then loses a lot, why don’t they just use their wealth to cover their debts? Why does the government have to step in to cover their debts? That is where the final step of the plan falls into place: because all of the generated wealth was paid out immediately in the form of “commissions, salaries and annual bonuses” that could be declared as capital gains instead of normal income and was taxed at less than half the rate. Beautiful, isn’t it? Generate a tremendous amount of wealth using schemes that you know can’t last, laundering the profit to private reserves, then telling the government that it can either let you fail (in which case the money-making machine finally collapses, but all past profits are available as personal savings) or save you to prevent economic collapse (in which case the scheme continues). In either case, you don’t become poor.

Save Us. Now.

It works out just great for the gamblers and we, the public, happily swallow the stories our government and media tell us about how they “had to be saved”. What, exactly, was saved? Not “industrial capitalism, or even banking as we know it”, but the right to continue this scheme into the future. It became such an integral part of our economy that this money—but not wealth or capital—making scheme has become our economy (at least, as told to use by our elected officials, who profit handsomely from it). But such talk is tantamount to treason; as the president himself said, “[t]here will be ample opportunity to debate the origins of this problem. Now is the time to solve it.” Typical. Never play the blame game when you might get the blame.

The article, The Wall Street Bailout: Why Politicians Can’t Be Trusted by Amy Goodman (AlterNet), includes excerpts from two very good interviews on Democracy Now! with Michael Hudson, professor of economics at the University of Missouri, Kansas City, and an economic adviser to Rep. Dennis Kucinich and Nomi Prins, who used to run the European analytics group at Bear Stearns and also worked at Lehman Brothers.

Prin described the situation succinctly:

“It’s about taking on too much leverage and borrowing to take on the risk and borrowing again and borrowing again, 25 to 30 times the amount of capital. … They had to basically back the borrowing that they were doing. … There was no transparency to the Fed, to the SEC, to the Treasury, to anyone who would have even bothered to look as to how much of a catastrophe was being created, so that when anything fell, whether it was the subprime mortgage or whether it was a credit complex security, it was all below a pile of immense interlocked, incestuous borrowing, and that’s what is bringing down the entire banking system.”

If it makes economic sense to bail out these investment banks in order to avoid a depression (called a “deep recession” in these sensitive times), then why doesn’t it make sense to help out the people who will also suffer massively from the ruination of the economy over the next several years? Whether or not they are to blame for their situation is neither here nor there, their free-fall from the middle class to below the poverty line will have long- and far-reaching consequences.

“A better use of the money […] would be to ‘save these 4 million homeowners from defaulting and being kicked out of their houses. Now they’re going to be kicked out of the houses. The houses will be vacant. The cities are going to [lose] property taxes, they’re going to have to cut back local expenditures, local infrastructure. The economy is being sacrificed to pay the gamblers.‘ (Michael Hudson)”

As to whether we should rescue this system or not, consider this: it is not the case that banks literally can’t sell their paper. The article Let’s Stop the Greatest Theft in the History of Humankind by Otto Spengler (AlterNet) notes that there are buyers for the horrible paper that investment banks currently hold: hedge funds. They just aren’t willing to pay top dollar for it, typically “25% to 30% below the prices that banks carry these assets on their books”. Banks that “hold about $30 of securities for every $1 of capital” can’t afford that kind of a write-down without going immediately insolvent. Which is what happened to Lehman Brothers: without a bail-out, they had no choice.

“Lehman Brothers classified 14% of its assets as Level III at the end of the first quarter; Goldman Sachs was at 13%. Why is Lehman bankrupt, and Goldman Sachs still in business? If Secretary Paulson, the former head of Goldman Sachs, had not proposed a general bailout last week, we might already have had the answer to that question.”

So Goldman Sachs is well-networked enough to get themselves a bailout, one in which the government is going 20% above market value for bad paper (otherwise, the bail-out wouldn’t work).

One Born Every Minute

 The financial system is at once complicated and very simple. It is complicated enough to be confusing to the layman (see preceding article) and simple enough to be compared, as the article How the financial markets fell for a 400-year-old sucker bet by Jordan Ellenberg (Slate) does, to “the martingale”. The Martingale is a doubling game, which “…doesn’t eliminate risk—it just takes your risk and squeezes it all into one improbable but hideous scenario”. Do we really want an economy that acts like the worst game in the casino? Do we really want to save it as it is? Or do we want to build something better, something more stable, something fairer to more people? With many of the dominoes having fallen, now is the time to prevent the same old guard from setting them back up again.


[1] You crazy bastard.
[2] There’s also a version on YouTube, broken into several parts, of course; here’s part one (YouTube).
[3]

The emphasized measure above, in particular, would address the all-out piracy that is rotting capitalism at the core today. That way, you only get a golden parachute if you actually created lasting value; what a concept! As to the fact that “[t]he CEO of Bear Stearns lost 95 percent of his personal portfolio in the forced merger of last March”, that’s still probably not enough for most people (this author included). Because of that CEOs malfeasance—and likely criminal fraud—hundreds of thousands of people will work longer, have less and likely suffer. The 95% sounds like a lot, but it’s only slightly higher than the tax rate in the U.S. for the super-rich in the 40's and 50's, the time of greatest economic growth in U.S. history. What was his net worth before he “lost it all”? Was he worth as much as Hank Paulson: $700 million? If so, then he’s still worth $35 million. So his gamble didn’t pay off and he ended up worth only $35 million instead of $700 million – that’s hardly a punishing lifestyle.

Dean Baker knows how close people are to lighting torches and lifting pitchforks:

“This isn’t about… constructing a bank rescue the way that business people would do it. We have an interest in a well-operating financial system. There is zero public interest in… Wall Street banks and their executives.”
[4] Here’s how I understand this mechanism. Leveraging is just a fancy term for lending. Leveraged money is money that has been loaned or invested; leveraging ratios indicate how often the same money has been lent. A ratio of 70 to 1 means that the bank has 70 dollars of debt for each dollar of debt that they own. The debt is balanced by collateral (like a house), which can be confiscated (repo-ed, foreclosed, etc.) if the amount of the loan cannot be collected. However, if the value of the collateral drops, then the bank cannot cover part of its obligations and has to cover those obligations from elsewhere. In the case of the housing-bubble collapse, the value of the collateral has fallen by 10, 15, 20% so far, leaving banks holding a lot of mortgages without any “safe” investments that they can use to cover their bad ones. Extreme leveraging increases the amount of profit in boom times, but is extremely sensitive to price fluctuations: whereas a leveraging ratio of 10 to 1 could feasibly survive a day-to-day fluctuation of up to 10% in collateral value, a ratio of 70 to 1 can barely survive a fluctuation of 1%. FDIC-Insured banks generally have to keep their leveraging between 8 to 1 and 12 to 1 (from what I’ve read), but considerably lower than the 30 to 1 and higher enjoyed by Bear Sterns and Lehman Brothers. Goldman Sachs is also at or near this level, but they somehow haven’t gone bankrupt yet. Funny that.
[5] As Daniel Gross put it: “[…] it’s difficult to imagine how Jimmy Carter could be responsible for the supremely poor decision-making seen in the financial system. I await the Krauthammer column in which he points out the specific provision of the Community Reinvestment Act that forced Bear Stearns to run with an absurd leverage ratio of 33 to 1.”
[6] Speaking of the Russians, they were at least better-prepared for their collapse than we’re likely to be. Their downfall may have appeared catastrophic, but it was likely a pillow-soft landing compared to the coming collapse of the American Way of Life™. Closing the ‘Collapse Gap’: the USSR was better prepared for collapse than the US by Dmitry Orlov (Energy Bulletin) goes into greater detail, noting that the high level of bureaucracy and large number of state-run services softened the landing for many. For example, health care and housing were largely unaffected because it was all state-run in the first place. There were no companies to go out of business, no property on which to foreclose and hospitals provided care as before, without wondering whether failing insurance companies would be able to cover costs. Even the emphasis on public transportation—and the co-location of housing near it—left very few people cut off from the bare essentials when the hammer (and sickle) came down. Not so with the U.S., where half of the people would have to become nomadic just to get near reliable food supplies. The U.S. also lacks repairable goods in its throwaway society, which means that it can’t survive without a constant influx of new goods and people are also generally incapable of fixing things for themselves. These circumstance could change, but it would require time and would be much worse than it was for the Russians. They had less, so they were used to suffering—in a way, it prepared them better for their collapse.
[7] They’re far, far richer than you, but comfort yourself that they’re probably not really happier. They can buy and sell you a thousand times over with your own tax money, but they are incapable of deriving true pleasure from it. So there’s always that to help you sleep at night.
[8] You’ll excuse the excessive use of quotes to indicate irony. When so many terms barely retain any of their notional meaning, one has to somehow make a distinction between valid and invalid usage.
[9] Thanks, lobbyists! And a corrupt Congress!
[10] Referring to the impeachment of President Musharraf, which was the right thing to do, as he had repeatedly violated the Pakistani constitution. The United States, on the other hand, does not impeach presidents for gross violations of the constitution or gross dereliction of duty.
[11] The AIG executives who spent hundreds of thousands of dollars on a single weekend honestly can’t understand where the problem lies. They received $87 billion and spent a few scraps on a weekend. Where’s the problem? What they don’t understand is that people don’t want to see them lose just 95% of their net worth; they don’t want to see them living only dozens of times above the station of a mere mortal. They want to see them down in the dirt with the rest of us, struggling to make a car payment. From their point of view, the public anger is completely overblown: imagine lending someone a thousand dollars to buy food and fix up an apartment; would you get angry if they bought a stick of gum with some of that money? They were given billions to save their business and they went to a retreat to discuss just that. Where’s the problem? From their point of view, there is none.
[12] If you’ve ever seen Monty Python’s Meaning of Life, you’ll remember the The Crimson Permanent Assurance (Wikipedia) segment at the beginning where a company engaged in hostile takeovers is depicted as a marauding pirate ship, plying the waters of financial districts in their building. It is, of course, available on YouTube. And it’s probably trite to mention that this is the way some people viewed the world of high finance 25 years ago, before it crashed all of our money away in the late 80's, late 90's and, most recently, the late 00's.
[13] According to Michael Hudson, “the accounting fictions written down by companies that had entered an unreal world based on false accounting” were not known only to a select few, while the rest clambered over one another toward the brass ring. He says that, realistically, “nearly everyone in the financial sector knew [the accounting] to be fake”.