Meltdown and Bailout: Why Our Economic System Is on the Verge of Collapse

Meltdown and Bailout: Why Our Economic System Is on the Verge of Collapse
By Joshua Holland, AlterNetPosted on September 22, 2008, Printed on September 22, 2008
The immediate cause of our financial meltdown is unchecked, unbridled greed. Mainstream newspapers and the business press are doing a fairly good job of explaining how the lack of regulatory oversight led us into this nightmare.
But you have to dig down one layer to find the cause of that situation. Under cover of the ideological euphemism known as the "free market" and with enormous cash investments over the past four decades, business elites have captured the regulatory organs of powerful democratic states -- nowhere more so than the United States -- and promoted their own narrow economic agendas for short-term gain.
There's an enormous amount of discussion about that in the independent media. But to drill down a layer deeper, to the bedrock of the crisis, you have to go to some deep thinkers who don't get much play in our mainstream economic discourse.
As foreign policy analyst Mark Engler notes in his new book, How to Rule the World, declining returns on traditional investments in manufacturing and industry since the 1970s go a long way toward explaining today's highly speculative economy -- pushing capital into developing countries and into bubble after speculative bubble in search of a better profit margin.
It's important to understand what's going on at all three levels, because we may have come to a fork in the road, a point at which the decisions made now may determine the future of the global economy.
We may or may not also be on the verge of another Great Depression.
The Bush Bailout: Privatizing Gains and Socializing Risk
On Saturday, hoping to stave off that dark possibility, the Bush administration proposed an unprecedented bailout for investors, a scheme that would authorize the Treasury Department to spend as much as $700 billion in tax dollars over the next two years to buy up bad securities, with little Congressional oversight save for a semiannual report on the process.
The move came after the federal government had already sunk a total of $900 billion into America's financial institutions this year, potentially bringing the total value of the Fed's tinkering to $1.6 trillion over three years.
The White House, Congressional leaders and Treasury officials are haggling over the details. Things are moving quickly, with a mammoth intervention that was unspeakable in economic circles a month ago now looking more and more inevitable.
The structure of the proposed bailout may change during those negotiations -- Democrats in Congress are pushing to save more homeowners and tie the package to some sort of limits on CEO pay for institutions that get a lifesaver -- but the deal outlined in the brief document released on Sept. 20 epitomizes the principle of privatizing gains while socializing risk. In other words, we're splitting an oil well with the Big Boys on Wall Street: They get the oil, we get the shaft.
It is, in short, a draft of what could be one of the greatest rip-offs in history. Bush, on the way out of power, is trying to create a publicly financed honeypot for the private sector on a scale never before imagined.
Those who played fast and loose with newer, ever shakier investment instruments in order to squeeze a few more bucks out of the markets' "irrational exuberance" about the housing sector would get a payday that would save their bacon. According to the New York Times, this huge pile of taxpayers' cash may even be available to foreign investors.
Home prices would continue to tank, though, as banks shed their bad loans at discounted prices to the government. Those subsidized assets would then be liquidated -- on the cheap because they're so overvalued -- to resuscitate the financial system. Rick Sharga, a senior officer with RealtyTrac, which monitors the housing market, told Reuters, "We've seen fewer and fewer properties go through the auction process because there's either little equity in them or even negative equity. So there's no incentive for people to buy them at the auctions."
Sharga added that "bank repossessions continue to grow at a pretty rapid clip," but an analyst told me recently that he knew of banks that simply weren't taking possession of foreclosed properties because they didn't want them on their balance sheets.
As those assets are disposed of, the value of all Americans' homes will continue to fall, because sales of comparable properties determine their worth. That would, in turn, leave a greater number of Americans with mortgages worth more than the amount of equity in their homes, and the cycle would continue. Things are already bleak on that front; the rate of U.S. foreclosures increased 75 percent in 2007 and 55 percent in the year ending this June. The Associated Press reported, "More than four million American homeowners with a mortgage, a record nine per cent, were either behind on their payments or in foreclosure at the end of June."
Many more will lose their homes, and all of us will get the tab: higher taxes, swelling deficits, higher interest rates and a moribund economy.
The plan doesn't specify what, if anything, U.S. taxpayers will get in return for their largesse. The government isn't spending more than a trillion dollars to nationalize failed institutions in order to protect stakeholders and liquidate those overvalued assets in an orderly manner. That might make a lot of sense, and it would essentially make Joe and Jane taxpayer owners of something that might rebound in value down the road.
Instead, Bush's proposal would take bad paper off the books of institutions that are ailing but haven't yet gone belly-up, and we wouldn't necessarily get a stake in those institutions; they'd only become "financial agents of the government," according to the draft released Saturday.
As Paul Krugman notes, "historically, financial system rescues have involved seizing the troubled institutions and guaranteeing their debts; only after that did the government try to repackage and sell their assets."
The feds took over S&Ls first, protecting their depositors, then transferred their bad assets to the (Resolution Trust Corporation, founded in the wake of that crisis). The Swedes took over troubled banks, again protecting their depositors, before transferring their assets to their equivalent institutions.
The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system -- that is, convince creditors of troubled institutions that everything's OK -- simply by buying assets off these institutions.
Making matters even worse is the fact that it's almost impossible to put a fair market value on this massive pile of bad debt. As Peter Goodman of the New York Times notes, "no one really knows what this cosmically complex web of finance will be worth, making the final price tag for the taxpayer unknowable. One may just as well try to predict the weather three years from Tuesday."
There will be a fight in Washington, and much debate, about which ideological direction the bailout should lean, and the version offered up by the Bush administration is -- no surprise here -- tilted heavily in favor of those at the top of the economic pile.
What's clear is that there is going to be a massive transfer of public wealth to the private sector, and at least the lion's share of that cash, if not all of it, will end up in the hands of an investor class whose recklessness got us into this mess in the first place.
Meltdown
This bailout is a desperate attempt to save the modern economic system from falling under the weight of its deep structural imbalances. As such, it's unlikely to work over the medium and long terms, even if it has the desired immediate effect of propping up creaky markets and restoring their (largely unjustified) sense of security.
The proximate cause of the financial system's meltdown is not all that hard to grasp. The decades-long supremacy of the ideology euphemistically called "free trade" resulted in capital being unmoored from national economies and freed to move around the world with few limitations (under the imperative of government not "intervening" in markets). Unconstrained by borders and investment rules, those dollars, yen, euros and what have you roamed the planet seeking a better rate of return. Investors moved in packs, rushing lemming-like to whatever hot up-and-coming market the Economist was writing about in a given month, and a series of bubbles resulted.
Those bubbles made some people incredibly rich, and hurt others badly.
Of late, real estate was the can't-miss investment, and as enormously overvalued housing bubbles sprang up, notably in the United States, Wall Street's financial whizzes started offering newer and more "creative" investment vehicles, bundling mortgages and selling them off to investors from around the globe.
That was driven by an era of relentless deregulation, both at home and abroad. Here in the United States, the trend of deregulation culminated in 1999 with the death of the Glass-Steagall Act, the New Deal-era legislation that had forced financial institutions to choose between investment banking and commercial lending. Meanwhile, international bodies like the WTO and the IMF were pressuring the governments of all countries to drop their controls on the flow of cash and goods.
Without fear of a regulatory backlash, the banks pushed their new investments hard, and investors gobbled them up with glee. Writing in the Columbia Journalism Review, Dean Starkman cited reports from the business press about loan agents at Ameriquest being ordered to watch "Boiler Room," the film about sleazy financial brokers pushing bad investments on gullible retirees (Ameriquest was a predatory subprime lender that went down last year). Starkman quoted an executive with Morgan Stanley's mortgage unit as saying, "It was unbelievable. We almost couldn't produce enough to keep the appetite of the investors happy. More people wanted bonds than we could actually produce."
In the end, investors were basically buying up paper that had only a distant relationship with anything concrete. The link that had long existed between homeowners and lenders was broken, and debt -- in this case debt tied to housing, but also commercial and consumer debt -- became a hot investment vehicle.
Convinced that the market would continue to grow indefinitely -- or maybe that they'd get bailed out if things headed south -- investors leveraged their assets further and further, in effect buying on margin just like the bad old days before the Crash.
The banks and investment houses worked hard to find new ways to make their own pounds or rubles, creating not only new types of debt-based securities, but also coming up with new forms of insurance to (supposedly) shield investors against the risk those loans represented.
That was all well and good for them, if not for the rest of us, until the housing market started to tank. Despite assurances from the government earlier this year that the disaster had been "contained" to the subprime market, it began to spread. As the Associated Press reported, the tanking real estate market "shifted from subprime loans made to borrowers with poor credit to homeowners who had solid credit but took out exotic loans with ballooning monthly payments." Bloomberg reported that 3 million American homeowners are holding prime (or, actually, semi-prime) "alt-A" loans (don't ask) worth about $1 trillion, or $150 billion more than the entire outstanding subprime market.
As those loans -- many of which were taken on investment properties by people expecting a nice, quick turnover -- started to go belly-up, a panic ensued. As the rot spread, banks started going down and investors essentially began a stampede on an already weakened financial sector. It was the modern-day equivalent of a bank run, but on a global scale.
That posed a risk to the mammoth and wholly unregulated market in insurance on bad loans that had grown up around these new kinds of investments. The market in what are known as "credit default swaps" is of unknown size, but it's estimated to be worth as much as $60 trillion, most of it essentially paper backed by too little in the way of hard assets.
The government knew that if that market tanked, it could take down the global economy. That threat was, in large part, the thinking behind the $85 billion dollar bailout of AIG less than a week ago -- AIG was a key player in this huge but hazy market, and it did business with banks around the world.
At that point, a feeling of panic was spreading, and lawmakers in Washington felt that they had to do something, anything, to stop the meltdown. The banking sector's crisis threatens the entire economy, as the capital needed for new investment and expansion has begun to dry up. Jared Bernstein of the Economic Policy Institute told the New York Times that "Wall Street isn't this island to itself" and warned that if the finance sector "gets worse, we're going to be stuck in the doldrums for a very long time, because that directly blocks healthy economic activity."
Global Capitalism's Crises of Poverty and Overproduction
The financial meltdown in the United States is huge, but it isn't unique. Think of the Asian financial crisis, Mexico's "peso crisis" or the dot com crash. All had one thing in common: an investor class that at one time valued thrift, limited risk and steady growth plunged trillions with almost suicidal abandon into one bubble after the next.
All of which begs the question of what it is about our modern economic system that creates this cycle of inflating and bursting bubbles.
The answer, in large part, comes down to a decline in profitability in investments in concrete things, which has sent investors scurrying for abstract financial instruments in search of a fat return.
That shift, in turn, results from a simple aberration: a small fraction of the planet's population is tied to an economic system in which productivity is effectively an end unto itself. It makes tons and tons of widgets, always seeking new widget markets (and sucking up most of the planet's raw materials). At the same time, the powerhouses of the global economy -- the United States, Europe, Japan and the "Asian Tigers" -- have given woefully low priority to economic development in the rest of the world. They've essentially relegated it to NGOs and an underfunded United Nations, and in their own development funding they've prioritized geopolitics -- their "national interests" -- over poverty relief.
That's left much of the rest of the world's population (and this includes people in the wealthiest countries as well as the poorest) with barely enough money to feed their families, much less buy all those widgets. According to the UN, 80 percent of the people on the planet live on $10 dollars a day or less, and they're not going to take many flights on Boeing's shiny new airplane, buy GE's dishwashers or use Nortel's broadband. Over just the past two years, the number of people living on the "edge of emergency" -- in imminent danger of starvation or death from disease epidemics -- has doubled, zooming from 110 million people to 220 million, according to CARE International.
In other words, at the heart of the current crisis, like those that preceded it in recent years, is a massive imbalance inherent in the modern system of capitalism. It is caused by twin crises inherent in the structure of our global economy: a crisis of overproduction in the "core" states with advanced economies, and soul-crushing poverty in much of the "periphery."
In the booming years after World War II, the wealthy countries, led by the United States, did very well manufacturing goods for the entire planet. But as Europe and Japan rose from the ashes, and later, as production in countries like Taiwan, South Korea and Singapore increased, the industrial world simply started making more crap than there were consumers to purchase it.
Capitalism's tendency toward overproduction has been something with which thinkers dating back to Karl Marx have wrestled. If, as one definition holds, capitalism is all about maximizing efficiency, what happens when meaningful production becomes so efficient that the system ends up cranking out more goods than the population needs -- more than it can absorb?
The answer is simple. Since the middle of the last century, investors' returns on real production -- manufacturing -- has been in steady decline. Economist Robert Brenner described it as a "long downturn" in the world's most advanced economies. He noted that the seven leading industrial economies grew by a steady rate of 5 percent or more annually from the end of World War II through the 1960s, but in the 1970s that fell to 3.6 percent, and it has averaged around 3 percent since 1980.
The social critic Walden Bello has arguably been the clearest voice connecting the problem of overproduction to the rush of speculation that has led to today's financial crash. Bello noted that in the 1990s, the heyday of corporate globalization, the "U.S. computer industry's capacity was rising at 40 percent annually, far above projected increases in demand."
The world auto industry was selling just 74% of the 70.1 million cars it built each year. So much investment took place in global telecommunications infrastructure that traffic carried over fiber-optic networks was reported to be only 2.5 percent of capacity. Retailers suffered as well, with giants like K-Mart and Wal-Mart hit with a tremendous surfeit of floor capacity. There was, as economist Gary Shilling put it, an "oversupply of nearly everything."
A report in the Economist, cited by Bello, found that the world of Clinton's "New Economy" was "awash with excess capacity in computer chips, steel, cars, textiles and chemicals," and noted that "the gap between capacity and output was the largest since the Great Depression."
An inevitable result of that imbalance was a massive migration of capital from real, productive industry to the "speculative sector" run by financial giants like AIG and Lehman Brothers. As Bello noted:
So profitable was speculation that in addition to traditional activities like lending and dealing in equities and bonds, the '80s and '90s witnessed the development of ever more sophisticated financial instruments such as futures, swaps and options -- the so-called trade in derivatives, where profits came not from trading assets but from speculation on the expectations of the risk of underlying assets.
Exacerbated by a relentless assault on public interest regulation and economic nationalism under the guise of "free trade," the increasingly speculative tendencies of global investors created fertile ground for the growth of that pile of bad paper to which the Bush administration is reacting with its trademark brand of top-down reverse socialism.
In a nutshell, our modern economic system has become divorced from what an "economy" is supposed to do in human terms. It was anthropologist Karl Polanyi who argued that the term "economics" has both a formal meaning -- a system of exchange of goods and services designed to maximize efficiency -- and a "substantive" one: the survival strategy of humans in their natural environment. It's a concept that transcends conventional economic concepts of supply and demand, markets and states, and it's one that we've ignored for too long.
As the financial sector threatens to fall apart around us, it's important to understand the crisis on all of these levels, or we run the risk of losing sight of the forest for the trees. One has to keep in mind that this is all happening during the era of the $100-plus barrel of oil, with the global economy integrated more than ever before and during a period of deep environmental peril due to global climate change and related problems of drought and desertification.
With the Bush administration pumping more than a trillion dollars into the private sector, Jim Bunning, the junior senator from Kentucky, lamented that the "free market for all intents and purposes is dead in America." As more mainstream economists talk about the possibility of sliding into a full-blown depression, we may well be in the grip of a kind of economic "Grotian Moment." The term, named for the 17th century Dutch legal philosopher Hugo Grotius, describes an event that has such a great impact that it results in fundamental changes to the prevailing system.
Slavoj Zizek wrote that "One of the clearest lessons of the last few decades is that capitalism is indestructible. Marx compared it to a vampire, and one of the salient points of comparison now appears to be that vampires always rise up again after being stabbed to death." That's true; for a generation, we've been constrained from even discussing the fundamental structures of the prevailing system -- its excesses and shortfalls. This may be a moment in which we can do so, and should.
If we are at such a juncture, then we as a society have a serious question to answer: Will we bail out the speculator class so that it can regroup and move on to the next bubble, precipitating the next crisis of capitalism, or will we address the underlying problems of underdevelopment and overproduction in a way that's adequately sustainable in an era of serious environmental peril?
So far, Bush and the Congress appear to have the wrong answer.
Joshua Holland is an AlterNet staff writer.
© 2008 Independent Media Institute. All rights reserved.View this story online at: http://www.alternet.org/story/99703/

“Economic 9/11,”

With the September 15, 2008 “Economic 9/11,” Are We Facing Depression Like 1929?
© 2008 by Linda Moulton Howe

“This is a classic Titanic situation in the sense that what we saw with the Fannie and Freddie bailouts and the Bear Stearns bailouts and now the AIG request for more than forty billion more dollars from the federal government – it’s just like the Titanic where the rich and affluent were given the lifeboats and the rest of the people went under from steerage. The rich and powerful are too big to fail; the rest of us are too small to save.”- Gerald Celente, Editor and Publisher, The Trends Journal
“They (Republican Party) had begun to consider the Government of the United States as a mere appendage to their own affairs. We know now that Government by organized money is just as dangerous as Government by organized mob.” - Franklin Delano Roosevelt, 1936, quoted in The FDR Years © 1995 by William Leuchtenburg
Crowd at New York's American Union Bank during a bank runearly in the Great Depression that began in 1929. The bank opened in 1917,and went out of business on June 30, 1931. Image source Wikipedia.
Crowd at IndyMac Bank in Pasadena, California, on Friday, July 11, 2008, after the federal government took control in the second-largest bank failure in U. S. history. Financial experts predicted at least 50 to 100 bank failures in the United States after IndyMac Bank.

Updated 11:00 PM EDT September 17, 2008 - Dow closed 450 down today in continuing “Economic 9/11,” after Feds loan AIG $85 billion and oil and metals spiked upward. “Right now, citizens don't trust banks and bankers don't trust other bankers. The financial system is freezing up,” said a CNBC Business Network analyst.
Investors also considered a report on new home construction that showed that housing starts dipped to a 17-year low. Further, the FDIC website lists 11 bank failures in 2008 since April, the latest being Silver State Bank in Henderson, Nevada, on September 5, 2008. The Pasadena, California, IndyMac Bank FDIC takeover on July 11, 2008, was the second largest bank failure in American history.

September 15, 2008 Rhinebeck, New York - Back on December 21, 2007, I interviewed Gerald Celente, Editor and Publisher of The Trends Journal based in Rhinebeck, New York. Mr. Celente has been interviewed by network newscasters for years and his trend predictions are generally correct. Below is the December 21, 2007, Earthfiles Headline and report I filed.
Trends in 2008
© 2007 by Linda Moulton Howe
“In 2008, we’re going to see some major, giant financial firms fall as they get hit by an economic 9/11.” - Gerald Celente, The Trends Journal
Trends Research Institute, Rhinebeck, New York. Also see: 122107 Earthfiles “Trends in 2008.”
Today, September 15, 2008, I talked to him about his forecast for an “Economic 9/11” - ironically an interview on the same day, September 15, 2008, that Lehman Brothers declared bankruptcy, Merrill Lynch sold to Bank of America for $50 billion and AIG begged the federal government for a $40+ billion bailout. AIG is a huge insurance company doing business in 130 countries with a trillion dollar spreadsheet.
More falling financial dominos from banks to other companies are expected. Are we facing depression greater than the “Great Depression of 1929?” I took that question to Gerald Celente and began by asking him how he was so accurate back in December 2007?
Interview:
Economic 9/11
Gerald Celente, Editor and Publisher, The Trends Journal, Rhinebeck, New York
Gerald Celente, Editor and Publisher, The Trends Journal, Rhinebeck, New York:“Current events form future trends. If you saw the current events unfolding, you could have seen – if you looked at the data objectively – you could have seen where the future was headed. But what happens is that the business media keeps downplaying the seriousness of events. They are not looking at the real fundamentals of what is going on. They are stuck in their Wall Street and Washington worlds. They don’t see what is going on throughout society.
In 2007, our summer edition of The Trends Journal, we warned that between July and November 2007, we would see a major financial crisis. That was the so-called ‘sub-prime’ crisis. What people needed to understand that they would not understand was that it wasn’t only the little people who caused those problems by taking out mortgages they could not pay off. That was only a small part of it. The big part of it was that all of these leverage buyout firms, all of the commercial real estate people, all of the developers that were building on speculation.
You had companies in New York, for example, like The New York Times reported of one that had about $60 million that they leveraged into $60 billion worth of real estate. Look at all the buyout firms such as The Blackstone Group, Carlisle Real Estate, Carlyle Group, Cerberus that bought Chrysler and Hilton. It’s not like these guys put up a billion dollars each and twenty of them bought a company. They bought these companies with no money down based on leverage.
Then there all the financial manipulations: auction-raised securities, Compulsory Purchase Orders (CPOs), Structured Investment Vehicles (SIVs). I mean they make up this stuff and it’s really a Ponzi scheme.
[ Editor’s Note: Wikipedia – “A Ponzi scheme was named after Charles Ponzi, who emigrated from Italy to the United States in 1903 and became notorious for the following scam. A Ponzi scheme is a fraudulent investment operation that involves promising or paying abnormally high returns (alleged profits) to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business. A Ponzi scheme usually offers abnormally high short-term returns in order to entice new investors. The high returns that a Ponzi scheme advertises (and pays) require an ever-increasing flow of money from investors in order to keep the scheme going. The system is doomed to collapse because there are little or no underlying earnings from the money received by the promoter. However, the scheme is often interrupted by legal authorities before it collapses, because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases.”]

It was all collapsing in front of us, but people did not want to believe it. We saw it coming. The top story in our Top 10 Trends of 2008 was the Panic of 2008 and Economic 9/11. We were precisely one week off in calling this the Economic 9/11 (September 11, 2008 was the seventh anniversary of the World Trade Center attacks). And it’s happened! This is the Economic 9/11. The Federal Reserve, the federal government, cannot save the day.

A Great 2008-2009 Depression? “The Feds cannot print enough money to save the day. We’re going into the worst depression that any living person has ever seen. It’s going to be worse than the Great Depression of 1929.”
Do you realize that Barack Obama recently said that he would not rescind the Bush tax cuts. He said this on ABC, September 7, 2008, IF the economy were in a recession. IF the economy is in RECESSION?! This is worse than a recession! We’re going into the greatest depression and people better beware.
I’ll tell you what I know other people are doing. They are taking their money out of the banks. People with a lot of money are moving it overseas into what they think are safer banks. There’s going to be a day here in the United States that the authorities are going to call a Bank Holiday. AIG is calling for more than $40 billion today. The Feds just bailed out Freddie Mac and Fannie Mac to the tune that could cost taxpayers up to $300 billion or more. Our national debt has been increased to at least $12 TRILLION! The Feds cannot print enough money to save the day.
So, we believe what the government is going to do is call a ‘bank holiday.’ You’re going to hear all those fat mouths out there that were saying that everything was OK, the FDIC was going to insure your money. But, Linda, no one is going to be able to get it out all at once. Just like they did in Argentina and they did it in Brazil when their economies collapsed and their currencies collapsed and their economies were sinking. You’re not going to be able to get all your money out at one time. Our government is going to say, ‘It’s insured. Don’t worry about it, but we need to pause. Take a deep breath.’ Oh, boy, do they love that phrase! ‘Take a deep breath.’
Take a look at this last Saturday’s (September 13, 2008) New York Times. The headlines story on the business page is to just pause and reflect. Don’t panic. Everything is OK. The ship is sinking and the best they can say is, ‘Doesn’t the band sound great!’

Implications for Future
WITH EVERYONE RUNNING TO TREASURIES AND INTERNATIONAL MARKETS ON SEPTEMBER 15, 2008, WHAT IS THE BOTTOM LINE TO THE IMPLICATION OF WHAT IS HAPPENING NOW?
We’re going into the worst depression that any living person has ever seen. It’s going to be worse than the Great Depression of 1929 and I’ll give you a some reasons why.
1) In the 1929 Depression, not many people owned homes, so they weren’t carrying that heavy mortgage load. The people who did have homes did not have something called ‘home equity loans,’ which is more money owed on top of the other money. They used to have something else back then called a ‘second mortgage.’ If you had one, you were a loser.
2) Back in the 1929 Depression days, people didn’t have things called ‘credit cards.’
3) The United States didn’t have $14 trillion worth of debt.
4) We still had a manufacturing base in the United States so that when WWII broke out and the economy improved afterwards, we were still able to produce more so than any other country in the world. But now, the U. S. off-shores so much manufacturing now.
5) Back in the Great Depression of 1929, the U. S. government was not $14 trillion in debt and they had a trade surplus, not a trade deficit.
6) We weren’t fighting two wars that have sapped already $2 trillion from our American treasury and it’s getting worse.

“Dragflation”
So, we’re going into a downturn as America is sinking. This is ‘dragflation,’ a term that we at The Trends Journal have coined. When you had stagflation you had a declining and stagnate economy; you had rising inflation. But you also had rising wages. People remember back in the 1970s, they got a 10% cost-of-living increase in our wages.
Now wages are declining, you’re lucky to have a job, the median American household income is below 1999 levels. So we’re in for a devastating crash and people are not prepared for it.

2008's Weak American Dollar
THE TOTAL AMOUNT OF GOLD BULLION IN THE UNITED STATES IN THE FEDERAL RESERVE AND AT FORT KNOX IS ONLY IN A FEW BILLION DOLLARS IF TRANSLATED INTO CURRENT MARKET VALUE. WITH A $14 TRILLION DEBT IN THE UNITED STATES, IT MEANS THAT THE DOLLAR IS NOT BACKED UP BY MUCH.
You’ve got it and it’s not only the dollar we are going to see problems with. We’re going to see all the paper currencies experience the same kind of problems. You’re looking at a global market unraveling. The Russian stock market is down almost 45% from the beginning of 2008. The Chinese and Indian are all down 40% to 50% from their highs. We’re going through a global crisis. We’ve been talking about this for a long time. I was just the keynote speaker at the International Diamond Conference in New York at the Waldorf Astoria on September 8. This is what we at The Trends Journal warned: the United States is going to go into a depression and the rest of the world into different levels of deep recession and depression.
If you look at the markets today, what’s going up and what’s going down? The softer commodities are retreating and the only thing going up in the markets today is gold. It’s coming off its lows where it’s been battered down, but it’s up some $17. We’re still firm believers that gold and diamonds and other precious gems and metals are going to be the things to invest in as the paper currencies collapse. There are no fiscal or monetary tools that can turn this around.
What people I know are doing is taking their money and putting it into other currencies, particularly the Swiss franc, and putting it into more secure international banks, and betting against America on every level. And we know it is only going to get worse. There is nothing to turn this around. What is the Federal Reserve going to do? Print more money?
On September 16, the Federal Reserve is going to decide whether or not to raise or lower interest rates. If they lower interest rates, you’re going to see the dollar plummet. If they keep interest rates the same, then we have the same situation we’re in now. They can’t raise interest rates. If they do, they will put the brakes on an already credit-squeezed economy and that will really push us into a really steep depression quicker than what we have seen. Looking across Europe, you can see the markets collapsing, along with the Russian market down 45%. There is no safety net. Ships do sink!
We like the Swiss franc because Switzerland always seems to survive at the worst of times, including back to World War II. But the Swiss banks are having problems, too. So, you have to be careful about which banks you put your money into. But what we’re saying is that people we know are hedging their bets by keeping some money in dollars and some money in Swiss francs, some money in Euros, so that if one goes down, others are up. So, you are preserving wealth. That’s the game right now. It’s not about making more money. It’s about preserving what you have.

Global Economic Depression?
In China, factory orders are plummeting. They have 1.2 billion people and millions of problems. So, they are not going to escape this global economic collapse either. There is no way out.
Remember the old fable about the grasshopper and the ant. The grasshopper played during the summer thinking it didn’t have to do anything to survive the cold winter coming. People are still acting like grasshoppers. What people are saying is, ‘I’m going to wait until after the elections to see what happens.’ To see what happens for what? The people running for office don’t have the economic skills.
AND WHOEVER IS ELECTED IN NOVEMBER 2008 IS INHERITING THE $14 TRILLION IN DEBT.
On top of that, government, corporate and private debt is over 200 times the gross domestic product, much worse than the Great Depression of 1929.
And Greenspan was saying as recently as May 2008 that the worst was behind us. So, too, was Hank Paulson, the U. S. Treasury Secretary. So, too, was the head of Lehman Brothers, Merrill Lynch and J. P. Morgan. They were all saying that the credit crisis was not as bad as it was because of the great bailouts of Countrywide and Bear Stearns. So, they were singing a different tune than now.
Never before have current events been so clear in front of us that spelled disaster. What is stopping people from admitting that the worst is yet to come and there are no plans to save it? This is a classic Titanic situation in the sense that what we saw with the Fannie and Freddie bailouts and the Bear Stearns bailouts and now the AIG request for $40 more billion from the federal government – it’s just like the Titanic where the rich and affluent were given the lifeboats and the rest of the people went under from steerage. The rich and powerful are too big to fail; the rest of us are too small to save. When we need to be saved, the government saves us with Katrina-quality rescue plans, which means that we drown.

United States Conditions in 2009?
“This Christmas 2008, you’re going to see major chains go bankrupt. If you can see Lehman Brothers go under – guess what? Macy’s, J. C. Penny, GAP and the rest of them could go down, too.”
IF THIS IS WORSE THAN THE GREAT DEPRESSION OF 1929, COULD YOU LAY OUT WHAT YOU EXPECT TO SEE HAPPEN OVER THE REST OF 2008 AND TO FALL 2009?
Let’s take retail sales, for example. This Christmas 2008, you’re going to see major chains go bankrupt. If you can see Lehman Brothers go under – guess what? Macy’s, J. C. Penny, GAP and the rest of them could go down, too.
All these companies, like the leverage buyout firms, have been built on an economic model of growth and expansion. That means opening new stores in new locations, but not necessarily increasing in store sales. You’re going to see major bankruptcies. We forecast this before. It’s going to happen.
You’re also going to see violence go to levels we’ve never seen before. You’re going to start to see gangland mentality that is running through Mexico start seeping up north into the United States. The Mexican government cannot control the level of violence. And we’re going to start to see it happening here: more gangs, more kidnappings, more violence and crime. The knee jerk reaction, of course, will be more police on the streets and that is not going to solve the problem.
We’re also going to see more movements for the break up of the American government – not necessarily in 2008, but we can certainly see the secessionist movements that have been gaining more strength because the federal government cannot fix this problem. It’s too big.

Alan Greenspan - Is Former Fed Chief Cause of Financial Dominoes Falling?
Greenspan is the guy that’s behind this whole collapse. By lowering interest rates during the dotcom bubble of 2000. They lowered the interest rates to 46-year-lows and created the situation that exists now for all this cheap money and all the financial games. Greenspan is the Prince of Destruction. The Federal Reserve is what is behind the destruction of this country and now Greenspan is warning us! He’s the one who caused all this!
Ron Paul (former candidate in 2008 presidential primary) has informed the people that the Federal Reserve is basically a rogue organization. It’s a private bank, it’s not a federal agency. They have taken the power of the money printing press out of the hands of Congress (Article 1, Section 8, Clause 5) that gives Congress the sole authority to print and regulate the money supply. And Alan Greenspan is the one that caused this Great Depression. He started it by bailing out the big guys following the 1987 Stock Market Crash, following the 1997 Asian currency crisis, following the 1998 long-term capital management bailout. I had an Op Ed piece in The New York Times in 1998 that I called ‘Capitalism for Cowards.’ This is what keeps happening – bailing out the big guys by printing cheap money because their friends are too big to fail.
WHAT HAPPENS THIS TIME IF THE UNITED STATES DOES NOT BAIL OUT AIG AND GIVE THEM THE $40 BILLION THEY ARE ASKING FOR?
It’s not going to make any difference whether they bail them out or not.
BUT IT’S IN MORE THAN 130 COUNTRIES WITH A TRILLION DOLLAR BALANCE SHEET.
Yes, but there are other huge ones that are going to be collapsing right along with it. What is going to happen when Blackstone goes under? Or Ceberus goes under? Or the Carlyle Group goes under? We’ve already eliminated the big names of Lehman Brothers and Merrill Lynch. Merrill Lynch was the nation’s largest brokerage firm and they were just gobbled up by Bank of America that was just gobbled up by the failing Countrywide. Who is going to bail out them? There is not enough money to bail them out. Where is the money going to come from? Americans are working two or three jobs already. Do you think they could do four jobs to bail these big people out? Impossible! We’re looking at the collapse of Empire America.
The 9/11 attack happened and it was the greatest military strike in history, much greater than the Trojan Horse. It brought down the financial pillars of the United States figuratively and literally.
The United States as not recuperated from the great strike of 9/11 and the debacle of the dotcom crash. It was temporarily ameliorated by Greenspan by putting interest rates at 46-year-lows and creating the credit bubble. So, it’s over now.
The United States looks like to me what you see when a third world country starts going into chaos like any other failing empire. It’s going to be a very ugly scene. As I said, we’re going to see more crime. We’re going to see more federal intrusion into our lives. We are going to see more geopolitical turmoil. We’re going to start seeing our minds diverted from the financial crisis into more geopolitical affairs. We can also see by Election Day 2008 that the United States is involved in a major geopolitical confrontation, whether it is Iran or Russia.

Geopolitical Tensions Add to Dominoes Falling?
You know, the Russians are really angry at America right now because of Georgia invading South Oscettia and Russia’s response. Since then the Russian stock market has collapsed 45% and Russians are blaming the United States. We’re going to see a lot of dirty dealing going on in a lot of different markets in a lot of different ways.
[ Editor’s Note: Wikipedia – “The 2008 South Ossetia War was a land, air and sea war fought between Georgia, on one side, and the separatist regions, South Ossetia and Abkhazia, and the Russian Federation, on the other. The Ossetians are an Iranian people whose ethnogenesis lies along the Don River. They came to the Caucasus after being driven out of their homeland in the Mongol invasions of the 13th century. Most clans settled in the territories today known as North Ossetia-Alania (currently part of Russia) and South Ossetia (currently northern part of Georgia).]

RUSSIA'S PUTIN WANTS TO BOTH EMBARRASS AND HURT THE UNITED STATES, SO THE NEXT STEP MIGHT BE WHAT BETWEEN RUSSIA AND THE U. S.?
We’re looking to the winter. People have to understand other cultures look at things in a different way than our knee jerk reactionary responses in the United States. Start watching the gas spicket being turned going into the Ukraine and Europe. I’m not certain of the number, but I believe it is 40% to 60% of the natural gas that Europe uses comes out of Russia. You’re going to start seeing Russia turn off spickets. You’re going to see the same thing happen in Venezuela. Those countries are going to start making energy really difficult to get. They aren’t going to give their product away. At the end of the day, Russia and Venezuela are going to get more money for their petroleum products.
DOES THE U. S. HAVE ANY LEVERAGE WITH ANYONE NOW?
The U. S. has no leverage with anybody now. We’re leveraged out. We used to be able to play the financial card. We can’t play that anymore. We used to play the military card. We can’t play that anymore. The United States is losing third world street fights in Afghanistan and Iraq. I don’t care about people telling me the surge is working. That is fairy tale language. As soon as there is a little rest, they are going to attack again. There were major bombings again this last week and they are not going to stop until the United States is thrown out. So, now you have all these countries that have weapons of mass destruction. They are not going to bow to America. It’s not like the old days of Venezuela or Chile or Argentina or Bolivia getting out of hand and the United States sends down gunboat diplomacy.
They are going to fight back and not with bows and arrows and little weaponry. They are armed to the teeth. So, the U. S. has lost its military supremacy and its economic supremacy. Yes, the United States could obliterate any country and bomb them into the Stone Age. But that country, what’s left of it, will retaliate again.
There is still a hole in the ground after the 9/11 attacks. That’s a metaphor. If anybody thinks the American government has the wherewithal, the intelligence or the integrity to get anything done, there is still a hole in the ground seven years later, there are still levees that have not been properly re-built after Katrina and people still can’t vote in the United States and have their vote properly counted because the voting machines don’t work. That’s America now.
IS IT IRONIC THAT BECAUSE OF WHAT HAS HAPPENED IN AMERICA, THE ENTIRE GLOBAL ECONOMY IS BEING DRAGGED DOWN AT THE SAME TIME?
It’s ironic in the fact that the international community bought into the same myths as everyone else. It’s greed that ruined this country and it’s greed that is ruining others. They all played the quick money game.
Another irony is that people could thrive in these times because as the old is dying, something new is being born. If there is intelligence, integrity and dignity behind the next movement, we could move into a new Renaissance, a brighter time and not a dark one.
HOW LONG DO YOU THINK IT WOULD TAKE TO GET OUT OF A DEPRESSION?
As long as it took 1929 and that was a war. And unfortunately, that’s the way authorities will start thinking. The only thing more I can say for this country is that the American people need to regain their dignity and look at their own moral base and what they are accepting as truth and lies. The only thing that will save us is enlightened leadership. I think it has to come from the individual and move up.
And unless people change the way they are living their lives, nothing is going to change. These people, Obama, McCain, Biden and Palin aren’t my leaders. They couldn’t lead me across the street! When are the American people find their own strength and become their own leaders? Until individual people find their own greatness within, nothing is going to change.
To everybody out there, make provisions now like the ant did for a cold, brutal winter wherever you live. Things are going to get very tough. Don’t waste a dime you don’t need to waste. Buy local and support your local community. Start by doing everything locally to preserve and save.”
More Information:
For further reports about trends research, please see other reports below in the Earthfiles Archive:
• 12/21/2006 — Top Trends for 2007 by Gerald Celente• 02/03/2006 — Trends 2006• 12/31/2000 — Top Trends 2001• 01/02/2000 — New Trends for 21st Century• 01/03/1999 — Trends in 1999 with Gerald Celente

The Point of No Return

Harry Reid: "No One Knows What to Do"
The Point of No Return
By MIKE WHITNEY
Following another erratic day of trading on the stock market, Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke convened an emergency meeting of the Senate Banking Committee and other congressional leaders to request fast-track authority for a sweeping plan to buy back illiquid assets and other complex securities from distressed and under-capitalized banks. The turbulence in the financial markets has intensified and there is every indication that the situation will get worse before it gets better.
There are a number of signs that the financial system is at the brink of collapse and that Wall Street is headed for a 1929-type crash. Depositors have begun to withdrawal their savings from money market funds alarmed by the gyrations in the market and the daily deluge of bad economic news. According to the Washington Post, funds dropped "by at least $79 billion, or about 2.6 per cent" on Wednesday alone. The withdrawals are the equivalent of a slow bank run just at the time when stressed commercial banks need access to cheap capital to finance daily operations and provide loans for a steadily weakening economy. There's also been a surge of panic-buying of US Treasurys which is considered the safest of investments. According to the Wall Street Journal, during Wednesday's market-rout, "investors were willing to pay more for one-month Treasurys than they could expect to get back when the bonds matured. Some investors, in essence, had decided that a small but known loss was better than the uncertainty connected to any other type of investment. That's never happened before." (Wall Street Journal) Also, the VIX, or "fear gauge", has soared to levels not seen since the crisis began in August just over a year ago.
On Tuesday, interbank lending rates spiked upwards causing banks to abruptly stop lending to each other. When banks stop lending to each other, they cannot perform their primary function of transmitting credit to consumers and businesses, and the economy shuts down. That is why the Fed and other members of the western banking cartel made a surprise announcement at 3 AM (EST) Wednesday morning.
From the Fed:
"Today, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank are announcing coordinated measures designed to address the continued elevated pressures in U.S. dollar short-term funding markets. These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets....The Federal Open Market Committee has authorized a $180 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide dollar funding for both term and overnight liquidity operations by the other central banks."
Before the end of the day, the Fed had quadrupled the amount of dollars (to $247 billion) that central banks around the world could access in an effort to loosen up trading between the banks and resume lending to loan applicants and businesses. According to Bloomberg: "The Fed will spray dollars around the world via swap lines with other central banks. They can then auction them in their own markets." At first, the stock market reacted positively to the Fed's announcement, but by noon the market was 200 points down and losing altitude fast. It took another surprise announcement by the Treasury Dept -- of a massive government intervention to remove the bad loans and withering mortgage-backed securities from banks' balance sheets -- of to jolt the market out of its funk and send it climbing 410 points higher on the day.
Paulson's emergency session with Congress last night was characterized by lawmakers who attended as "chilling". The situation is much worse than government officials have let on so far. The resurrecting of the Resolution Trust Corporation (RTC) is a desperate attempt to address the banking systems troubles head-on by providing a taxpayer-funded clearinghouse for illiquid assets and toxic mortgage-related securities for which there is presently no market. The taxpayer is being asked to pay up to $1 trillion for the speculative excesses of Wall Street investment banks and their fraudulent securities scam. Homeowners who are likely to lose their homes through foreclosure will not benefit from Paulson's RTC. Both presidential candidates have already declared their support for the plan.
According to the New York Times: "Rumors about the Bush administration’s new stance swept through the stock markets Thursday afternoon. By the end of trading, the Dow Jones industrial average shot up 617 points from its low point in mid afternoon, the biggest surge in six years, and ended the day with a gain of 410 points or 3.9 percent."
If ever there was proof of Plunge Protection Team activity; Thursday's market is it. The market was sinking fast at midday even though the Fed just added nearly $250 billion in liquidity to the global system. Investors were buying short-term Treasurys in record numbers, the VIX "fear gauge" was soaring, money markets were collapsing, and the aftershocks from defaulting AIG and Lehman were still being felt around the world. Were investors really that eager to buy back battered investment bank stocks or was the PPT busy panic-buying up futures and forcing the market upwards 617 points?
Bloomberg News: "Options under consideration (by congress) include establishing an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corp. to insure investors in money-market funds, said two people briefed by congressional staff who spoke on condition of anonymity because the plans may change."
Not a dime of public money is provided for over-extended mortgage-owners trying to stay in their homes. Not one congressman or senator at Thursday's meeting rejected the bailout plan or called for a criminal investigation of to establish whether laws were broken in the sale of fraudulent securities which have clogged the global system; pushed banks, hedge funds, insurance companies and homeowners into default, and precipitated the greatest financial crisis in the nation's 230 year history.
Ironically, the very people who created this mess, are the ones who will decide how to resolve it; the Federal Reserve and the US Treasury. Where else, but Washington would such massive failure be rewarded with more power and authority.
The investment giants and the Federal Reserve are entirely responsible for the current meltdown. Currency deregulation brought foreign capital flooding into the equities and bond markets while the real economy suffered. Businesses were off-shored while good paying manufacturing jobs were moved overseas. Wall Street gorged itself on foreign capital while America was transformed into a nation of construction workers and service industry workers. Now those jobs are vanishing by the millions and unemployment lines are swelling.
The ratings agencies, prevaricating mortgage applicants, and appraisers all played a part, but it's Wall Street that's really to blame. They lobbied to deregulate the system so investment banks could merge with commercial banks and allow the world's biggest risk takers to have unrestricted access to the cheapest capital available; deposits. They even crafted a bogus ideology, "market fundamentalism"; touting trickle-down, free market, Voodoo economics that was entirely designed to further enrich the wealthy and savage the middle class. Earlier this week, former Senator Jack Kemp appeared at a whistle-stop with John McCain in Jacksonville, Florida. Kemp was one of the primary architects of "supply side" economics, the thoroughly discredited Reagan-era doctrine which has led us to our present economic catastrophe. Kemp's theories fit with Milton Friedman's "greed is good" Chicago School mumbo jumbo. Both Friedman and Kemp believe that what is good for the stock market is good for America, ignoring the shocking economic polarization that has divided the nation. Now, more and more people are beginning to see that Friedman was a charlatan who provided ideological cover for obscenely rich financiers and their dodgy investment scams.
Economist and author Henry Liu summed it up brilliantly in a recent article in the Asia Times:
"The collapse of market fundamentalism in economies everywhere is putting the Chicago School theology on trial. Its big lie has been exposed by facts on two levels. The Chicago Boys' claim that helping the rich will also help the poor is not only exposed as not true, it turns out that market fundamentalism hurts not only the poor and the powerless; it hurts everyone, rich and poor, albeit in different ways. When wages are kept low to fight inflation, the low-wage regime causes overcapacity through over investment from excess profit. And monetary easing under such conditions produces hyperinflation that hurts also the rich. The fruits of Friedman test are in - and they are all rotten."
Whatever headwinds the country now faces economically can be directly attributed to the inherently flawed ideology of market fundamentalism.
Tuesday's 449 point bloodbath on Wall Street is the beginning of an unavoidable market crash. Regardless of Paulson's plan, there's more pain on the way. According to Bloomberg: "More than $19 trillion has been wiped off global stock market value since a high on Oct. 31 as the worst U.S. housing recession since the Great Depression and a resulting global credit crisis slowed the world economy." All of the economic indicators point to greater losses. Once the system begins to deleverage, there's nothing anyone can do to stop it. Paulson can place himself in front of a market avalanche if he chooses, but it won't change the outcome. Market corrections are as inexorable as the force of gravity. That's why equity bubbles cannot be allowed to develop without interest rate intervention. Responsible action by the Central Bank could have prevented the present crisis.
On Wednesday, Forex.tv reported that the net long-term TIC flows came in below the consensus forecast, totaling $6.1 billion in July, while total TIC flows for the month fell to $74.8 billion, according to data released by the U.S. Treasury on Tuesday morning. Economists had been expecting net long-term flows to rise to $55.0 billion compared to the previous month's previously reported figure of $53.4 billion.
$6.1 billion does not meet the requirements of our current account deficit of $700 billion. The dollar is headed for a fall.
On Wednesday, New York Mayor Michael Bloomberg warned that the "next wave" of financial pain may come from overseas if foreign entities stop buying U.S. debt." It's not clear who's going to be buying our debt," said Bloomberg. "It may very well be that the next wave is going to come back and bite us."
The New York Times tells a similar story except this time about Asia:
"Asia’s savings have, in essence, bankrolled American spending for decades (but) Asian interest in American assets is wilting, a trend that seems to have started over the summer...Little-noticed data released by the Treasury Department on Tuesday showed that a sharp shift in international capital movements began in July. Private investors pulled a net $92.9 billion out of the United States, after putting $46.8 billion into American securities in June. ("Asia rethinks American Investments Amid Market Upheaval", Keith Bradsher, New York Times)
Foreign central banks and investors have turned off the tap. They can see that the US financial system is teetering and that the dollar is weakening. "The perceived risk of U.S. government debt, long held to be absent of any default risk, also climbed to a record yesterday as the government's involvement in bailing out financial markets weighed on its own balance sheet." (Bloomberg News) The "full faith and credit" of the United States government is slipping. US debt will be downgraded. Triple A is no longer guaranteed. America's stock just moved to Level 3 assets. The US is now a subprime economy on life support.
Presently, "there is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion." (Mish's Global Economic Trend Analysis)
$273.7 Billion is a paltry sum, insufficient to meet the needs of even a minor run on the banking system. The storm hasn't even touched ground yet in middle America, and already the system is buckling. 2009 will be bleak, indeed.
The battered and over-leveraged US financial system is facing its greatest challenge in the months ahead. The frantic search for capital has already begun, but with predictably disappointing results. Neither China nor the Saudi princes are buying any more failing investment banks. They'll leave that for the US taxpayer. What started off as a brilliant plan to pedal garbage mortgage-backed paper to gullible investors around the world has suddenly backfired and now threatens to bring the entire system crashing down and change the geopolitical power paradigm for the forseeable future.
On Monday night, Senate Majority Leader Harry Reid was briefed on the gravity of the situation in a secret meeting with the Treasury Secretary and Federal Reserve Chairman. Reid's remarks are the best summary yet of the events of the last 14 months. He said, ""We are in new territory, this is a different game...No one knows what to do."
Mike Whitney lives in Washington state. He can be reached at fergiewhitney@msn.com

How the Chicago Boys Wrecked the Economy

An Interview with Michael Hudson
How the Chicago Boys Wrecked the Economy
By MIKE WHITNEY

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.
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.
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).
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

Tail Wagging the Dog

March 27, 2008
Tail Wagging the Dogby Randy
The Fed is trying to consolidate its power base
March 27 (Bloomberg) -- America's financial system faces its biggest overhaul since the Great Depression as officials weigh lessons from the credit-market rout and the near collapse of Bear Stearns Cos.
Federal Reserve policy makers are redefining which companies are vital to the flow of credit, an area once the sole domain of commercial banks, and which institutions pose risks to the entire economy if they fail. Treasury Secretary Henry Paulson said in a speech yesterday that the Fed should broaden its oversight to include Wall Street investment firms, now regulated by the Securities and Exchange Commission.
Former regulators predict the changes will see the Fed accrue influence at the expense of the SEC, which was created by President Franklin Roosevelt to make rules for dealers and stock exchanges. The Fed is taking almost $30 billion in assets off Bear Stearns's balance sheet to encourage JPMorgan Chase & Co. to buy the firm, even though Bear's main supervisor is the SEC.
"This is tectonic," said Ralph Ferrara, a former general counsel at the SEC, and now a partner at Dewey & LeBoeuf LLP in Washington. "We no longer want to have a balkanized response to a national crisis."
My Thoughts:
The Federal Reserve, a private banking institution authorized by Congress to loan money created from nothing and charge interest for doing so, is already a powerful, rouge institution that operates without Congressional oversight. Should we now hand them more power?
The Fed's latest "unprecedented" act of lending of money directly to investment banks (swapping treasuries for valueless garbage) and their recent creation of the a) Term Auction Facility b) Term Securities Facility and c) Primary Dealer Credit Facility are all confirmation as to where their loyalties lie (not the people) -- and their mischievous, manipulative, rouge ways of supporting their brethren.
Additionally, the bailout of a private company (Bear Stearns) with US taxpayer money, without Congress's approval, is unfathomable -- Who is in control of these guys (shareholders? -- see my note towards bottom of post)
So, the question of the day: does the dog (our government) wag the tail (fed) or does the tail (fed) wag the dog (government)? I think the answer is crystal clear...
If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation,(i.e., the "business cycle") the banks and corporations that will grow up around them will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.
Thomas Jefferson, President of the United States 1801-1809
I believe that banking institutions are more dangerous to our liberties than standing armies.
Thomas Jefferson,1816
We have come to be one of the worst ruled, one of the most completely controlled and dominated, governments in the civilized world - no longer a government by free opinion,no longer a government by conviction and the vote of the majority, but a government by the opinion and the duress of small groups of dominant men.
Woodrow Wilson, President of the United States 1913-1921
(Note: Federal Reserve's controlling stock is owned by: Rothschild Banks of London and Berlin, Lazard Brothers Bank of Paris, Israel Moses Sieff Banks of Italy, Warburg Bank of Hamburg and Amsterdam, Lehman Brothers Bank of New York, Kuhn Loeb Bank of New York, Chase Manhattan Bank of New York and Goldman Sachs Bank of New York)
I think Dr. Schoon said it best in his latest, must read article: The Die Is Cast The Cast Will Die
"The banker's credit money system is now everywhere as are their resultant unsustainable debts; and those who profit by that system, the bankers (and the corporations that grew up around them) now control the media, the political process, and the agencies charged with overseeing and regulating the economy - the US Federal Reserve Bank, the SEC, the US Treasury, and indeed the US government itself: the Presidency, the Congress, and the Supreme Court."

Randycontrarian2day

Blame abounds for housing bust

Blame abounds for housing bust
December 26, 2007 By Patrice Hill - First of three parts This year's housing bust is shaping up to be one of historic proportions. Sales and construction have sunk to levels not seen since the 1990 savings and loan crisis, while foreclosures and price drops are the largest since the Great Depression — and expected to get worse next year. Many parallels can be seen with earlier housing debacles. Each episode had some combination of easy money, loose lending, greed and fraud that turned a housing boom into a speculative bubble. But few housing bubbles have ended so badly as the one today, when the nation is confronting the prospect of mass foreclosures and family dislocations. John Stumpf, president of Wells Fargo & Co., the second-largest U.S. mortgage lender and a survivor of the housing busts of the 20th century, blames today's crisis on unscrupulous lending practices, which joined in a toxic mix with outright greed and extraordinarily low interest rates to send house prices soaring 90 percent between 2000 and 2006. When the bubble burst, house prices collapsed by 5 percent to 20 percent in cities nationwide. "We have not seen a nationwide decline in housing like this since the Great Depression," Mr. Stumpf told investors in New York last month as major banks and securities firms reported an accumulated $80 billion of losses on their portfolios of mortgage investments and widely cut back on lending as a result. Now the country faces a vicious cycle: As house prices fall, homeowners lose equity in their homes, which makes it more difficult or impossible for them to sell or refinance. Many are not able to refinance their adjustable-rate loans when the starter interest rates expire and reset to reflect higher market rates, and so they are faced with sharply higher mortgage payments they cannot afford to pay. The dilemma has sent defaults and foreclosures to historic levels — with potentially millions more in train in the next two years as more than $1 trillion in mortgages reset nationwide. As homes are sold under pressure, prices drop further and cast a pall over entire neighborhoods, driving down the value of homes of even creditworthy Americans and undermining their biggest source of wealth and security. State and local governments also have been hit hard by the declining revenues from property taxes and real-estate transactions, and the housing slump is dragging down the manufacturing and construction sectors. The whole mess threatens to sink the broader economy the longer it wreaks havoc on consumer confidence and spending power. While Americans have grappled with ballooning mortgages and adjustable interest rates in the past, the epidemic of resetting loans today is unprecedented and is the result of a bewildering array of mortgage options for consumers that banks and securities firms developed and mass marketed for the first time this decade. Consumers often were given the option of not paying principal on their loans and even deferring some interest. Many seemed unaware of the consequences of postponing their obligations and chose to make only minimal payments during the first few months or years, backloading their loans so that the payments increased sharply and even doubled after the interest rates reset. The complexity of the loans was exceeded only by the complicated schemes banks developed to package the loans and market them to sophisticated investors, which involved setting up off-balance-sheet investment vehicles and slicing mortgage securities into segments that supposedly allocated the risk of default away from top-rated tiers to junk-rated bottom tiers. Mr. Stumpf, a 30-year industry veteran, said even he was surprised when he read newspaper articles about what some banks were doing. Wells Fargo avoided the riskiest practices and, as a result, is not suffering the major losses that are crippling top lenders such as Countrywide and Citigroup, though it, too, made some unwise investments in home-equity loans, Mr. Stumpf said. "It's interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine," he joked. Easy money While the unprecedented wave of creative and sometimes questionable loans was a key cause of the housing bubble and ensuing bust, lenders were aided greatly by the lenient policies set by the Federal Reserve from 2000 to 2004, economists say. The housing boom started in the wake of the technology-stock bubble that burst in 2000, which ushered in the 2001 recession and prompted the Fed to dramatically cut interest rates. Housing was just beginning to emerge from a long slumber in the 1990s, as it took much of the decade to recover slowly from the preceding housing bust of 1990-91. As the economy slumped and financial markets sank in the wake of the September 11, 2001, terrorist attacks, the Fed accelerated its rate cuts, adding fuel to the budding housing boom. By mid-2003, the Fed had driven interest rates to the lowest in a generation, with rates on 30-year fixed-rate loans falling to a 40-year low, around 5 percent. The even lower short-term rates set by the Fed drastically cut rates on adjustable-rate mortgages as well as borrowing costs for banks and Wall Street firms, enabling them to invent an array of new mortgage products with irresistibly low starter rates, which appealed to home buyers. While the Fed's actions under former Chairman Alan Greenspan were applauded at the time, many economists now blame the central bank for nurturing the housing bubble. "The Fed played an important role" by encouraging people to shift resources to real estate speculation, said Michael D. Larson, analyst with Weiss Research. "The Fed replaced one bubble, mostly confined to the technology sector, with another, far-larger bubble, encompassing most of the housing market." Mr. Greenspan forcefully rejects such accusations. He contends the housing bubble and credit bubble that accompanied it were worldwide phenomena. Moreover, he maintains the only way the Fed could have stopped the bubble was to have raised interest rates sharply, which would have not only deflated the bubble, but brought down the economy with it. Mr. Larson also blames global investors — including many international banks and hedge funds — for misjudging the risks of the securities. And Wall Street firms, by setting minimal standards on the loans and then securitizing them for sale to distant investors, also "removed, minimized and postponed the consequences of poor lending decisions," he said. Global investors were thirsty for the high returns on subprime and exotic mortgages that were packaged as "collateralized debt obligations," and they trusted the high ratings assigned to most of the debt by Wall Street ratings agencies Moody's Investors Service and Standard & Poor's Corp. The global market "stressed quantity over quality" on loans, making it "easier and more profitable" for mortgage brokers and banks to convince consumers to take inappropriate loans, Mr. Larson said. Loose lending With their low introductory monthly payments and easy terms, the loans were easy to sell to the public. In many ways, mortgage brokers followed the playbook of auto dealers, who swamped their showrooms with people on car-buying binges in 2002 and 2003 by advertising zero-interest loans on their cars. As they did with the car loans, many borrowers who acquired subprime and exotic mortgages with low starter rates rarely looked at the loan's overall costs or terms other than the initial monthly payments that were loudly trumpeted in ads and brochures. Loans with introductory rates as low as 1 percent made the obligations of owning expensive houses appear to be easy or manageable and had the effect of driving up home prices as buyers armed with such loans surged into the market and bid up prices. Home sellers found they were able to raise prices by thousands of dollars from one sale to the next with seemingly no resistance. Even the highest-priced homes at the height of the boom in 2005 and 2006 sold quickly, sometimes within minutes with multiple bids. The new-found wealth for homeowners was just as intoxicating as the easy-money loans that transformed millions of former renters, even those with shaky credit ratings, into proud homeowners. Consumers didn't need to sell their homes to cash in on the double-digit gains in their home values; they used home-equity loans and cash-out refinancings instead. Many people used their homes like ATMs, refinancing once or twice a year to take out equity and using the cash to buy cars, go on vacations and make down payments on second homes or investment properties. By 2005, nearly every homeowner in America had refinanced at least once. The cash-outs, which typically extracted $20,000 to $30,000 from home equity, were an elixir for both consumers and the economy, enabling homeowners to supplement stagnant incomes while stimulating consumer spending, the biggest source of economic growth. Loans came not only with minimal payments but often required no down payments or income documentation, enticing millions of people to jump into the market for second homes and investment properties. Coastal resorts and Sun Belt cities like Miami and Las Vegas became lucrative profit centers for "flippers" who weren't interested in owning properties but only wanted to make quick profits buying and selling them. Cable television offered 24-hour housing channels and TV shows demonstrating how anyone could become a "flipper," putting down as little as $5,000 on a condominium and then reselling at a profit before construction was even finished. Greed stokes craze By the height of the housing boom in late 2005 and early 2006, millions of people had been pulled into real-estate speculation, which had become the new "Internet craze," said Stefan Swanepoel, author of the Swanepoel Trends Report on housing. Tales of making quick money in housing became a hot topic at cocktail parties, while cab drivers offered housing tips. "Anything containing the words 'home or real estate' seemed to be as hot as anything with a dot-com during the late 1990s," Mr. Swanepoel said. "The consumers' hunger seemed to have no end," he said, noting that the buying frenzy was nurtured not only by "a plate full of new mortgages," but "bullish customer confidence" and steady employment and income gains. Thomas Martin, president of the National Mortgage Complaint Center, which has heard from hundreds of homeowners stuck with mortgages they can't afford, said the phenomenon of the housing bubble can be summed up in one word: "Greed." "It was a game of musical chairs," he said. "At some point, the music would stop, and someone would get left without a chair," he said, including the banks, homeowners and pension funds experiencing losses today. Besides the "greedy mortgage industry" and the "suicidal" loans they peddled, Mr. Martin blames regulators and legislators in Congress who were "all asleep at the switch with respect to ridiculous mortgage products." Regulators did not seriously clamp down on questionable lending practices until last week, when the Fed approved tough new rules for lenders nationwide, cracking down on dangerous practices like offering loans to subprime borrowers with no income documentation, often called "liar loans." Congress until this year was largely uncritical of the wave of questionable mortgages and sought only to nurture home sales by heaping more subsidies on the industry. One of the last acts of Congress before it adjourned in 2006 was to accede to the wishes of the mortgage industry by enacting a new tax deduction for mortgage insurance. "The housing boom was good politics, " Mr. Martin said, noting the housing and lending industries are among the biggest campaign contributors to legislators. Moreover, Congress since the 1990s has pushed lenders to offer more credit to blacks, Hispanics and other minorities — a drive that led to an explosion of subprime mortgages that went disproportionately to minorities during the housing boom. The "democratization" of mortgage credit appeared to be a shining success until this year, when the subprime crisis emerged and precipitated a much broader credit crunch and retrenchment from loose lending practices. Widespread fraud also fed the crisis, Mr. Martin said, particularly the inflating of house assessments by appraisers under pressure from mortgage brokers, developers and real-estate agents eager to make sales at ever-higher prices. "The combination of blackmailing real-estate appraisers into inflated valuations, combined with insane mortgage products, creates the perfect storm for a real-estate disaster that could be our nation's most costly real-estate meltdown in history," he said. The Fed moved to ban such coerced appraisals as well as the "liar loans" that were the most widespread fraud perpetuated by individual borrowers. The FBI is pursuing 1,000 cases of mortgage fraud and estimates there were close to 36,000 instances of fraud nationwide. States' attorneys general also are pursuing hundreds of cases. In one notable case, New York Attorney General Andrew M. Cuomo is investigating reputed appraisal fraud in deals done by Washington Mutual, the largest savings and loan in the country and an aggressive marketer of subprime and exotic loans. Back to basics As the sordid tales of tainted loans and gigantic losses emerged this year, borrowers and lenders have returned to the basic practices that once made the U.S. mortgage market one of the safest investment havens on earth. Traditional 30-year, fixed-rate mortgages are back in style, with borrowers now shunning exotic mortgages such as "option ARMs" that they snapped up during the housing craze. Lenders require higher credit scores, larger down payments and bigger fees to cover their losses. To securitize the loans, banks are turning again to the federal lending agencies — Fannie Mae, Freddie Mac and Ginnie Mae — which had fallen out of favor and lost market share during the housing boom. While agency-sponsored loans constituted only 45 percent of the mortgage market in 2005 and 2006, they surged to 72 percent of the market this year. Subprime borrowers now are applying for help from the Federal Housing Administration, the federal home insurer created during the Great Depression to address that earlier housing crisis. The housing saga is far from over, many analysts say. With millions more mortgages resetting in the next two years, many more people could lose their homes. Banks, securities firms and investors could foot another $300 billion in losses, by some estimates. If consumers are daunted by bleak housing news and their loss of wealth and spending power, they could capitulate and send the economy into a recession, economists say. Already, consumer borrowing for home purchases and cash-out refinancings has plummeted from a $1.2 trillion annual rate in the first quarter of 2007 to $691 billion in the last quarter, according to Fed figures. David A. Levy of the Levy Forecasting Center said he expects the economy to muddle through, despite the Ponzi finance schemes that led to the housing collapse, and despite further drops in housing prices that could accumulate to 30 percent or more nationwide. "So far, the housing decline has occurred prior to serious weakness elsewhere in the economy," and that has prevented the problems from being even worse, Mr. Levy said.

The Unintended Consequences of the Housing Bubble Bursting

The Unintended Consequences of the Housing Bubble Bursting (December 10, 2007) As the housing bubble pops with a reverberating shockwave heard round the world, we can be sure the players who inflated it did not intend or anticipate the ramifications now unfolding. Just as the teenagers racing down the cliffside highway with bellies full of alcoholic beverages did not intend to lose control of their vehicle and plunge off the cliff to their deaths, the mortgage brokers, investment bankers and their partners-in-fraud, the rating agencies, did not really intend to bring down the entire economy. Yet this is indeed the "unintended consequence" of the housing bust. Let's consider two "unintended consequences" which are emerging as the housing and mortgage-derivative markets break through the safety barrier and descend in a slow-motion cliff-dive. 1. As risk is "re-priced" higher, the cost of borrowing will rise. Frequent contributor Albert T. explains:
The problem with the bailout is that it devalues money by diluting the weighted average of money outstanding through bailing out people/firms whom shouldn't have got it. Ergo, stupid banks who took stupid risks and stupid borrowers. While we won't notice it right away, when the rate freeze is in effect in actuality it will reprice all new risk with a higher implied rate to compensate for the future freeze possibility, hence we will all pay higher rates to subsidize the current "crack addicts". (emphasis added-CHS) Once this happens two things will occur: five years from now instead of losing 30% on the loan, the bank will lose 70% except that 70% will be insured by the gov't as a thank you for the freeze. Hence we will have the doubling of our money supply on loans that weren't supposed to create it. In effect the gov't will allow banks to print money in the future to make up for the loss today. Albert sent in this link Homeowner bailout is a lousy idea (John Markman, MSM Money) and called attention to the following excerpt as evidence of another kind of risk repricing is already underway:
"Indeed, everywhere you look now is evidence that the subprime-debt crisis is morphing and expanding like a creature in a horror movie. Just this week, we learned from hearings in Congress that strapped credit card companies such as Capital One Financial (COF) and Bank of America (BAC) had begun to soak customers by jacking up interest rates on balances for the slightest changes in their credit profiles." "If you so much as apply for a new credit card, according to testimony gathered at the hearing, your current card provider can boost your rates as high as 30% per year." In other words: since lenders now know the government may "freeze" the rates they've charged customers, they'll be re-pricing those rates higher to compensate for that possibility. If the government might step in and freeze the rates I am charging my customers, then it behooves me to raise rates on all customers now, not just the riskiest ones because, well, it's not longer a "risk-free world." The government might freeze all interest rates, or "low-risk customers" might soon become "poor-risk." How does this re-pricing hurt the economy? Since borrowing is the grease which lubricates the entire economy, re-pricing risk means higher borrowing costs for everyone-- regardless of Fed-Speak or the Fed dropping the Fed Funds Rate. This chart reveals how the ratio of mortgage debt to disposable income has risen far above the last housing bubble top in 1990. Simply put: people are spending more on debt service and this has reduced their remaining disposable income. The rubber band of debt service has already been stretched to extremes unseen in 30 years; so the question becomes, how much more can the rubber band be stretched before it snaps? Just to refresh our awareness of how critical debt/borrowing is to our current "prosperity," take a look at this chart: 2. As non-U.S. investors realize they have been handed hundreds of billions in losses, they will be wary of buying more U.S. debt. We are already hearing that the market for SIVs, CDOs and MBS (mortgage backes securities) is dead, over, gone, dried up, history. And just to refresh our awareness of how debt-based derivatives like CDOs and credit swaps have grown, look at this chart: How dependent is the U.S. on foreign/non-U.S. buyers of debt? Very. The standard number tossed around is the U.S. needs to offload $2 billion a day onto non-U.S. investors just to keep the U.S. debt/borrowing/spending machine humming. But now, as this article from the San Francisco Chronicle details, we have ripped off our non-U.S. investor friends and are busily shredding all evidence of fraud --even though we all know every step of the housing bubble, from appraisals to mortgage funding to securitizing of the mortgages to the rating agencies' "AAA stanp of approval" on those securitized loans was riddled with "wink-wink-nudge-nudge" fraud: MORTGAGE MELTDOWN Interest rate 'freeze' - the real story is fraud
But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense. The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth. The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process. And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it. I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse." I can hear it all now--as no doubt you can, too. The non-U.S. pension or township or sovereign fund, realizing its supposedly "safe" U.S.-based investments are now worth 50% or 20% or perhaps 0% of the purchase price, now go to New York and hire a razor-sharp law firm to force the investment bank which sold them the garbage to buy it back, based on the fraud which permeates the entire pool of mortgages and debt. But oh my gosh, we didn't know it was fraudulent. Proving fraud, after all the emails have been deleted and the hard-drives crushed and the paper trails shredded will be very difficult, indeed. The "innocent" bankers will point to the rating agencies like Moodys, who will point to the mortgage underwriters and brokers, who will point to the originators and the appraisers, who will promptly declare bankruptcy or point to the realtors who forced them to support inflated valuations. And after all the attorneys' fees have been deducted from the paltry settlements reached years from now, there will be pennies left for the non-U.S. investors. We all know how this works because we've seen the play before in the aftermath of the dot-com debacle: investors lose $200 million due to fraud, the company settles for $11 million, the attorneys take $5 million for their work and the investors get a whopping 3% compensation. So how does this massive, seamless, trillion-dollar fraud hurt the U.S. economy? Just ask what happens when non-U.S. players tire of getting ripped off or become wary of "AAA low-risk" U.S.-based debt. What happens is this: when non-U.S. buyers of new debt vanish, then the great debt-churn-spending machine that is the U.S. economy grinds to a halt--or at least loses $700 billion a year in non-U.S. funding. Anyone who is an investor (as opposed to a "pusher" who needs to "fund the junkie's habit" so he can afford to buy more "product", i.e. the central banks of China and Japan) will turn away from U.S. debt (other than Treasuries) in complete disgust. Ask yourself this: if a national government might arbitrarily "freeze" or lower the interest rate being paid on a security, thereby lessening its value, how anxious are you to buy more of that nation's debt? If you do, you'll want a hefty risk-premium to compensate you for the unknown risks that the government will gerrymander your return in order to placate their banker buddies and restive domestic voters. Bottom line: as risk rises, so do borrowing costs. As non-U.S. investors shun new U.S. commercial and mortgage debt, those markets dry up. Since debt can no longer be sold to unwary non-U.S. "marks" (suckers), then who's left to fund $5 trillion in new mortgages? Essentially bankrupt U.S. banks? Negative-equity U.S. households? Negative savings rates Americans? If this sounds bleak, please consider this chart: