Wednesday,
September 17, 2008
The U.S.
Financial System in Serious Trouble
“…
a bailout of GSE (Fannie
and Freddie) bondholders would be perhaps the greatest taxpayer rip-off in
American history. It is bad economics and you can be sure it is terrible
politics.”
Matt Kibbe, President of Freedom Works
"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)
[After the
Bear Stearns bailout] "As more firms lost access to funding, the
vicious circle of forced selling, increased volatility, ... and margin calls that was already well
advanced at the time would likely have intensified. The broader economy could
hardly have remained immune from such severe financial disruptions."
Ben Bernanke, Fed Chairman (March 2008)
In August 2007, at the very beginning of the
subprime financial
crisis in the U.S., and referring to the alchemy-like practice of creating artificial financial
instruments, such as mortgage-backed securities (MBSs), here is what I wrote:
“Like all 'Ponzi
schemes', such pyramidings of debts
with no liquid assets behind them are bound to implode sooner or later.” I also wrote about the Fed's
intervention in such cases, that “it alleviates the 'liquidity
crisis', for sure, but this does nothing to cure the underlying 'solvency crisis' of institutions holding
large chunks of non-performing mortgage-based assets. Sooner or later, such
low-valued derivatives will have to be written off, and this will necessarily
lead to an erosion of these institutions' capital base. Bankruptcies of the
most leveraged and imprudent institutions are to be expected.”
In
fact, such bankruptcies of over-leveraged financial institutions become
unavoidable. For a while, forced mergers between banks, initiated by the Fed or
the Treasury, can soften the blow. But after a while, outright bankruptcies
cannot be avoided and balance sheets have to be balanced.
What
is the cause of this financial mess?
Last
month, I provided a short answer:
“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.”
Today I say that this major crisis has to be placed at
the very feet of the Washington
establishment. This is a politico-financial establishment that
has pushed to the limits its ideology of deregulation of financial markets and
stretched the working of unregulated corporate market capitalism to the
breaking point. Now, the system is imploding under our very eyes and financial
institutions are falling like dominos. As I wrote last August, and repeated in
April of this year,
the U.S. financial problem is not one of liquidity, (there is plenty of
liquidity provided by the Fed when banks and brokers can borrow at will newly
printed dollars from the Fed’s discount window) but one of solvency, weak
balance sheets, risky assets and debt liquidation. That's a horse of a
different color.
Over the last twenty-five years, beginning with the
Reagan administration and culminating with the current Bush-Cheney
administration, the Washington establishment dismantled piece by piece the
system of protection that had been built since the 1930's economic
depression and removed nearly all government regulations that
could stand in the way of greed and gouging on the part of unscrupulous market
operators.
And that's where
the rubber hits the road. Short of bankruptcies is
the nationalization of the over-leveraged banks by the government. And the
Bush-Cheney administration took a big step in that direction when it came to
the rescue of the two largest mortgage financing institutions, Fannie
Mae (Federal National Mortgage
Association: FNM) and Freddie Mac, (Federal
Home Loan Mortgage Corporation: FRE) which were close
to being insolvent. This step was initiated after foreign central banks
(in China, Japan, Europe, the Middle East and Russia) threatened to stop buying
U.S. bonds and debentures issued by the two shaky financial institutions.
But
the Bush-Cheney administration, while providing public money to keep the two
lenders in operation, stopped short of nationalizing them. Indeed, the U.S.
government committed to invest
as much as $200 billion in preferred stock and extend credit through 2009, to
keep the two mortgage lenders solvent and operating.
But instead
of taking them over by placing them into administrative receivership, in order to change their
business model, as they should have done since the government is now
guaranteeing their outstanding debts, (more than $5 trillion US) the U.S. government chose rather to keep the appearance
that these were still two privately run banks and only appointed a legal conservator for Fannie Mae and Freddie Mac. Even when they bail
out what can be called two Government
sponsored enterprises (GSEs), their market ideology prevents
them from doing the right thing.
After years of
irresponsible public deregulation and private mismanagement and irresponsible,
pyramiding risk taking, the American financial system is now in serious
trouble, and it may draw the U.S. economy further down with it in the months
and years to come.
In the coming
weeks, however, as other American financial institutions teeter on the brink of
bankruptcy, the U.S. government will have to consider
creating a Bank Resolution Trust under the model of the 1989 Resolution
Trust Corp. which took over the savings and loans banks that
were then in financial difficulties. For example, as recently as February 16 of
this year, the British government did not hesitate to nationalize the Northern Rock bank
and rescued this large British bank with about
£55 billion ($107 billion) in public loans and guarantees. Sooner or
later, the American government will have to do the same, in order to stabilize
the financial system, because the financial problems in the U.S. are systemic
and much more serious than elsewhere.
By the same token,
maybe the U.S. government should correct an anomaly of the 20th
Century, that is the semi-private status of its central bank. Indeed, the
American Federal Reserve,
is a semi-public and semi-private central bank organization that is as much
responsible to large private banks as it is to the U.S. government and the
population. This creates an unhealthy conflict of interests that is not fair to
the American public. Indeed, the American practice of privatizing profits and
socializing losses would be considered unacceptable in most other democracies.
What we are
witnessing these days in the U.S. is a massive wealth transfer from taxpayers,
savers and retirees to banks, their creditors and their managers. On the one
hand, the Fed has pushed real interest rates deep into negative territory to
help troubled banks, and, on the other hand, the American taxpayers have foot
the bill for bailing out very large financial institutions.
I wonder what the
two presidential camps, the Obama and the McCain camps, have to say about that!
They both want to increase the federal deficit and add significantly to the
already high national debt.
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/
En français: http://www.LeCodePourUneEthiqueGlobale.com/
Posted,
Wednesday, September 17, 2008, at 5:30 am
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