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Thursday, October 16, 2008

Borrowing our way to bigger bailouts

We’re nearing the end of an eight-year process of government enlargement. Our federal deficit has doubled, going from about $5 trillion to over $10 trillion. Two very expensive wars have increased expenditures radically. Wars--particularly endless police actions-- are no tool of fiscal conservatism.

Talking before a New Hampshire crowd yesterday, Sarah Palin tried to differentiate herself and John McCain from the previous eight years. I would have thought for sure that Palin and McCain were running against a Democratic incumbent, had I not known that their agenda had been to distance themselves from Bush.

Fiscally, Bush has been more of a liberal than conservative. Neo-conservatives espouse a blend of “free market” capitalism, ultranationalism, and socially conservative values. Traditionally conservative political values like fiscal conservatism and small government have been abandoned.

Bush and crew have also become the ultimate Washington insiders. I’d define the insiders as those who profit from their closeness to the political hierarchy. Insiders are also distinguishable by the unerring adherence to what is known as the Washington consensus--a set of assumptions about how to govern a world that revolves around Washington, D.C..

Corporate control

As a result of incessant lobbying, the Washington culture has become thoroughly corrupt. The hubris of the insiders who run and/or profit by the political system has been fed by corporate donations which vie for influence over the legislative process and seek to influence the regulatory framework.

Nowhere has the corporatization of our society been more apparent than with the media. Under the direction of the FCC, media power has been consolidated since 9/11, which has crushed the independent voice of the media, democracy’s crucial fourth estate.

Bush’s legacy will be one far bigger than bad government, or larger government, or betrayal of his conservative credentials. Corporations have risen to control Washington’s authority.

Our federal government has strangled itself. The Founders did create our three party system of government in order to balance the interests of one group against the other. Since the birth of the Unitary Executive, the Presidency has become by far the more powerful, and the other branches weak sisters.

Lord Acton said absolute power corrupts absolutely. Taking that as our central thesis, we’ve seen the Bush Presidency grow fond of more power and control. In their wisdom, the Founders saw the need to give Congress the power of the purse, which should keep spending in check. Perhaps they didn’t anticipate the lengths to which corporations would go to secure federal contracts, or how eager Congress would be to respond to corporate advances in the form of donations and lobbying.

Eisenhower did anticipate the power of the military-industrial complex, which he forecast as a major threat after World War Two. Vested interests who sought to find new enemies for America emerged at the end of the Cold War. Vice President Dick Cheney wrote a 1992 Defense Planning Guidance laying out new strategies for confronting America’s enemies, whoever they were or needed to be in order to keep the war machine grinding on.

The Cold War had been good for business, and today’s Pentagon may be even better at doling out contracts to well-positioned businesses. Over 40% of all Pentagon spending flows to private contractors, skipping the role of an intermediary entirely. Some admirals and general complain about getting submarines and planes they don’t need nor ever asked for.

Borrow and spend

Economists like Milton Freidman certainly would find fault with how Federal money is spent through the military industrial complex. Freidman’s message was hijacked by neo-conservatives, who beat a drum of de-regulation so loud that it drowned out the whimpers calling for fiscal prudence. “We are at war, dammit!”

Abandoning fiscal conservatism, Friedman’s distaste of higher taxes ended up justifying big government spending policies sponsored by the New Conservatives. Private sector efficiencies that Friedman praised were abandoned. Massive amount of government spending, coupled with lower taxes, meant introducing bundles of new government debt. When the government borrows,it drains funds available for private investment, “crowding out” the riskier alternatives in private sector debt, particularly in times when the risk premium (or spread) is so high.

Adding liquidity is no solution to the crisis, especially when fiscal policy is so expansionary and the consequences of too much borrowing--manifesting themselves in the current crisis-- so destructive.

The huge influx of government money makes the credit markets less efficient. Rather than allow privately raised capital to choose between investment alternatives, huge floods of cash have entered the markets, essentially washing over good debt and bad. All manner of investments--regardless of their level of risk--have been washed over with a tide of federal money based on the same easy-come, easy-go monetary policies that created the real estate, then commodities bubble.

Rather than punish the companies that lent or borrowed foolishly, the inexhaustible largesse of the Fed coffers has given them a reprieve. Instead of reducing the pool of available credit--the logical result of any prolonged period of over-spending--the Fed has made more money available. Instead of allowing credit to dry up, the Fed has chosen to side with more politically acceptable response to borrow and spend more. Until the elections pass, politicians will do what they can to avoid a severe recession which would emerge as Americans’ access to credit dried up, a phenomena which has already begun to some degree.

To keep the economy chugging on for at least a few more months, the Fed and Treasury have elected to expand the money supply. Typically this results in overspending down the road, but this cycle appears to have undercut increases in worker pay to the point inflation is a non-factor, at least for now. Gas prices have fallen. Also, as cheap labor and goods come from China, prices are depressed. So perhaps the government feels as if it can avert inflation. The deflation of asset prices might be enough to forestall burgeoning inflation, which was running higher with the now-deflated commodities bubble.

At least until a commodity bubble began in 2007 or so, inflation was largely under control. The commodity bubble reflected the “chickens come home to roost” phenomena: all those dollars in circulation began to flow into commodities. Rules on commodity speculation had been eased in the de-regulatory flurry, and interest rates stayed ridiculously low, so little kept large financial companies from over-investing in the bull market for commodities.

It’s all relative

If the Federal Reserve were to give every American a million dollars, to ease our pain, it’d actually do very little good. Prices would simply rise, and the value of pensions and savings shrink in real terms. But when the Fed offers limitless amounts of money to banks, there are no real consequences for negative behaviors. They can lend and lend irresponsibly, knowing there will be always more, and that the Feds will bail them out if the need arises.

Money is essentially free. The only thing giving it any value is its desirability, its value as a medium of exchange. The truth that money is just green pieces of paper introduces a great deal of uncertainty to the credibility of our currency, on which our future standard of living, as well as our government’s power to tax and spend, is based.

If the dollar becomes over-abundant, it is less desired, and worth less. If diamonds could be found most anywhere, or man-made without great cost, they’d surely not be valuable. It’s the scarcity of a resource that gives it value.

Any number of dollars can produced costing no more than a penny per bill. And money can be distributed widely, as the fiscal stimulus bill has shown, earning Federal Reserve chairman Bernanke the dubious distinction “Helicopter Ben.” It’s as if money can rain down from above like mana from heaven, distributed freely in the downward rotor wash of a helicopter, where it falls into the hands of the poor masses huddled below. And they’re instantly rich--rich for just as long as it takes shop owners and companies to raise their prices.

During the Gold Rush, champagne and perfume from Paris could be found in mining towns deep in the Alaskan hinterland. Prices simply went up because everyone had more gold. Yet unlike the Gold Rush, which was based on gold, the Debt Crush is based purely on paper money. Prices will go up, but for staples like gasoline and bread, not just luxuries, which will become ultra-expensive and scarcer, because people have less real purchasing power.

Hyperinflation occurs when the government relies on printing limitless quantities of money and distributing them directly. The more money that’s needed to buy things, the more must be spent, and the more made. Money acts like a commodity--if gold appeared in everyone’s backyard, you’d need an awful lot of the stuff to be considered rich.

The Federal Reserve Board actually gives a mechanism for limiting the quantity of money that enters circulation. It forces the Treasury to give up bonds, promises to pay the borrower principal and interest based on the government’s implicit right to tax the future earnings of Americans.

In exchange for its “Federal Reserve Notes”--pieces of paper with no intrinsic value--we the people promise a private corporation, the Fed, which is made up of large banks, ownership of our bonds. We give bonds, they give the Treasury the cash. We pay interest, they collect interest. In this regard, the Fed wins by increasing the amount we owe. The more debt, the more of our present and future tax receipts they can stake claim. The Fed lending us an additional $700 billion means the Treasury must pay that much more interest--which our government is finding harder to do without borrowing more.

So indebted we have become that our tax payments now do nothing more than service the debt; I’ve read that checks made out to the Treasury are stamped as received by branches of the Federal Reserve. With so much debt, we can’t hope to pay down any principal, meaning the Federal Reserve maintains an exploitative relationship with the taxpayer.

Meanwhile banking profits belong to the banks. In their defense, consumer banks do encounter risks performing their chief function of lending. Yet in this crisis we see that the main cause of losses is the lending to hedge funds on margin and risky behavior investment banking divisions. Consumers might fail, but they do so not because of investment decisions, but rather broader economic conditions.

Consumer and small business loans are far more beneficial than IPOs and hedge fund lending, though they are less lucrative to the banks, and entail more risk, at least without the false security of Credit Default Swaps, insurance which was sold alongside the mortgage-backed securities.

Federal Reserve notes are brought into circulation through consumer lending are more valuable to the economy. The trickle up effect of new money being spent means real things are being bought and solid by real people, instead of shifting money from one pile to another.

Retail banking is where the risk and work of lending meet the free market; bad loans fail and hurt the bank that lent. Yet since a Savings and Loan crisis in the early eighties, one which could be attributed to inadequate regulation and disproportionate influence exerted on the so-called Keating Five (McCain was one), the federal government has taken on the role of insurer to the banks.

S&L repeat

The S&L crisis was the forerunner of today’s bailout. In both cases, the government failed to hold financial entities accountable. The creation of FDIC insurance, rather than reduce risk, has become a backstop by which banks can practice riskier lending and know government help will be forthcoming should market conditions get bad enough.

The combination of political gamesmanship and corporate influence contributed directly to the crisis we face today. Government wanted more houses built, and instructed Freddie and Fannie to lend more. Now some say that those entities were acting under a federal mandate when they made so many of their bad loans; others say the subprime mistakes were made on account of greed and poor management. Either excuse still fails to explain the role of moral hazard, which is the conditioning of typically risk-averse entities like banks to take on more risk, knowing that their losses would be covered by a “implicit guarantee,” a promise by government to bail them out.

Instead of seeking out the root of all the wrong-doing, the banks can defer to the “mortgage problems.” Instead of blaming unethical and greedy practices for the mistakes, failing banks have chosen to blame mortgage holders who are defaulting.
With so many millions in political donations from financial services companies circulating in Washington, we’re assured not to get any real accountability out of our political system, just a great deal of finger pointing and wrist wringing.

The focus on bad mortgages also focuses attention away from the real problem, in what’s become a standard operating procedure for Washington and its media. Far bigger than sub-prime are the credit default swaps and derivatives markets, which reach into dizzying amounts. These are essentially promises to buy based on some event or the passage of time. CDSs are agreements among financial entities to bail each other out if a lender fails.

Unfortunately, these structured investment vehicles (SIVs) made no allowance for market risk, which can be defined as the possibility of economic conditions and fiscal condition deteriorating to the point that the safety of no single investment or debt security can be assured. One default could trigger unforeseen consequences.

What was so truly remarkable was the unwillingness of so many to see the upcoming collapse. Or maybe, players within the system did see it coming, and tried to get their piece of the action before it all came crashing down.

One hallmark of American-style capitalism has been greed. If anyone out there doesn’t think that greed could have precipitated this crisis, then they surely don’t understand the American ethos. After seeing Enron’s collapse, who among us can believe that the fat cats haven’t stowed away their gains in some offshore account? The lesson of hyper-capitalism is clear: get what you can and get out!

Justly, the banks that practiced the least discretion in their lending and packaging of investment products and swaps have suffered the most. Some, like Citigroup and Bank of America, certainly now see themselves as too big to fail. Like Freddie and Fannie, they must see themselves as immune, too important a part of the system to ever be removed from it. Undoubtedly, this breed of implicit government guarantees will lead to more reckless decisions in the future.

Another huge potential negative is the ongoing interdependence of the Federal government and the large financial institutions. Already, banks have been forced to buy failing companies Merrill Lynch, Washington Mutual, and Bear Sterns. While no one may have mandated these buy-outs, I can hardly believe these actions were accomplished in a purely market-driven environment. If those companies had gone bankrupt, like Lehman Brothers, the contagion could have destabilized the markets even further, so at least the interventions were beneficial, and necessary, this time.

Can we trust government not to meddle in the markets in the future, perhaps when their actions aren’t necessarily imperative? Rather than maintain oversight, the government will use lenders to further political objectives. We saw the thrust towards unrealistic levels of home ownership precipitate over-lending to under-qualified buyers by Freddie/Fannie, which was a important contributor to the crisis (though by no means its most significant manifestation.)

With politicians in control of the banking industry, we can’t determine what dangers await us. We do know however that any command/control style approach to the political economy will actually increase risk, not diminish it. In trying to save the value of investment portfolios and keep the stream of lending going, we’ve set ourselves up for a bigger failure later when banks assume they’ll be bailed out whatever they do.

Pain of change

Growth slows because it needs to slow, in order to remove the excesses of the past. Change is not without pain. Unfortunately the politicians responsible for our fiscal and monetary policies have chosen to neglect the regulatory element, which is a vital and necessary function of government. This has made the pain of change even greater.

If something can’t go on forever it won’t. We see the Bush administration on its heels, leaving behind a toxic legacy of fiscal imprudence, foreign military interventions, and unsound monetary policies coupled with the consequences of inadequate regulation. From irresponsibility practiced on so wide a scale, the only consequences can emerge are negative.

Even if the the immediate pain of a recession can be forestalled, it can’t--or shouldn’t--be avoided. The alternative may be an economic catastrophe of an even higher magnitude, brought on by even bigger government interventions that will debase our currency and could lead to hyperinflation.

The death of laissez faire (anything goes), hyper-capitalism need not cripple the American economy. Regulatory standards need to be reinstated.

We can’t have sound financial markets without fiscal conservatism. As our nation’s borrowing increases, we’re seeing a boom and bust cycle emerge. Our money needs to be backed by restraint and moderation, which were abandoned by the faux conservative Bush.

The good news is that the self-destructive tendencies of naked and unrestrained capitalism have been revealed. The American people have been made aware of the consequences of unrestrained de-regulation and need to press their political representatives to re-regulate.

Throwing huge sums at the problem will do little more than delay the full impact of the financial transgressions, for which Republican-led government shares in the blame.

Spillover into the “real” economy is inevitable. We’ve built a “service economy” around pushing piles of cash around, and so ironically, the real economy might help stabilize the situation, especially as the asset bubble breaks. A weaker dollar will help exports, but we shouldn’t depend on financial maneuvers to revitalizing our manufacturing sector.

In the current credit crisis, the rest of the world might stand to lose even more than the U.S.. Iceland’s banks were nationalized in a collapse there. The scope of the problem is massive, magnified by interconnectedness of the world’s economy. Like the Great Depression, what happens here affects them over there, and vice versa.

Criteria for revolution

Back home, none of us can escape the consequences of sliding economic competitiveness. Nor can we disguise the consolidation of wealth in the hands of fewer and fewer people. I’ve noted several times here on this blog how societies tend to radicalize if too much wealth coalesces around too small a group.

In the New Feudalism brought on by a self-serving Bush and his cronies, it’s been all about getting the most for oneself, and discarding the importance of the common good. This collapse really represents the assertion of an elevated “me,” the ascent of the societal value elevating the accumulation of money over all other things.

As it turns out, only so many can have so much. There is a zero sum game being played, where the world’s wealthy in First World nations deprive the underclasses and Developing World of income, which could mean so much in their lives.

The Age of Greed has ended badly for all but those at the very top, who’ve seen incomes rise under tax policies created for their benefit.

This investor class needs to be cautious, to continue to lobby and keep their profits safe. In times of crisis, governments tend to take up a larger role in regulatory affairs. Taxes on the wealthy could rise. Income redistribution will be more likely and necessary.

Who bears responsibility for this crisis? By failing to regulate, government allowed the crisis to occur. But the irresponsible behavior of hedge funds and investment banks magnified the subprime problem. Mortgage-backed securities based on inaccurate appraisals should never have been offered to the public. Neither should have derivates trading been allowed to go unregulated. Unfortunately it will not be those who profited the most who will pay for the losses, but instead those who pay a larger proportion of their income to the government.

We can’t blame government alone for all the problems we now face. Nonetheless, government will be called on to provide solutions.

We seem incapable of realizing that we’re in a cycle of misery imposed by the crass pursuit of capital at any cost. Heads down, stuck in the rat race, I guess we’re all too busy trying to secure our future in an uncertain world.

The richer some of us get, the more the multitudes seem destined to have less. It’s not that the rich intend to deprive the less wealthy, that’s just what seems to invariably happen.

Just like the Great Depression, the excesses of previous period lead to inevitable decline. The nation’s poorest will likely bear the greatest economic burden, despite the fact they did the least to bring on the crisis.

With the turning of every economic cycle, the wealthy appear better able to weather the storm, and end up wealthier at the beginning of the next expansion. If this amalgamation of capital and political influence continues, American society could be radicalized, not unlike during the Great Depression, where Marxism, communism, and a host of political experiments were proposed to deal with the economic crisis.

The status quo is itself reactionary, and can’t deal with the speed and chaos of rapid changes. Still, at some point the powers that be, the Washington consensus, will realize that not enough is being done to maintain social equilibrium and will restrict the system’s more exploitative qualities.

The political system we have, while not perfect, should be able to reorder our society’s priorities so as to protect the economically disadvantaged. If not, it might be cast off, and replaced with something far less benign for the interests of corporations and the wealthy, who do seek to maintain some degree of normalcy if for no other reason than to continue exploiting their economic hegemony over the system.

A political reawakening could ensue that could shake the country’s political and investor class to the core. Faced with the possibility of radical political upheaval, corporations, the media, and politicians will relent, and try to stabilize the economic situation.

It’s truly a dangerous game that’s being played. No one knows how the credit crisis will unfold, so all the Fed and government can do is react. The political ramifications of the financial crisis could snowball as the economy worsens.

To make matters worse, large numbers of voters desperately need huge sums for medical expenses and social security, which will become harder to provide as the monetary base erodes due to over-borrowing. Sensitive to the values of their 401(k)s, Baby Boomers will likely vote their concerns over the economy. John McCain is hurting in the polls for this reason.

Schemes afoot?

Was a plan to starve the beast premature? I’ve talked about how radical Republicans have planned to sabotage the Democrats by de-funding social programs, a la Grover Norquist’s shrinking government “down to the size where we can drown it in the bathtub.”

Draining the public treasury would seem to be a destructive means of winning votes, so I’m not sure how viable this approach could be. In this vein, McCain promised to hold off on all new spending except that which is “essential,” a definition which I suppose will be up to McCain to determine after his election.

“Social programs” are a favorite target of spending cuts. Cutting war spending in Iraq and Afghanistan would presumably be off limits, at least according to the oft-voiced national security concerns that have been waved in our faces since 9/11 as an excuse to spy, torture, lie, and do God knows what else, beyond any scrutiny or accountability.

The Republicans have been caught between honoring the truly conservative value of fiscal restraint while accepting the need to deal with the financial crisis so they don’t alienate the middle class. This inner disharmony could well doom them in the upcoming election.

The Democrats have been eager to engineer an intervention, and don’t seem that bothered by the huge sums involved. They’ve never been known for their fiscal conservatism, but they are eager to look like they’re helping the less fortunate. I don’t know if any sum will be sufficiently large to deal with the effects of the credit crisis, so they are likely tossing trillions out without really gauging the bailout’s effectiveness.

Other sources

In an interview with OpEdNews.com’s Rob Kall, Naomi Klein talks about the “debt bombs” that companies are trading in for public Treasury debt under Secretary Paulson’s plan.

The Fed has opened less transparent, Congressionally unapproved method for federalizing the risk associated with risky debt out of the hands of Paulson’s investment banking cronies, who get U.S. Treasuries in a 1:1 tradeoff.

The shock of the credit implosion might be just another way to introduce changes that benefit the investor class at the expense of the public. Passing off of all that toxic debt as a “solution” to a wholly preventable crisis might well be part of the continued deception that has made insiders incredibly wealthy.

For an explanation on credit Default Swaps, see this article by David Vaughn.


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