Rene — Paulson's Cascade of Lies

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Locking in the Loot at the Reagan Library
Paulson’s Cascade of Lies
Weekend Edition
November 21 / 23, 2008
On Thursday, November 20, Treasury Secretary Henry Paulson presented,
even by his own lamentably low standards, an amazingly deceptive speech
at the Ronald Reagan Presidential Library in Simi Valley, California.
In its false framing of Washington’s financial giveaway to Wall Street
it rivaled some of the outstanding fables created by the Master
Imagineer himself, for whom the library is named.
What prompted the speech seems have been Congressional criticism of Mr.
Paulson’s bait-and-switch transfer of public funds to Wall Street, and
the Federal Reserve’s transfer of an amount twice as high as Congress’s
$700 billion. His most urgent aim was to ward off accusations that the
Treasury and Federal Reserve have acted illegally. `Federal law, and in
particular the Anti-Deficiency Act, prohibits Treasury from spending
money, lending money, and guaranteeing or buying assets without
Congressional approval. The Federal Reserve can and does lend on a
secured basis, but only if it expects not to realize losses.’ (Italics
But Congress did not approve the Treasury’s $250 billion of `preferred’
stock investments in Wall Street banks. The happy recipients, their
stockholders and officers evidently worried precisely that20this
`investment’ would end up taking losses. That is why the Treasury
stands in back of bona fide creditors. That is why `preferred’ stock
was preferred by existing stockholders to loans and guarantees (which
have priority in case of bankruptcy), not to mention the conditions
that Congress thought it had laid down calling for these institutions
to renegotiate mortgages to bring them in line with the debtor’s
ability to pay.
The Fed has refused to let Congress know any details ` any details at
all ` about its cash-for-trash swaps with these institutions. This is
what concerns Congress, and what has prompted reporters at Bloomberg
to bring a lawsuit in order to discover and publicize the details. It
is not hard to see why this curiosity exists. The only reasonable
explanation as to why investment banks, American International Group
(A.I.G.) and commercial banks apparently headed by Citibank (whose
shares plunged yet another 26 per cent on Thursday) have turned over a
trillion dollars worth of illiquid mortgage securities, junk bonds and
who knows what other junk to the Fed is to avoid taking a loss on these
bad loans and investments. As Mr. Paulson explained matters, `the
Federal Reserve has statutory authority to lend against a pool of
mortgage loans on a fully secured basis. The Fed was able to assist the
JPMorgan purchase because they believed that there was a reasonable prospect of avoiding losses.’
What time frame are we talking about here? Evidently one in which Mr.
Paulson will have left the administration, sticking his successor with
the losses and, presumably, the blame.
Everything seems to have been unexpected to Mr. Paulson ` as if
ignorance is a defense. `When I came to Washington in 2006,’ he
reminisced, `markets were benign.’ We were still in Alan Greenspan’s
idea that inflating asset prices on credit constitutes `wealth
creation.’ At that time I myself was only one of many who warned that
the real estate market had come to rest on a foundation of junk
mortgage lending. Every banker with whom I spoke at the time knew this.
But most were still seeking to make hay while the making was good, and
it was still quite good ` for the banks, that is. Matters were not
benign for the increasingly debt-ridden U.S. economy, but at least they
were rosy for Wall Street. Bank executives were paying themselves
enormous salaries and even larger stock options. Meanwhile, the smarter
money managers were beginning to shift their funds out of the U.S.
economy in a wave of capital flight of a magnitude not seen since
Russia in the mid-1990s.
Acting as if all this could not have been foreseen, Mr. Paulson assured
his mistake-friendly audience, `There was no playbook for responding to
a once or twice
in a hundred year event.’ A kind of random historical
earthquake seems to have been at work, a financial San Andreas fault.
Mr. Paulson then trivialized this, however, with the euphemism `housing
The key is, what is to be corrected? Is it not the financial market
Mr. Paulson then set about dissembling the character of the U.S. and
global financial system. `Our financial system,’ he claimed, `is built
on the hard work of our citizens; it is built on the savings of our
This is where he seeks to spread the disinformation about the explosion
of debt that now burdens the U.S. economy, which is the result of
autonomous credit-creation by the commercial banking system and has
nothing to do with the savings habits of `our citizens’. The basic
financial principle of modern banking is that `loans create deposits.’
The bank loan comes first ` then the deposit or `saving.’
Here’s how it works. A bank’s marketing department seeks to drum up
customers for debt. A borrower will go into a bank and sign a
promissory note, and the bank then creates a checking account in the
amount that is stipulated. The note calls for a specific rate of
interest to be paid ` a rate much higher than that which the bank can
borrow from the Federal Reserve or in the money market in general. One=2
0benchmark global rate to bankers is the London Interbank Borrowing
Overnight Rate (LIBOR), and the other is the Federal Reserve’s discount
rate to banks. (Japanese banks also provided loans to large financial
institutions at under 1% per year, spurring the international `carry
trade,’ borrowing cheap in yen and then converting the funds into other
currencies and lending at a higher rate.)
None of this involves saving. It involves credit creation in which
banks have a legal monopoly, with funding monetized by the U.S,
Japanese and other major foreign central banks. This free credit
creation is at the root of the problem, not the natural growth of
What have banks done with this credit-creating privilege? Nearly all
their loans have been to enable buyers to purchase assets (real estate,
stocks and bonds or entire companies) already in place, or to enable
hedge funds to play the mathematical games that have come to
characterize today’s casino capitalism. Mr. Paulson depicts the
resulting financial system as being essential for the good functioning
of `Main Street.’ But surely he must know some lawyer who might explain
to him that only very, very wealthy speculators are allowed to play the
hedge fund game of financial derivatives that lies at the heart of
today’s financial breakdown and negative equity for banks that have
made bad gambles. The legal reality is that in ord
er to invest in hedge
funds and similar casino capitalism gambles (or in Broadway plays and
other high-risk ventures, for that matter), prospective financiers must
sign releases attesting to the fact that they can afford to lose their
`If the financial system were allowed to collapse,’ Mr. Paulson warned,
`it is the American people who would pay the price. This has never been
just about the banks; it has always been about continued prosperity and
opportunity for all Americans.’ Not really. Wall Street is hardly so
altruistic. It has increasingly made its money off Americans by
engaging in increasingly predatory, extractive lending to the economy.
That is what has caused the U.S. debt burden to soar so far ahead of
the ability of debtors to pay. It also is what is now diverting
spending away from consumption and (for companies) new capital
investment to pay creditors.
Not content with misrepresenting how the U.S. economy works, Mr.
Paulson then drew a picture of the global economy that also is a
travesty. `The world was awash in money looking for higher return,’ he
explained, `and much of this money was invested in U.S. assets.’
Not exactly. The world economy has been awash in the U.S. payments
deficit, which has swollen the reserves of central banks in the
creditor nations from Asia to Western Europe. These central banks have
recycled $4 trillion of20their dollar inflows to the United States under
dollar hegemony. Rather than seeking a `higher return,’ central banks
have found themselves obliged to invest in low-yielding U.S. Treasury
securities, or somewhat higher Fannie Mae and Freddie Mac securities.
These returns are much lower than U.S. investors have sought in buying
up foreign companies and their stocks, whose price appreciation far
exceeded the rate that foreign economies were able to recoup on their
dollar recycling to the United States.
Mr. Paulson wants above all to deter foreign economies from breaking
away from this dysfunctional system. `The second important priority,’
he explained to his Reagan Library audience, `must be continued reform
of the International Financial Institutions like the World Bank and the
IMF to allow for greater participation of developing nations.’ The aim
here is to make the financial sector’s lobbying control over the
world’s financial system global. `A final reform priority must be
consistent liberalization of policies on trade and investment, with an
emphasis on avoiding new protectionist measures and achieving a
breakthrough in the Doha round of global trade talk.’
`New protectionist measures’! Even as U.S. auto companies are
advocating special subsidies for the U.S. auto industry in Detroit and
pursuing beggar-my-neighbor financial policies (let foreign banks and
economies absorb20the financial loss from playing in the Wall Street
casino), foreign countries are not to develop a financial system more
highly regulated, an agriculture more aimed at feeding their own
people. They are not to block capital outflows from the United States
based on `free’ credit creation to buy out the commanding heights of
their economies as the IMF imposes austerity plans and forced
privatization sell-offs on Third World and post-Soviet countries, while
cutting taxes at home in the face of an escalating U.S. trade deficit
and rising foreign military spending.
Mr. Paulson’s speech looks like a major salvo in the Bush
Administration’s attempt to make both the Wall Street bailout and the
U.S. predatory finance irreversible, while the government replaces
public debt (Treasury bonds) for Wall Street’s bad gambles. His errors
are calculated to misinform, as are most lobbying efforts by the
banking and financial sector. One can only hope that Congress will
question his testimony that has repeatedly followed this line with more
acumen than prompted its earlier acceptance of the Treasury’s bailout
act. It’s time to clean up this act.
PS: As I watched Citibank’s stock (C ) take yet another plunge of 10
per cent in the firsthour of Thursday morning, my wife showed me
something that a Citibank advertiser was handing out to students at New
York University yesterday afternoon: A flyer be
gging them to put their
money in at 3.10 per cent per year. (Vanguard’s Treasury-money market
fund offers under 1 per cent at present.) I told Grace that our net
worth was higher than Citibank’s, but I’m not able to draw down a $10
million a year salary like their jokers do.
The Citibank handout (when have you ever heard of street hawkers for
banks says, “You’ll have the safety of FDIC insurance and your CD’s
term is just 6 months. So you can keep your money secure at a great
rate. …Citi never sleeps.”
Citi’s stock has fallen 84 per cent this year, and the company is on
the rocks. I’d be sleepless too, if I were them!
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) He can be
reached via his website, mh@michael-hudson.com