Friday, August 1,
2008
"I
think the
[US financial] system is basically sound, I truly do."
George W.
Bush, July 15, 2008
“Since
1951, the budget of the Department of Defense each year exceeds the net profits
of all U.S. corporations. So, in finance capital terms, that means that the
management of that budget controls the largest single block of finance capital
resources.”
Seymour
Melman (1917–2004)
"The first panacea for a mismanaged nation is
inflation of the currency; the second is war. Both bring a temporary
prosperity; both bring a permanent ruin. But both are the refuge of political
and economic opportunists."
Ernest Hemingway (1899-1961), (September 1932)
There have been many policy missteps over
the last twenty some years, and this has amounted to a mismanagement of the U.S. economy.
The result has been an
unhealthy mixture of greed, shortsightedness and market manipulation. And now,
all the chickens are coming home to roost and the crisis is deepening. This
does not mean that the private side of the U.S. economy is not resilient and strong.
It only means that government policies have often been misguided and have
damaged the private economy and hurt the people economically.
Essentially, at
the government level, each new economic crisis seems to have been
“solved” by creating the conditions for the next one. This is
particularly true in regards to regulation policy,
monetary policy,
and fiscal policy.
Each time a policy choice
had to be made, it seems that short-term benefits were often privileged at the
expense of long-term costs.
First, let us consider
regulation policy for the crucial financial sector. Over the last
twenty years, U. S. deregulation of the financial sector has been based on
developing what I would call predator financial capitalism, that is to say the
systematic encouragement of excessive risk taking (moral hazard) and of corporate greed
in general,
the
development of the pyramidal $2.5 trillion hedge fund industry, the
practice of highly-leveraged buyouts (LBOs) of healthy companies with
their own high-yield debt, also known as
"bootstrap" investments, and the practice of program trading.
Moreover, this was a system that was not only risky but also fraught with shady activities.
To accomplish
this deregulation or non-regulation of
the financial sector and to encourage the over-indebtedness
of the U.S. economy, a whole series of safeguards that had been wisely
established to prevent a repeat of the financial and economic disasters of the
1930's were dismantled and cast aside. The last one in line was the reckless
abolition by the U.S. Securities and Exchange
Commission (SEC) of the speculative prevention rule
called the downtick-uptick rule
(which prohibited
short-selling when stock prices were falling), in July 2007. Such safeguards
had been put in place in order to avoid systemic financial instability, to make
financial institutions more responsible to users and to avoid costly government
bailouts when large financial institutions fail. Today, we are back to the
1930s with large financial institutions reaping huge profits and paying obscene
salaries to their CEOs in good times and with government bailing them out with
public money when things turn sour.
During the Reagan-Bush era of
the 1980's, deregulation encouraged unsound real estate lending by Savings and
Loans financial institutions (S&Ls) and this led to the
1986-1995 Savings and Loan associations
crisis, when about $160 billion was lost, most of it through a
$124.6 billion bailout by the U.S. Government.
The 1980s also saw the
flourishing of vulture or predatory capitalism
when financial operators were allowed to raid profitable companies and saddle
them with the debt incurred to take them over. In 1989, for example, the
corporate raider firm of Kohlberg Kravis
Roberts (KKR) closed in on a $31.1 billion dollar hostile
takeover of RJR Nabisco. It was, at that time, the
largest hostile leverage buyout in history. The event was chronicled in the
book (and later the movie), Barbarians at the Gate: The
Fall of RJR Nabisco.
To this day, nothing has been done to stop this practice that rewards irresponsible gambling and punishes prudent
behavior. For the time being, however, it can be said that the practice
of leveraged finance and of high-yield debt
was somewhat stalled last August (2007) when the subprime crisis
began to unfold.
At the center of current
financial problems is the failure to adapt standard financial regulation to new
financial institutions, such as broker-investment banks, off-shore based hedge funds
and large derivatives markets that
remain, for the most part, outside of the traditional authority of regulators.
However, when things go wrong, as they did with Bear Stearns last March, their demise threatens to
destabilize the entire financial system and handy government bailouts are
quickly called in.
Second, let us consider
monetary policy.
Over the last few years, U.S.
monetary policy has resulted in a massive wealth transfer from savers, retirees
and money holders in general to banks, mortgage lenders and debtors in general
as the purchasing power of the dollar has plummeted. Last September, after the Bernanke Fed
decided to drop interest rates as the U.S. dollar was already in the downtrend,
I wrote, "foreign
(dollar) investors have been 'taxed' by the American Fed's policy of benign
neglect regarding the dollar."
Since then, the Bernanke Fed
has gone much further. It has pushed the Federal funds rate to the 2 percent
level from the 5.25 percent level it was in mid-September 2007. In so doing, by
pushing real interest rates deep into negative territory and by depreciating
the U.S. dollar, the Fed has heavily taxed retirees and savers in its rush to
shore up American financial institutions. Indeed, it can be said that the
semi-private Fed has been floating American financial problems in a sea of new
money by running the printing press.
The act of printing excessive amounts of
bills is the
worst enemy of sound money. It is a way to destroy fiat currencies. It is the main source of inflation and, sometimes, of hyperinflation.
In the end, we
know that it robs people of their savings and lowers their standards of living.
Paradoxically,
while the Fed is lending heavily to financial institutions in trouble by
discounting their bad subprime loan paper through its so-called new special lending facilities
(at 2% annual interest rate), banks become more selective in extending credit
to borrowers, forcing companies and consumers alike to cut down on their
investment and consumption projects.
The economy is
thus placed in a sort of “liquidity trap” where
everybody wishes to remain short term and liquid. There is a lot of money
around, as the monetary base, or
"High-powered money", is increasing rapidly, certainly enough to feed
inflation, depreciate the U.S. dollar and push long term bonds down (long term
interest rates are on their way up), but banking credit as such remains
scarce and may be getting more scarce as banks attempts to recapitalize
themselves.
What the Bernanke Fed is doing
nowadays is a continuation, although at a much higher level, of what the
Greenspan Fed did in the late 1990's. At that time, then Fed Chairman Alan Greenspan reacted to
the collapse of an investment firm specializing in hedged funds, Long-Term Capital Management,
by pumping large amounts of liquidity into capital markets and by
lowering interest
rates. This approach was called a "Greenspan put",
because it had the effect of guaranteeing the profitability of many risky
financial operations that otherwise would have failed. That policy paved the
way for the dot-com stock market bubble of
1999-2000.
In the same spirit, some refer
to the Fed's bailouts of troubled investment banks as a sort of Bernanke put,
because of the Fed's aggressive policy of reducing interest rates to fight
market falls or to bail out financial companies in trouble.
Because of the current
economic slowdown, the inflationary consequences of such a policy is not
apparent yet, but it could be the foundations of future inflation down the
road. Let us keep in mind that historically-low interest rates, lax lending standards,
and inadequate regulation were behind the U.S. housing bubble.
The seeds are now sown for the next bubble.
Third, let us look quickly at
fiscal policy.
The Bush-Cheney
administration's fiscal policy has been characterized by budget deficit upon
budget deficit, whatever the state of the economy. In its entire eight years in
office, in fact, it has never balanced the budget. On the contrary, it has even
spent the budget surplus
that it inherited from the Clinton administration. And it has announced that it
plans to leave the coming administration with a record 2009 deficit
of half a trillion dollars. Indeed, the previous Bush-Cheney administration's
record was its 2004 $413 billion deficit.
Although such deficits at
about 3.3 percent of the gross national product (GDP) are lower than the 6.0
percent of GDP we saw in the early 1980's, they are cumulative, and they have
occurred at a time when U.S. foreign indebtedness is much higher and the U.S.
dollar much weaker. It can be said that they have contributed to weakening the
United States and making it more vulnerable to economic and financial shocks.
Conclusion
In economics, bad decisions
and bad policies do not always result in immediate negative consequences. It
takes time for them to work their way through the economy and produce their
corrosive effects. Many of the current economic and financial problems of today
are the result of bad policies of the past.
Rodrigue Tremblay is professor emeritus of
economics at the University of Montreal and can be reached at rodrigue.tremblay@yahoo.com
He is the author of the book 'The
New American Empire'
Visit his blog site at: www.thenewamericanempire.com/blog.
Author's Website: www.thenewamericanempire.com/
Check Dr.
Tremblay's coming book "The Code for Global Ethics" at: www.TheCodeForGlobalEthics.com/
Posted,
Friday, August 1, 2008, at 5:30 am
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