Rene — THE U.S. FINANCIAL SYSTEM IN SERIOUS TROUBLE
Topic(s): US Analysis | Comments Off on Rene — THE U.S. FINANCIAL SYSTEM IN SERIOUS TROUBLETHE U.S. FINANCIAL SYSTEM IN SERIOUS TROUBLE
By Rodrigue Tremblay
Online Journal Sep 17, 2008, 00:28
” . . . a bailout of GSE (Fannie and Freddie) bondholders would be
perhaps the greatest taxpayer rip-off in American history. It is bad
economics and you can be sure it is terrible politics.” –Matt Kibbe,
President of Freedom Works
“The first panacea for a mismanaged nation is inflation of the
currency; the second is war. Both bring a temporary prosperity;
both bring a permanent ruin.
But both are the refuge of political and economic
opportunists.” –Ernest Hemingway (1899-1961), (September 1932)
[After the Bear Stearns bailout] “As more firms lost access to funding,
the vicious circle of forced selling, increased volatility, . . . and
margin calls that was already well advanced at the time would likely
have intensified. The broader economy could hardly have remained immune
from such severe financial disruptions.” –Ben Bernanke, Fed Chairman
(March 2008)
In August 2007, at the very beginning of the subprime financial
crisis in the U.S., and referring to the alchemy-like practice of
creating artificial financial instruments, such as mortgage-backed
securities (MBSs), here is what I wrote: “Like all ‘Ponzi schemes’,
such pyramidings of debts with no liquid assets behind them are bound
to implode sooner or later.”
I also w rote about the Fed’s intervention in such cases, that “it
alleviates the ‘liquidity crisis,’ for sure, but this does nothing to
cure the underlying ‘solvency crisis’ of institutions holding large
chunks of non-performing mortgage-based assets. Sooner or later,
such low-valued derivatives will have to be written off, and this
will necessarily lead to an erosion of these institutions’ capital
base. Bankruptcies of the most leveraged and imprudent institutions
are to be expected.”
In fact, such bankruptcies of over-leveraged financial institutions
become unavoidable. For a while, forced mergers between banks,
initiated by the Fed or the Treasury, can soften the blow. But after
a while, outright bankruptcies cannot be avoided and balance sheets
have to be balanced.
What is the cause of this financial mess?
Last month, I provided a short answer:
“At the center of current financial problems is the failure to adapt
standard financial regulation to new financial institutions, such
as broker-investment banks, off-shore based hedge funds and large
derivatives markets that remain, for the most part, outside of the
traditional authority of regulators. However, when things go wrong,
as they did with Bear Stearns last March, their demise threatens to
destabilize the entire financial system and handy government bailouts
are quickly called in.”
Today I say that this major crisis has20to be placed at the very
feet of the Washington establishment. This is a politico-financial
establishment that has pushed to the limits its ideology of
deregulation of financial markets and stretched the working of
unregulated corporate market capitalism to the breaking point. Now,
the system is imploding under our very eyes and financial institutions
are falling like dominos. As I wrote last August, and repeated in April
of this year, the U.S. financial problem is not one of liquidity,
(there is plenty of liquidity provided by the Fed when banks and
brokers can borrow at will newly printed dollars from the Fed’s
discount window) but one of solvency, weak balance sheets, risky
assets and debt liquidation. That’s a horse of a different color.
Over the last 25 years, beginning with the Reagan administration and
culminating with the current Bush-Cheney administration, the Washington
establishment dismantled piece by piece the system of protection that
had been built since the 1930s economic depression and removed nearly
all government regulations that could stand in the way of greed and
gouging on the part of unscrupulous market operators.
And that’s where the rubber hits the road. Short of bankruptcies is
the nationalization of the over-leveraged banks by the government. And
the Bush-Cheney administration took a big step in that direction
when it came to the rescue of the two largest mortgage financing
institution s, Fannie Mae (Federal National Mortgage Association:
FNM) and Freddie Mac, (Federal Home Loan Mortgage Corporation: FRE)
which were close to being insolvent. This step was initiated after
foreign central banks (in China, Japan, Europe, the Middle East and
Russia) threatened to stop buying U.S. bonds and debentures issued
by the two shaky financial institutions.
But the Bush-Cheney administration, while providing public money to
keep the two lenders in operation, stopped short of nationalizing
them. Indeed, the U.S.
government committed to invest as much as $200 billion in preferred
stock and extend credit through 2009, to keep the two mortgage lenders
solvent and operating.
But instead of taking them over by placing them into administrative
receivership, in order to change their business model, as they should
have done since the government is now guaranteeing their outstanding
debts, (more than $5 trillion US) the U.S. government chose rather
to keep the appearance that these were still two privately run banks
and only appointed a legal conservator for Fannie Mae and Freddie
Mac. Even when they bail out what can be called two government
sponsored enterprises (GSEs), their market ideology prevents them
from doing the right thing.
After years of irresponsible public deregulation and private
mismanagement and irresponsible, pyramiding risk taking, the American
financial system is now in serious trouble, and it may draw the
U.S. =0 D economy further down with it in the months and years to come.
In the coming weeks, however, as other American financial institutions
teeter on the brink of bankruptcy, the U.S. government will have to
consider creating a Bank Resolution Trust under the model of the 1989
Resolution Trust Corp.
which took over the savings and loan banks that were then in financial
difficulties. For example, as recently as February 16 of this year,
the British government did not hesitate to nationalize the Northern
Rock bank and rescued this large British bank with about £55 billion
($107 billion) in public loans and guarantees. Sooner or later, the
American government will have to do the same, in order to stabilize
the financial system, because the financial problems in the U.S. are
systemic and much more serious than elsewhere.
By the same token, maybe the U.S. government should correct an anomaly
of the 20th century, that is the semi-private status of its central
bank. Indeed, the American Federal Reserve is a semi-public and
semi-private central bank organization that is as much responsible
to large private banks as it is to the U.S. government and the
population. This creates an unhealthy conflict of interests that
is not fair to the American public. Indeed, the American practice
of privatizing profits and socializing losses would be considered
unacceptable in most other democracies.
What we are witnessing these days in the U.
S. is a massive wealth transfer from taxpayers, savers and retirees
to banks, their creditors and their managers. On the one hand, the
Fed has pushed real interest rates deep into negative territory to
help troubled banks, and, on the other hand, the American taxpayers
have foot the bill for bailing out very large financial institutions.
I wonder what the two presidential camps, the Obama and the McCain
camps, have to say about that? They both want to increase the federal
deficit and add significantly to the already high national debt.
Rodrigue Tremblay lives in Montreal and can be reached at
rodrigue.tremblay@yahoo.com. He is the author of the book
“‘The New American Empire.” His new book, “The Code for Global
Ethics,” will be published in 2008. Visit his blog site at
thenewamericanempire.com/blog.