Another More Terrible Financial Crisis Is Coming— For the Benefit of a Few

"So we may not be that far away from the next bubble bursting, and I could imagine, if I think about policy, what we just talked about, with the end of a recovery cycle, we’ve pumped $4 trillion in this country, $30 trillion globally, into the economy with monetary policy.   So that’s tapped out.

We are now using fiscal policy to overheat a late-stage recovery in order to keep the Republicans in office.  We are doing nothing to bolster underlying growth with educational reform, infrastructure reform, et cetera."

Rana Foroohar, The Rich Have an Escape Plan


"I think it’s important in the power of finance and how pervasive this is throughout the economy, this has very little to do with Republicans and Democrats. In fact, some of the key opening doors for finance happened in the Clinton administration."

Paul Jay, Clinton's Committee To Save the World Unleashes Wall Street

Rana Foroohar is an associate editor and global business columnist for The Financial Times, and CNN’s global economic analysts. She’s the author of Makers and Takers: The Rise of Finance and the Fall of American Business.

The Warning: A Financial Cauldron of Very High Leverage and Interwoven Risks

"The current bubbles in junk bonds and foreign debt are not in any way driving the economy. Presumably we are seeing somewhat more investment as a result of the fact that uncreditworthy companies were able to borrow at a low cost, but there is no notable boom in such investment.

Similarly, if foreign borrowers have a harder time getting access to credit, it may be bad news for them, but the impact on the U.S. economy will be limited.

If some banks or other financial institutions have over committed themselves in these areas, the plunge in prices may threaten their survival. This could lead to some late nights for folks at the Fed and other regulators, but it will not pose a major risk to the economy."

Dean Baker, Bubbles that We Have to Worry About and Bubbles We Don't, 18 December 2015

And how large was Long Term Capital Management? And the Knickerbocker Trust?

Could they have been said to be 'driving the economy?

And most importantly, is the failure of any major financial institution likely to be an 'isolated incident' in this current financial structure?

I like Dean Baker quite a bit, and read his column every day, often linking to it.

But he may be greatly underestimating the size and interconnectedness and the leverage in the derivatives markets, which while it is a bit harder to see than the housing or tech bubbles is nonetheless there and even more deadly.

It is not the bubble itself that causes the problem alone, but the context in which a risk like that develops, the 'transmission' of the failure throughout the system.  Often in a system that has become sufficiently vulnerable the actual event that causes a collapse can seem relatively minor, until it is examined with an open systems mind after the fact.

The system is at the heart of the problem, not the source of the particular failure that sets its tumbling.

Should one ignore the estimated notional size of the $1.2 quadrillion global derivatives market. And the estimates that put it at more than 10 times the total world GDP.

Oh yes, I know, the insurance and cross-party netting surely mitigates these risks.  And this is the same bad estimate and theory that feeds and precedes almost every major financial panic and crisis.

What happens when a large failure of a 'single institution' takes down a major counterparty affecting multiple financial firms in a cascading of mispriced risks?

Suddenly these theoretically controlled derivatives turn into a tsunami of cross party financial contagion.   This is the real risk, not the derivatives themselves, but their size and their relative fragility to the unexpected, and the concentration of their holdings in a few systemically important places.

Does Dean really believe that it may be too bad for some 'foreign borrowers' but the exceptional American financial system will be able to withstand the winds that blow through the world markets?

What is the estimate of the damage that can be done when confidence fails and there is a widespread and sudden withdrawal of liquidity and a freezing of the short term global credit markets from an enormously interconnected and grossly leveraged financial system that resembles a pyramid scheme?

Are we going to go through all of this again, with the hopes that only the Fed and few Bank regulators will have some sleepless nights but otherwise all is well?   The last time they quickly panicked and went to the Congress with a blank check and a threat of civil chaos.

And what is so different now?   Now they are like the 300 Spartans, willing to risk all and lay down their careers for the sake of the American public, saving them from the consequences a financial system that has been gorging itself on the rich rewards of massive speculation?

Are you kidding me?

Genuine financial reform and hard systemic firewalls like Glass-Steagall are the only remedy.  And we most certainly do not have them now.

Why are there so many plans that now include the 'bail-ins' of public savings and pensions?

I am not fear-mongering.  I am raising all of the hard questions that politicians like Elizabeth Warren and Bernie Sanders have been asking, and which have largely gone unanswered behind a wall of opaque secrecy inside a crony club of the revolving door,  with deriding dismissals and vague assurances of hope for change.

And we had all of that before the financial crisis of 2008 as well.

Remember Brooksley Born?

"We didn't truly know the dangers of the market, because it was a dark market," says Brooksley Born, the head of an obscure federal regulatory agency -- the Commodity Futures Trading Commission [CFTC] -- who not only warned of the potential for economic meltdown in the late 1990s, but also tried to convince the country's key economic powerbrokers to take actions that could have helped avert the crisis. "They were totally opposed to it," Born says. "That puzzled me. What was it that was in this market that had to be hidden?"

PBS Frontline, The Warning

And the risks are still hidden, and growing rather than diminishing, such is the tide of the influence of Big Banking and Big Money.

In this current financial system, no TBTF Bank is an island of secular failure anywhere in the world.

US Dollar Very Long Term Chart for Year End 2014

The US dollar has ended this year on a high note not seen in some time, not since the time of the financial crisis and collapse in 2008.

Dollar strength, at least in this index, is largely a reciprocal function of weakness in the euro, and to a lesser extent the yen, the pound, and the loon.

I have not worked the data yet, and may not do so for some time, but I would imagine that this spike in dollar strength will see the same sort of demand coming out of Europe as we saw in the two prior instances labeled Eurodollar Squeeze I & II.

This time it is most likely helped by the ongoing crisis in the yen and the ruble, the first being the objective of Abenomics, and the latter being the target of the West, through the actions of their sanctions and the currency action of their Banks, in this phase of the ongoing currency war.

In general, a stronger currency helps the financial and foreign investment sectors of a nation, and is much less helpful for the manufacturing and producing sectors.  It tends to make exports more expensive, and imports more affordable. And it gives purchasing power for those of a mind to acquire and privatize major foreign assets.

This is not a prescription for a recovery in a real producing economy, but it is a boost to the moneyed class of financiers.  This is in keeping with the financialization of the economy that came to fruition during the 1990's, and has continued to dominate the economy and the political process ever since.

Let's see how things develop in 2015.

 

 

 

 

 

Green Slime: The Return of Franken-Money

"Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country.

When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin!

Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, (bringing his fist down on the table) I will rout you out."

Andrew Jackson

The reason that there is a 'currency war' underway globally, and why there is increasing civil and political tension domestically, is not because of an envy for the Anglo-American one percent's way of life.

The reason is that the monetary system and the Western economies have gone off the rails with financialization and speculation, and there is a commensurate revulsion from it from those who are in a position to seek alternatives wherever they may. Those who cannot will be victims.

This system is fragile, and will not cohere.

This is why the precious metals have spiked, and will contain to struggle against the very obvious financial repression that is being driven by the Banks.  It is an exercise in the abuse of power and the corruption of governance.

This does not mean that austerity or repression are the solution, anymore than mindless stimulus in pursuit of a top-down recovery of a corrupt, wealth transfer system is either. 

The nature of the cure is in equal justice and significant reform, the protection of the weak from the overreach and encroachments of the powerful and the wealthy, whether they are allied in a foul bargain with the state or not.

We may try scheme after scheme, from clever gimmicks to 'new' theories, until we will stand exhausted on a wreckage of our own devices. There is no substitute for transparency, justice, and reform.

Related: Money Supply, A Primer

 

Robert Johnson with Paul Jay: The Convergence of Finance and Politics

As you may know, Robert Johnson is one of my favorite speakers on economic matters. He does not get sufficient exposure, and certainly not on the mainstream media.

Here is an interesting perspective on recent financial history of the US, leading up to the development of our current system of finance and governance. It is an interview on The Real News with Paul Jay. You may find the interviews there with transcripts.

Reality will indeed assert itself at some point. The longer the wait, the great the force required to delay it, and the more dramatic the eventual reversion to the mean, whatever that might ultimately prove to be. It does vary, depending on the selected dataset and how one chooses to measure it.

Some would contend that the natural state of mankind is the dominance of the few and the enslavement of the many. Others would see it as an ever rising and falling impulse to freedom and virtue. Perhaps as Heraclitus contended, the only constant is change.

I will present the next segment on 'breaking the Bank of England' in the next segment as it becomes available.




Here are parts I and II of the same interview which consist largely of Johnson's personal background and development.

Michael Hudson: The Financialization of the Economy

I enjoyed this recent essay by Michael Hudson. It is a nice overview of the financialization process, and how the economic hitmen, who had ravaged the Third World, started coming home.

Of course I do not necessarily agree with everything in it. But the things he says make some real sense, and provide a balance to the prevailing economic mythos, and some would say propaganda, that comes out of the mainstream media in support of the financialization process.

Reality economics

December 19, 2012

By Michael Hudson

A review of Norbert Häring and Niall Douglas, Economists and the Powerful (London: Anthem Press, 2012).

“Whom the gods would destroy, they first make mad.”

And if they would destroy economies, they first create a wealthy class on top, and let human nature do the rest. The acquisition of power soon leads to its abuse, to economic and social hubris. By seeking to protect its gains, perpetuate itself and make its wealth hereditary, power elites lock in their position in ways that exclude and injure those below. Turning government into an oligarchy, the wealthy indebt and shift the tax burden onto the less powerful.

It is an ancient tale. The Greeks got matters right in seeing how power leads to hubris, bringing about its own downfall. Hubris is the addiction to wealth and power, an arrogant over-reaching that involves injury to others. By impoverishing economies it destroys the source of profits, interest, capital gains, and even recovery of the original savings and debt principal.

This abusive character of wealth and power is not what mainstream economic models describe. That is why economic theory is broken. The concept of diminishing marginal utility implies that the rich will become more satiated as they become wealthier, and hence less addicted to power. This idea of progressive satiation returns gets the direction of change wrong, denying the basic thrust of the past ten thousand years of human technology and civilization.

Today’s supply and demand approach treats the economy as a “market” in a crudely abstract way, as quantities of goods (already produced), labor (with a given productivity) and capital (already accumulated, no questions asked) are swapped and bartered with each other. This approach does not inquire deeply into how some people get the capital to “swap” for “labor.” To top matters, this approach gets the direction of technological growth and basic business experience wrong, by assuming conditions of diminishing returns and diminishing marginal utility. The intellectual result is a parallel universe, whose criterion for economic excellence is merely the internal consistency of its abstract assumptions, not their realism.  (Life imitates models lol - Jesse)

Häring and Douglas show that the economics discipline did not get this way by accident. They are leading organizers of the World Economic Association, which emerged from the Post-Autistic-Economic movement intended to provide an alternative to mainstream neoclassical and neoliberal economics. (Häring is co-editor of the World Economic Review.)

Toward this end they provide a wealth of references tracing how economics was turned into a propaganda exercise for financiers, landlords, monopolists, insiders, fraudsters and other rent-seeking predators whom classical economists sought to tax and regulate out of existence. This state of affairs reflects the century-long drive of these free lunchers to fight back against classical economics by sponsoring self-serving fictions that depict them as earning their fortunes not in predatory and extractive ways, but by contributing to output as “job creators.”

Any given distribution of wealth and income is treated as an equilibrium reflecting voluntary choice, without examining the organizational and social structures of workplace hiring, production and distribution. The authors provide an antidote to this tunnel vision by pointing to the real invisible hands at work: insider dealing, anti-labor and anti-union maneuvering, and outright looting and fraud. What they mean by power is employers hiring strikebreakers, lobbying for special favors and insider deals, and backing the election campaigns of lawmakers pledged to act on behalf of the 1%.

Criticizing the textbook theory of the firm, they point out that that most production has increasing returns. Unit costs fall as fixed capital investment is spread over more output. As a producer with nearly zero marginal cost, for instance, Microsoft obtains a rising intellectual property rent on each program sold. On an economy-wide level, raising the minimum wage would enable most firms to benefit from increasing returns, by increasing demand.

Firms use political leverage to make sure that anti-labor referees are appointed to the courts and arenas that arbitrate disputes about employment, working conditions and firing. Capital-intensive industries outsource low-skill jobs to small-scale providers using non-union labor. Privatizing public utilities also aims largely at breaking labor union power. Marginalist supply and demand theory implies that each additional worker that is hired increases wage rates, prompting business to oppose full employment policies in order to keep wages low, even though this limits the market for their output.

So technology and diminishing terms are not the reason why wages have been pressed down – or why financial and other non-production costs have been rising for most Western economies. These cost increases are headed by debt charges for leveraged buyouts and corporate raiding, plus CEO salaries, bonuses and stock options. Labor also faces high costs of living as a result of the soaring mortgage debt taken on to obtain housing, student loan debt to obtain an education as a precondition for middle-class employment, and credit-card debt to maintain consumption standards, and rising wage withholding for Social Security and Medicare as taxes become regressive.

This personal debt service (including housing costs) and various taxes absorb more than two-thirds of the typical paycheck. So even if workers did not have to buy any of the goods and services they produce – food, clothes and other basic consumer needs – they still could not compete with labor in less financialized and debt-ridden economies.

At the corporate level, financial engineering is more about raising stock prices than new tangible capital investment. Even this is not being done in ways that serve stockholders’ long-term interest or that of the economy at large. Häring and Douglas give a scathing review of “motivating” managers by paying them in stock options. Managers maximize the value of these options by spending corporate revenue on stock buy-backs instead of new direct investment to expand their business. Even worse, companies borrow to buy their stock or even to pay out as dividends to bid up its price. The “capital” in this gain is financial, not industrial. It also turns out to be anti-labor, as loading companies down with debt enables corporate raiders use the threat of bankruptcy to demand pension downgrades and wage givebacks.  The problem with financial planning is its short hit-and-run time frame aiming at extracting income rather than taking the time to invest in new production and develop markets. Concealing this short-termism with Enron-style “mark to model” accounting fictions, managers take the money and run, leaving bankrupt shells in their wake.

Debt leveraging is encouraged by taxing asset-price gains at much lower rates than earnings (wages and profits), and permitting interest to be tax-deductible. This fiscal subsidy is by no means an inherent feature of markets. It reflects the financial sector’s capture of tax policy, along with regulatory capture to disable the government’s oversight so as to make fortunes by deregulating, privatizing, and popularizing the idea that economies can get rich by going into debt. Neoliberal doctrine demonizes government as the only power able to regulate and tax unearned income and prosecute fraud. This inverts the idea of free markets away from the classical meaning of markets free from unearned economic rent, to connote today’s arena free for predatory rentiers.

This strategy is capped by the power to censor. The misleading and deceptive depiction of the economy drawn by financiers, real estate speculators and monopolists is careful to conceal their own behavior from sight. This is the ultimate power of today’s mainstream economics: to shape how people perceive the economy. The starting point is to distract the public from noticing (and hence regulating or taxing) the real-world power structures at work. They prefer to make themselves invisible, above all the financial power to indebt the economy. It is by financial means, after all, that finance has shifted economic planning out of the hands of government to Wall Street and similar banking centers abroad.

Lobbyists for the 1% popularize a view that today’s economy is a fair and indeed natural inevitable product of Darwinian evolution. As Margaret Thatcher put it: There Is No Alternative (TINA). This narrow-mindedness is enforced by a censorial policy: “If the eye offend thee, pluck it out.” Häring and Douglas describe the academic process of weeding out any offending eyes that might introduce more realism when it comes to predatory behavior and rent seeking.

The prime directive is to depict financial planning as better than that of public agencies. In contrast to the Progressive Era’s endorsement of public infrastructure keeping costs down so as to better compete in global markets, the financial sector seeks to privatize public enterprises – on credit, preferably at distress prices to create new fortunes. The task of today’s mainstream economics, as the authors describe it, is to distract attention away from Balzac was more realistic, in observing that behind every family fortune lay a great, usually long-forgotten theft.

They focus on domestic power rather than spelling out the international dimension of how economic power is wielded. The IMF, U.S. Government and European Union bureaucracy wield foreign-debt leverage to impose the neoliberal Washington Consensus. This is how the European “troika” imposes austerity on Greece to replace democratic government with “technocrats” whose policies serve the 1% in today’s class war. This path leads in due course to the targeted assassinations by which the Chicago Boys imposed their kleptocratic “free market” on Chile under Pinochet, elaborated by Operation Condor assassinating labor leaders, land reformers and Liberation Theology priests and nuns throughout Latin America and in the United States itself. But I can understand that the authors evidently decided that they had to draw the line between economics and its military tactic somewhere, focusing on the economic core itself.

Finance has become the modern mode of warfare. It is cheaper to seize land by foreclosure rather than armed occupation, and to obtain rights to mineral wealth and public infrastructure by hooking governments and economies on debt than by invading them. Financial warfare aims at what military force did in times past, in a way that does not prompt subject populations to fight back – as long as they can be persuaded to accept the occupation as natural and even helpful. After indebting countries, creditors lobby to privatize natural monopolies and create new monopoly rights for themselves....

Read the entire essay here.

How the Chicago Boys Wrecked the Economy

We do not agree with Michael Hudson on several points in this interview, but we do think it is thought-provoking to say the least.

In particular we view the polarization of wealth distribution in the United States as a trend that is alarming. It is a prerequisite for a severe testing of our democratic republic.

Because a system has been subverted and corrupted does not mean that the sytem is no good, but rather it merely proves that it is of human origin, and requires constant care and occasional renewal after a severe crisis brings the faults to the forefront.


How the Chicago Boys Wrecked the Economy By MIKE WHITNEY
CounterPunch

Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JP Morgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002

Mike Whitney: The United States current account deficit is roughly $700 billion. That is enough "borrowed" capital to pay the yearly $120 billion cost of the war in Iraq, the entire $450 billion Pentagon budget, and Bush's tax cuts for the rich. Why does the rest of the world keep financing America's militarism via the current account deficit or is it just the unavoidable consequence of currency deregulation, "dollar hegemony" and globalization?

Michael Hudson: As I explained in Super Imperialism, central banks in other countries buy dollars not because they think dollar assets are a “good buy,” but because if they did NOT recycle their trade surpluses and U.S. buyout spending and military spending by buying U.S. Treasury, Fannie Mae and other bonds, their currencies would rise against the dollar. This would price their exporters out of dollarized world markets. So the United States can spend money and get a free ride.

The solution is (1) capital controls to block further dollar receipts, (2) floating tariffs against imports from dollarized economies, (3) buyouts of U.S. investments in dollar-recipient countries (so that Europe and Asia would use their central bank dollars to buy out U.S. private investments at book value), (4) subsidized exports to dollarized economies with depreciating currency, and similar responses that the United States would adopt if it were in the position of a payments-surplus country. In other words, Europe and Asia would treat the United States as its Washington Consensus boys treat Third World debtors: buy out their raw materials and other industries, their export plantations, and their governments.

MW: Economist Henry Liu said in his article "Dollar hegemony enables the US to own indirectly but essentially the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little in the way of monetary penalties.....World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy at "market prices" quoted in dollars." Is Liu overstating the case or have the Federal Reserve and western banking elites really figured out how to maintain imperial control over the global economy simply by ensuring that most energy, commodities, and manufactured goods are denominated in dollars? If that's the case, then it would seem that the actual "face-value" of the dollar does not matter as much as long as it continues to be used in the purchase of commodities. Is this right?

Michael Hudson: Henry Liu and I have been discussing this for many years now. We are in full agreement. The paragraph you quote is quite right. His Asia Times articles provide a running analysis of dollar hegemony.

MW: What is the relationship between stagnant wages for workers and the current credit crisis? If workers wages had kept up with the rate of production, isn't it less likely that we would be in the jam we are today? And, if that is true, than shouldn't we be more focused on re-unionizing the labor force instead looking for solutions from the pathetic Democratic Party?

Michael Hudson: The credit crisis derives from “the magic of compound interest,” that is, the tendency of debts to keep on doubling and redoubling. Every rate of interest is a doubling time. No “real” economy’s production and economic surplus can keep up with this tendency of debt to grow faster. So the financial crisis would have occurred regardless of wage levels.

Quite simply, the price of home ownership tends to absorb all the disposable personal income of the homebuyer. So if wages would have risen more rapidly, the price of housing would simply have risen faster as employees pledged more take-home pay to carry larger mortgages. Stagnant wages merely helped keep down the price of houses to merely stratospheric levels, not ionospheric ones.

As for labor unions, they haven’t been any help at all in solving the housing crisis. In Germany where I am right now, unions have sponsored co-ops, as they used to do in New York City, at low membership costs. So housing costs only absorb about 20% of German family budgets, compared to twice that for the United States. Imagine what could be done if pension funds had put their money into housing for their contributors, instead of into the stock market to buy and bid up prices for the stocks that CEOs and other insiders were selling.

MW: When politicians or members of the foreign policy establishment talk about "integrating" Russia or China into the "international system"; what exactly do they mean? Do they mean the dollar-dominated system which is governed by the Fed, the World Bank, the IMF, and the WTO? Do countries compromise their national sovereignty when they participate in the US-led economic system?

Michael Hudson: By “integrating” they mean absorbing, something like a parasite integrating a host into its own control system. They mean that other countries will be prohibited under WTO and IMF rules from getting rich in the way that the United States got wealthy in the 19th and early 20th centuries. Only the United States will be permitted to subsidize its agriculture, thanks to its unique right to grandfather in its price supports. Only the United States will be free from having to raise interest rates to stabilize its balance of payments, and only it can devote its monetary policy to promoting easy credit and asset-price inflation. And only the United States can run a military deficit, obliging foreign central banks in dollar-recipient countries to give it a free ride. In other words, there is no free lunch for other countries, only for the United States.

Other countries do indeed give up their national sovereignty. The United States never has adjusted its economy to create equilibrium with other countries. But to be fair, in this respect only the United States is acting fully in its own self-interest. The problem is largely that other countries are not “playing the game.” They are not acting as real governments. It takes two to tango when one party gets a free ride. Their governments have become “enablers” of U.S. economic aggression.

MW: What do you think the Bush administration's reaction would be if a smaller country, like Switzerland, had sold hundreds of billions of dollars of worthless mortgage-backed securities to investment banks, insurance companies and investors in the United States? Wouldn't there be litigation and a demand that the responsible parties be held accountable? So, how do you explain the fact that China and the EU nations, that were the victims of this gigantic swindle, haven't boycotted US financial products or called for reparations?

Michael Hudson: International law is not clear on financial fraud. Caveat emptor is the rule. Foreign investors took a risk. They trusted a deregulated U.S. financial market that made it easiest to make money via financial fraud. Ultimately, they put their faith in neoliberal deregulation – at home as well as in the United States. England is now in the same mess. The “accountability” was supposed to lie with U.S. accounting firms and credit rating agencies. Foreign investors were so ideologically blinded by free market rhetoric that they actually believed the fantasies about “self-regulation” and self-regulating markets tending toward equilibrium rather than the real-world tendency toward financial and economic polarization.

In other words, most foreign investors lack a realistic body of economic theory. The United States could simply argue that they should take responsibility for their bad investments, just as U.S. pension funds and other investors are told to do.

MW: The Congress recently passed a bill that gives Treasury Secretary Henry Paulson the unprecedented authority to use as much money as he needs to keep Fannie Mae and Freddie Mac solvent. Paulson assured the Congress that he wouldn't need more than $25 billion but, the 400 page bill allows him to increase the national debt by $800 billion. How will the Fannie/Freddie bailout affect the dollar and the budget deficit? Are interest rates likely to skyrocket because of this action?

Michael Hudson: The Fed can flood the economy with money, Alan Greenspan-style, to prevent interest rates from skyrocketing. Nobody really knows what will happen to FNMA and Freddie Mac, but it looks like the mortgage and financial crisis will get much, much worse over the coming year. We are just heading into the storm where adjustable-rate mortgages (ARMs) are scheduled to reset at higher rates, and where U.S. banks have to roll over their existing debts in a market where foreign investors fear that these banks already have no net worth left.

So the principle here is “Big fish eat little fish.” Wall Street will be bailed out, and banks will be allowed to “earn their way out of debt” as they did after 1980, by exploiting retail customers, above all credit-card customers and individual borrowers. There will be a lot of bankruptcies, and people will suffer more than ever before because of the harsh pro-creditor bankruptcy law that Congress passed at the behest of the bank lobbyists. (Mike needs to consider a change in government administration - Jesse)
MW: A few months ago, the Wall Street Journal ran an editorial which said that they could imagine two nightmare scenarios if the current credit crisis was not handled properly; either there would be a run on the dollar causing a sudden plunge in its value, or the unexpected failure of a major financial institution could send the stock market crashing. Last week, the former head of the IMF Kenneth Rogoff triggered a sell-off on Wall Street when he said, "We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper; we’re going to see a big one — one of the big investment banks or big banks." What happens if Rogoff is right and Merrill, Citi or Lehman go belly up? Is that enough to send the stock market freefalling?

Michael Hudson: Not necessarily. Citibank would be nationalized, then sold off. The principle should be that if a bank is “too big to fail,” it should be broken up.

This should start with a repeal of the Clinton Administration’s repeal of Glass-Steagall.


As for Lehman, that would be given the Bear Stearns treatment, and also sold off – probably to a hedge fund. Merrill is much larger, but it also could be parceled out, I suppose. The stock market’s financial index would plunge, but not necessarily industrial stock prices.

MW: According to MarketWatch: "In the three months from April to June, banks posted their second worst earnings performance since 1991.... Earnings for the quarter totaled just $5 billion, compared with $36.8 billion a year ago, a decline of 86.5%." Also, according to a front page article in the Wall Street Journal: "financial institutions will have to pay off at least $787 billion in floating rate notes and other medium term obligations before the end of 2009." How are the banks going to pay off nearly $800 billion ($200 billion by December!) when they only earned a measly $5 billion in the quarter!?! And how in the world is the Federal Reserve going to keep the banking system functioning when earnings can't even cover current liabilities? Do the banks have some secret source of revenue we don't know about or is the system headed for disaster?

Michael Hudson: The traditional way to pay debt is with yet MORE debt. The interest due is simply added on to the principal, so that the debt grows exponentially. This is the real meaning of “the magic of compound interest.” It means not only that savings left to accumulate interest keep on doubling and redoubling, debts do to, because the savings that are lent out on the “asset” side of the creditor’s balance sheet (today, that of America’s wealthiest 10%) become debts on the “liabilities” side of the balance sheet (the “bottom 90%”).

The banks don’t have a secret source of revenue. It’s right out in the open. They will take their junk mortgages to the Federal Reserve and borrow the money at full face value. The government will be left with the junk.

It then can either take over the bank, as the Bank of England did with Northern Rock when it went bankrupt early this year, or it can let the bank “earn” money by stiffing its customers some more.

MW: From 2000 to 2006, the total retail value of housing in the United States doubled, going from roughly $11 trillion to $22 trillion in just 6 years. For the last 200 years, housing has barely kept pace with the rate of inflation, usually increasing 2 to 3% per year. The Federal Reserve's low interest rates were the main cause of this unprecedented housing bubble and, yet, ex-Fed chief Alan Greenspan still denies any responsibility for what "The Economist" calls "the largest bubble in history". Did Greenspan understand the problems he was creating with his "loose" monetary policies or was there some ulterior motive to his actions?

Michael Hudson: He simply didn’t care about the problem. He saw his job as a cheerleader for people who were able to get rich fast. These always had been his major clients in his years on Wall Street, and he saw himself as their servant – sort of like a pilot fish for sharks.

Mr. Greenspan’s idea of “wealth creation” was to take the line of least resistance and inflate asset prices. He thought that the way to enable the economy to carry its debt overhead was to inflate asset prices so that debtors could borrow the interest falling due by pledging collateral (real estate, stocks and bonds) that were rising in market price. To his Ayn-Rand view of the world, one way of making money was as economically and socially productive as any other way of doing so. Buying a property and waiting for its price to inflate was deemed as productive as investing in new means of production.

Ever since his days as co-founder of NABE (the National Association of Business Economists), Greenspan has long looked only at GNP and the national balance sheet as an economic indicator, being “value-free.” This is his intellectual and conceptual limitation. He wanted to provide a way for savvy investors to get rich, and the easiest way to get rich is to be passive and get a free lunch. His ideology led him to believe the “free market” ideology that the financial sector would be self-regulating and hence would act honestly. But he opened the floodgates to financial crooks. His set of measures did not distinguish between Countrywide Financial getting rich, Enron getting rich, or General Motors or industrial companies expanding their means of production. So the economy was being hollowed out, but this didn’t appear in any of the measures he looked at from his perch at the Federal Reserve.

So just as journalists and the mass media proclaim every market downturn as “surprising” and “unexpected,” he was as clueless as a lemming running headlong over the cliff. It’s an inherent instinct for free-market boys. (And for most true believers everywhere including believers in a strong dollar deflation which can only occur if the US achieve a dictatorial control over the world's economy. And so many will betray themselves for a belief. - Jesse)
MW: The housing market is freefalling, setting new records every day for foreclosures, inventory, and declining prices. The banking system is in even worse shape; undercapitalized and buried under a mountain of downgraded assets. There seems to be growing consensus that these problems are not just part of a normal economic downturn, but the direct result of the Fed's monetary policies. Are we seeing the collapse of the Central banking model as a way of regulating the markets? Do you think the present crisis will strengthen the existing system or make it easier for the American people to assert greater control over monetary policy?

Michael Hudson: What do you mean “failure”? Your perspective is from the bottom looking up. But the financial model has been a great success from the vantage point of the top of the economic pyramid looking down? The economy has polarized to the point where the wealthiest 10% now own 85% of the nation’s wealth. Never before have the bottom 90% been so highly indebted, so dependent on the wealthy. From their point of view, their power has exceeded that of any time in which economic statistics have been kept.

You have to realize that what they’re trying to do is to roll back the Enlightenment, roll back the moral philosophy and social values of classical political economy and its culmination in Progressive Era legislation, as well as the New Deal institutions. They’re not trying to make the economy more equal, and they’re not trying to share power. Their greed is (as Aristotle noted) infinite. So what you find to be a violation of traditional values is a re-assertion of pre-industrial, feudal values. The economy is being set back on the road to debt peonage. The Road to Serfdom is not government sponsorship of economic progress and rising living standards; it’s the dismantling of government, the dissolution of regulatory agencies, to create a new feudal-type elite.

The former Soviet Union provides a model of what the neoliberals would like to create. Not only in Russia but also in the Baltic States and other former Soviet republics, they created local kleptocracies, Pinochet-style. In Russia, the kleptocrats founded an explicitly Pinochetista party, the Party of Right Forces (“Right” as in right-wing). (This is why Bill Gates was able to praise the People's Republic of China as 'my kind of capitalism.' - Jesse)
In order for the American people or any other people to assert greater control over monetary policy, they need to have a doctrine of just what a good monetary policy would be. Early in the 19th century the followers of St. Simon in France began to develop such a policy. By the end of that century, Central Europe implemented this policy, mobilizing the banking and financial system to promote industrialization, in consultation with the government (and catalyzed by military and naval spending, to be sure). But all this has disappeared from the history of economic thought, which no longer is even taught to economics students. The Chicago Boys have succeeded in censoring any alternative to their free-market rationalization of asset stripping and economic polarization.

My own model would be to make central banks part of the Treasury, not simply the board of directors of the rapacious commercial banking system. You mentioned Henry Liu’s writings earlier, and I think he has come to the same conclusion in his Asia Times articles.

MW: Do you see the Federal Reserve as an economic organization designed primarily to maintain order in the markets via interest rates and regulation or a political institution whose objectives are to impose an American-dominated model of capitalism on the rest of the world?

Michael Hudson: Surely, you jest! The Fed has turned “maintaining order” into a euphemism for consolidating power by the financial sector and the FIRE sector generally (Finance, Insurance and Real Estate) over the “real” economy of production and consumption. Its leaders see their job as being to act on behalf of the commercial banking system to enable it to make money off the rest of the economy. It acts as the Board of Directors to fight regulation, to support Wall Street, to block any revival of anti-usury laws, to promote “free markets” almost indistinguishable from outright financial fraud, to decriminalize bad behavior – and most of all to inflate the price of property relative to the wages of labor and even relative to the profits of industry.

The Fed’s job is not really to impose the Washington Consensus on the rest of the world. That’s the job of the World Bank and IMF, coordinated via the Treasury (viz. Robert Rubin under Clinton most notoriously) and AID, along with the covert actions of the CIA and the National Endowment for Democracy. You don’t need monetary policy to do this – only massive bribery. Only call it “lobbying” and the promotion of democratic values – values to fight government power to regulate or control finance across the world. Financial power is inherently cosmopolitan and, as such, antagonistic to the power of national governments.

The Fed and other government agencies, Wall Street and the rest of the economy form part of an overall system. Each agency must be viewed in the context of this system and its dynamics – and these dynamics are polarizing, above all from financial causes. So we are back to the “magic of compound interest,” now expanded to include “free” credit creation and arbitraging.

The problem is that none of this appears in the academic curriculum. And the silence of the major media to address it or even to acknowledge it means that it is invisible except to the beneficiaries who are running the system.

Michael Hudson can be reached via his website, mh@michael-hudson.com

Mike Whitney lives in Washington state. He can be reached at: fergiewhitney@msn.com