How a $13 Trillion Cover Story was Written

Free money creation to bail out America’s elite financial speculators, but not for Social Security or Medicare

Only the “Crazies” Get the Bank Giveaway Right

Financial crashes were well understood for a hundred years after they became a normal financial phenomenon in the mid-19th century. Much like the buildup of plaque deposits in human veins and arteries, an accumulation of debt gained momentum exponentially until the economy crashed, wiping out bad debts – along with savings on the other side of the balance sheet.

Physical property remained intact, although much was transferred from debtors to creditors. But clearing away the debt overhead from the economy’s circulatory system freed it to resume its upswing. That was the positive role of crashes: They minimized the cost of debt service, bringing prices and income back in line with actual “real” costs of production. Debt claims were replaced by equity ownership. Housing prices were lower – and more affordable, being brought back in line with their actual rental value. Goods and services no longer had to incorporate the debt charges that the financial upswing had built into the system.

Financial crashes came suddenly. They often were triggered by a crop failure causing farmers to default, or “the autumnal drain” drew down bank liquidity when funds were needed to move the crops. Crashes often also revealed large financial fraud and “excesses.”

This was not really a “cycle.” It was a scallop-shaped ratchet pattern: an ascending curve, ending in a vertical plunge. But popular terminology called it a cycle because the pattern was similar again and again, every eleven years or so. When loans by banks and debt claims by other creditors could not be paid, they were wiped out in a convulsion of bankruptcy.

Gradually, as the financial system became more “elastic,” each business recovery started from a larger debt overhead relative to output. The United States emerged from World War II relatively debt free. Downturns occurred, crashes wiped out debts and savings, but each recovery since 1945 has taken place with a higher debt overhead. Bank loans and bonds have replaced stocks, as more stocks have been retired in leveraged buyouts (LBOs) and buyback plans than are being issued to raise new equity capital. Behind every LBO is the desire to keep stock prices high, lavishing rewards to managers via the stock options they give themselves.

But after the stock market’s dot.com crash of 2000 and the Federal Reserve flooding the U.S. economy with credit after 9/11, 2001, there was so much “free spending money” that many economists believed that the era of scientific money management had arrived and the financial cycle had ended. Growth could occur smoothly – with no over-optimism as to debt, no inability to pay, no proliferation of over-valuation or fraud. This was the era in which Alan Greenspan was applauded as Maestro for ostensibly creating a risk-free environment by removing government regulators from the financial oversight agencies.

What has made the post-2008 crash most remarkable is not merely the delusion that the way to get rich is by debt leverage (unless you are a banker, that is). Most unique is the crash’s aftermath. This time around the bad debts have not been wiped off the books. There have indeed been the usual bankruptcies – but the bad lenders and speculators are being saved from loss by the government intervening to issue Treasury bonds to pay them off out of future tax revenues or new money creation.

The Obama Administration’s Wall Street managers have kept the debt overhead in place – toxic mortgage debt, junk bonds, and most seriously, the novel web of collateralized debt obligations (CDO), credit default swaps (almost monopolized by A.I.G.) and kindred financial derivatives of a basically mathematical character that have developed in the 1990s and early 2000s.

These computerized casino cross-bets among the world’s leading financial institutions are the largest problem.

Instead of this network of reciprocal claims being let go, they have been taken onto the government’s own balance sheet. This has occurred not only in the United States but even more disastrously in Ireland, shifting the obligation to pay – on what were basically gambles rather than loans – from the financial institutions that had lost on these bets (fraudulently inflated loans) onto the government (“taxpayers”).

The government took over the mortgage lending guarantors Fannie Mae and Freddie Mac (privatizing the profits, “socializing” the losses) for $5.3 trillion – almost as much as the entire national debt. The Treasury lent $700 billion under the Troubled Asset Relief Plan (TARP) to Wall Street’s largest banks and brokerage houses. The latter re-incorporated themselves as “banks” to get Federal Reserve handouts and access to the Fed’s $2 trillion in “cash for trash” swaps crediting Wall Street with Fed deposits for otherwise “illiquid” loans and securities (the euphemism for toxic, fraudulent or otherwise insolvent and unmarketable debt instruments) – at “cost” based on full mark-to-model fictitious valuations.

Altogether, the post-2008 crash saw some $13 trillion in such obligations transferred onto the government’s balance sheet from high finance, euphemized as “the private sector” as if it were the core economy itself, rather than its calcifying shell.

Instead of losing on their bad bets, bad loans, toxic mortgages and outright fraudulent claims, the financial institutions cleaned up, at public expense. They collected enough to create a new century’s power elite to lord it over “taxpayers” in industry, agriculture and commerce who will be charged to pay off this debt.

If there was a silver lining to all this, it has been to demonstrate that if the Treasury and Federal Reserve can create $13 trillion of public obligations – money – electronically on computer keyboards, there really is no Social Security problem at all, no Medicare shortfall, no inability of the American government to rebuild the nation’s infrastructure.

The bailout of Wall Street showed how central banks can create money, as Modern Money Theory (MMT) explains. But rather than explaining how this phenomenon worked, the bailout was rammed through Congress under emergency conditions. Bankers threatened economic Armageddon if the government did not create the credit to save them from taking losses.

Even more remarkable is the attempt to convince the population that new money and debt creation to bail out Wall Street – and vest a new century of financial billionaires at public subsidy – cannot be mobilized just as readily to save labor and industry in the “real” economy. The Republicans and Obama administration appointees held over from the Bush and Clinton administration have joined to conjure up scare stories that Social Security and Medicare debts cannot be paid, although the government can quickly and with little debate take responsibility for paying trillions of dollars of bipartisan Finance-Care for the rich and their heirs.

The result is a financial schizophrenia extending across the political spectrum from the Tea Party to Tim Geithner at the Treasury and Ben Bernanke at the Fed. It seems bizarre that the most reasonable understanding of why the 2008 bank crisis did not require a vast public subsidy for Wall Street occurred at Monday’s Republican presidential debate on June 13, by none other than Congressional Tea Party leader Michele Bachmann – who had boasted in a Wall Street Journal interview two days earlier, on Saturday, that she voted against the Troubled Asset Relief Program (TARP) “both times.”

She complains that no one bothered to ask about the constitutionality of these extraordinary interventions into the financial markets.

“During a recent hearing I asked Secretary [Timothy] Geithner three times where the constitution authorized the Treasury’s actions [just [giving] the Treasury a $700 billion blank check], and his response was, ‘Well, Congress passed the law.’ …With TARP, the government blew through the Constitutional stop sign and decided ‘Whatever it takes, that’s what we’re going to do.’”

Clarifying her position regarding her willingness to see the banks fail, she explained:

I would have. People think when you have a, quote, ‘bank failure,’ that that is the end of the bank. And it isn’t necessarily. A normal way that the American free market system has worked is that we have a process of unwinding. It’s called bankruptcy. It doesn’t mean, necessarily, that the industry is eclipsed or that it’s gone. Often times, the phoenix rises out of the ashes.[1]

There were easily enough sound loans and assets in the banks to cover deposits insured by the FDIC – but not enough to pay their counterparties in the “casino capitalist” category of their transactions. This super-computerized financial horse racing is what the bailout was about, not bread-and-butter retail and business banking or insurance.

It all seems reminiscent of the 1968 presidential campaign. The economic discussion back then between Democrat Hubert Humphrey and Republican Richard Nixon was so tepid that it prompted journalist Eric Hoffer to ask why only a southern cracker, third-party candidate Alabama Governor George Wallace, was talking about the real issues. We seem to be in a similar state in preparation for the 2012 campaign, with junk economics on both sides.

Meanwhile, the economy is still suffering from the Obama administration’s failure to alleviate the debt overhead. He should be making banks write down junk mortgages to reflect actual market values and the capacity to pay. Foreclosures are still throwing homes onto the market, pushing real estate further into negative equity territory while wealth concentrates at the top of the economic pyramid. No wonder Republicans are able to shed crocodile tears for debtors and attack President Obama for representing Wall Street (as if this is not equally true of the Republicans). He is simply continuing the Bush Administration’s policies, not leading the change he had promised. So he has left the path open for Congresswoman Bachmann to highlight her opposition to the Bush-McCain-Obama-Paulson-Geithner giveaways.

CONTINUED

 

Michael Hudson is a former Wall Street economist. 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) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy. Visit his website at Michael-Hudson.com

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