http://www.counterp unch.org/ hudson09202008. html
Weekend Edition
September 20 / 21, 2008
The Market and the Terminator Machines
America's Own Kleptocracy
By MICHAEL HUDSON
Nobody expected industrial capitalism to end up like this. Nobody even saw it
evolving in this direction. Im afraid this failing is not unusual among
futurists: The natural tendency is to think about how economies can best grow
and evolve, not how it can be untracked. But an unforeseen road always seems to
appear, and there goes society goes off on a tangent.
What a two weeks! On Sunday, September 7, the Treasury took on the $5.3
trillion mortgage exposure of Fannie Mae and Freddie Mac, whose heads already
had been removed for accounting fraud. On Monday, September 15, Lehman Brothers
went bankrupt, when prospective Wall Street buyers couldnt gain any sense of
reality from its financial books. On Wednesday the Federal Reserve agreed to
make good for at least $85 billion in the just-pretend insured winnings owed
to financial gamblers who bet on computer-driven trades in junk mortgages and
bought counter-party coverage from the A.I.G. (the American International
Group, whose head Maurice Greenberg already had been removed a few years back
for accounting fraud). But it is Friday, September 19, that will go down as a
turning point in American history. The White House committed at least half a
trillion dollars more to re-inflate real estate prices in an attempt to support
the market value junk mortgages
mortgages issued far beyond the ability of debtors to pay and far above the
going market price of the collateral being pledged.
These billions of dollars were devoted to keeping a dream alive the
accounting fictions written down by companies that had entered an unreal world
based on false accounting that nearly everyone in the financial sector knew to
be fake. But they played along with buying and selling packaged mortgage junk
because that was where the money was. Even after markets collapse, fund
managers who steered clear were blamed for not playing the game while it was
going. I have friends on Wall Street who were fired for not matching the
returns that their compatriots were making. And the biggest returns were to be
made in trading in the economys largest financial asset mortgage debt. The
mortgages packaged, owned or guaranteed by Fannie and Freddie alone exceeded
the entire U.S. national debt the cumulative deficits run up by the American
Government since the nation won the Revolutionary War!
This gives an idea of just how large the bailout has been and where the
governments (or at least the Republicans) priorities lie! Instead of waking
up the economy to reality, the government has thrown all its resources to
promote the unreal dream that debts can be paid if not by the debtors
themselves, then by the government taxpayers, as the euphemism goes.
Overnight, the U.S. Treasury and Federal Reserve have radically changed the
character of American capitalism. It is nothing less than a coup dêtat for the
class that FDR called banksters. What has happened in the past two weeks
threatens to change the coming century irreversibly, if they can get away
with it. This is the largest and most inequitable transfer of wealth since the
land giveaways to the railroad barons during the Civil War era.
Even so, there seems little sign that it even may end the free-market patter
talk by financial insiders who have managed to avert public oversight by
appointing non-regulators to the major regulatory agencies and thus created
the mess that Treasury Secretary Henry Paulson now says threatens the bank
deposits and jobs of all Americans. What he really means, of course, are simply
the largest Republican campaign contributors (and to be fair, also the largest
contributors to Democratic candidates on key financial committees).
A kleptocratic class has taken over the economy to replace industrial
capitalism. Franklin Roosevelts term banksters says it all in a nutshell.
The economy has been captured by an alien power, but not the usual suspects.
Not socialism, workers or big government, nor by industrial monopolists or
even by the great banking families. Certainly not by Freemasons and Illuminati.
(It would be wonderful if there were indeed some group operating with centuries
of wisdom behind them, so at least someone had a plan.) Rather, the banksters
have made a compact with an alien power not Communists, Russians, Asians or
Arabs. Not humans at all. The groups cadre is a new breed of machine. It may
sound like the Terminator movies, but computerized Machines have indeed taken
over the world at least, the White Houses world.
Here is how they did it. A.I.G. wrote insurance policies of all sorts of that
people and businesses need: home and property insurance, livestock insurance,
even aircraft leasing. These highly profitable businesses were not the problem.
(They therefore will probably be sold off to pay the companys bad gambles.)
A.I.G.s downfall came from the $450 billion almost half a trillion dollars
it was on the hook for as a result of guaranteeing hedge-fund counterparty
insurance. In other words, if two parties played the zero-sum game of betting
against each other as to whether the dollar would rise or fall against sterling
or the euro, or if they insured a mortgage portfolio of junk mortgages to make
sure that they would get paid, they would pay a teeny tiny commission to A.I.G.
for a policy promising to pay if, say, the $11 trillion U.S. mortgage market
should stumble or if losers placing trillions of dollars in bets on foreign
exchange
derivatives, stock or bond derivatives should somehow find themselves in a
position that so many Las Vegas patrons are in, and be unable to come up with
the cash to cover their losses.
A.I.G. collected billions of dollars on such policies. And thanks to the fact
that insurance companies are a Milton Friedman paradise not regulated by the
Federal Reserve or any other nation-wide agency, and hence able to get the
proverbial free lunch without government oversight writing such policies was
done by computer printouts, and the company collected massive fees and
commissions without putting in much capital of its own. This is what is called
self-regulation. It is how the Invisible Hand is supposed to work.
It turned out, inevitably, that some of the financial institutions that made
billion-dollar gambles usually in the form of a thousand million-dollar
gambles in the course of a few minutes or so, to be precise couldnt pay up.
These gambles all occur in microseconds, at strokes of a keyboard almost
without human interference. In that sense it is not unlike alien pod people
taking over. But in this case they are robot-like machines, hence the analogy I
drew above with the Terminators.
Their sudden rise to dominance is as unforeseen as an invasion from Mars. The
nearest analogy is the invasion of the Harvard Boys, World Bank and U.S.A.I.D.
to Russia and other post-Soviet economies after the Soviet Union was dissolved,
pressing free-market giveaways to create national kleptocracies. It should be a
worrying sign to Americans that these kleptocrats have become the Founding
Fortunes of their respective countries. We should bear in mind Aristotles
observation that democracy is the political stage immediately preceding
oligarchy.
The financial machines that placed the trades that bankrupted A.I.G. were
programmed by financial managers to act with the speed of light in conducting
electronic trades often lasting only a few seconds each, millions of times a
day. Only a machine could calculate mathematical probabilities factored in
regarding the squiggles up and down of interest rates, exchange rates and stock
and bonds prices and prices for packaged mortgages. And the latter packages
increasingly took the form of junk mortgages, pretending to be payable debts
but in reality empty flak.
The machines employed by hedge funds in particular have given a new meaning to
Casino Capitalism. That was long applied to speculators playing the stock
market. It meant making cross bets, lose some and win some and getting the
government to bail out the non-payers. The twist in the past two weeks turmoil
is that the winners cannot collect on their bets unless the government pays the
debts that the losers are unable to cover with their own money.
One would have thought that this requires some degree of control over the
government. The activity probably never should have been licensed. In fact, it
never was licensed, and hence nor regulated. But there seemed to be a good
reason: Investors in hedge funds had to sign a paper saying that they were rich
enough to afford to lose their money on this financial gambling. Your average
mom and pop investors were not permitted to participate. Despite the high
rewards that millions of tiny trades generated, they were deemed too risky for
the uninitiated lacking trust funds to play with.
A hedge fund does not make money by producing goods and services. It does not
advance funds to buy real assets or even lend money. It borrows huge sums to
leverage its bet with nearly free credit. Its managers are not industrial
engineers but mathematicians who program computers to make cross-bets or
straddles on which way interest rates, currency exchange rates, stock or bond
prices may move or the prices for packaged bank mortgages. The packaged loans
may be sound or they may be junk. It doesnt matter. All that matters is making
money in a marketplace where most trades last only a few seconds. What creates
the gains is the price fibrillation volatility.
This kind of transaction may make fortunes, but it is not wealth creation in
the form that most people recognize. Before the Black-Scholes mathematical
formula for calculating the value of hedge bets, this kind of put and call
option was too costly to provide much profit to anyone except the brokerage
houses. But the combination of powerful computers and the innovation of
almost free credit and free access to the financial gambling tables has made
possible a frenetic back-and-forth maneuvering.
So why has the Treasury found it necessary to enter this picture at all? Why
should these gamblers be bailed out, if they had enough to lose without having
to become public wards by going on welfare? Hedge fund trading was limited to
the very rich, for investment banks and other institutional investors. But it
became one of the easiest ways to make money, loaning funds at interest for
people to pay out of their computer-driven cross-trades. And almost as fast as
it was made, this revenue was paid out in commissions, salaries and annual
bonuses reminiscent of Americas Gilded Age in the years prior to World War I
years before the income tax was introduced in 1913. The remarkable thing about
all this money was that its recipients didnt even have to pay normal income
tax on it. The government let them call it capital gains, which meant that
the money was taxed at only a fraction of the rate that incomes were taxed.
The pretense, of course, is that all this frenetic trading creates real
capital. It certainly does not do so in the classical 19th-century concept of
capital. The term has been decoupled from producing goods and services, hiring
wage labor or from financing innovation. It is as much capital as the right
to conduct a lottery and collect the winnings from the hopes of the losers. But
then, casinos from Las Vegas to riverboats have become a major growth
industry, muddying the language of capital, growth and wealth itself.
For the gaming tables to be closed and the money paid out, the losers must be
bailed out Fannie Mae, Freddie Mac, A.I.G. and who knows what to come? This
is the only way to solve the problem of how companies that already have paid
out their revenue to their managers and stockholders instead of putting it in
reserves are to collect their winnings from insolvent debtors and insurance
companies. These losers also have paid out their income to their financial
managers and insiders (along with the usual patriotic contributions to the
political candidates on the key committees in charge of deciding the nations
financial structuring) .
This has to be orchestrated well in advance. It is necessary to buy politicians
and give them a plausible cover story (or at least a well-crafted set of
poll-tested euphemisms) to explain to voters just why it was in the public
interest to bail out gamblers. Good rhetoric is needed to explain why the
government should let them go into a casino and let them keep all their
winnings while using public funds to make good on the losses of their
counterparties.
What happened on September 18-19 took years of preparation, capped by a faux
ideology crafted by public-relations think tanks to be broadcast under
emergency conditions to panic Congress and voters right before the
presidential election. This seems to be our September election surprise. Under
staged crisis conditions, Pres. Bush and Treasury Secretary Paulson are now
calling for the country to come together in a War on Defaulting Homeowners.
This is said to be the only hope to save the system. (What system is this?
Not industrial capitalism, or even banking as we know it.) The largest
transformation of Americas financial system since the Great Depression has
been compressed into just two weeks, starting with the doubling of Americas
national debt on September 7 with the nationalization of Fannie Mae and Freddie
Mac. (My computers spellchecker will not permit me to use the euphemism
conservatorship that Mr. Paulson applied to
bailing out the Fannie Mae and Freddie Mac fraudsters.)
Economic theory used to explain that profits and interest were a return for
calculated risk.
But today, the name of the game is capital gains and computerized gambling on
the direction of interest rates, foreign currencies and stock prices and when
bad bets are made, bailouts are the calculated economic return for campaign
contributions. But this is not supposed to be the time to talk of such things.
We must act now to protect our nations economic health from serious risk,
intoned Pres. Bush on September 19. What he meant was that the White House must
make the Republican Partys largest group of campaign contributors whole Wall
Street, that is by bailing out their bad gambles. There will be ample
opportunity to debate the origins of this problem. Now is the time to solve
it. In other words, dont make this an election issue. In our nations
history there have been moments that require us to come together across party
lines to address major challenges. This is such a moment. Right before the
presidential
election! The same guff was heard earlier on Friday morning from Sec. Paulson:
Our economic health requires that we work together for prompt, bipartisan
action. The broadcasters said that half a trillion dollars was discussed for
this days maneuverings.
Much of the blame should go to the Clinton Administration for leading the call
to repeal Glass-Steagall in 1999, letting the banks merge with casinos. Or
rather, the casinos have absorbed the banks. That is what has put the savings
of Americans at risk.
But does this really mean that the only solution is to re-inflate the real
estate market? The Paulson-Bernanke plan is to enable the banks to sell off the
homes of five million home mortgage debtors faced with default or foreclosure
this year! Homeowners with exploding adjustable-rate mortgages will lose
their homes, but the Fed will pump enough credit into the mortgage-lending
agencies to enable new buyers to go deeply enough into debt to take the junk
mortgages off the hands of the gamblers who presently own them. Time for
another financial and real estate bubble to bail out the junk mortgage lenders
and packagers.
America has entered into a new war a War to Save Computerized Derivative
Traders. Like the Iraq war, it is based largely on fictions and entered into
under seeming emergency conditions to which the solution has little relation
to the underlying cause of the problems. On financial security grounds the
government is to make good on the collateralized debt obligations packaged
(CDOs) that Warren Buffett has called weapons of mass financial destruction.
Hardly by surprise, this giveaway of public money is being handled by the same
group that warned the country so piously about weapons of mass destruction in
Iraq. Pres. Bush and Treasury Secretary Paulson have piously announced that
this is no time for partisan disagreements over this shift of public policy to
favor creditors rather than debtors. There is no time to make the biggest
bailout in election history an election issue. Not an appropriate time to
debate whether it is a good thing to re-inflate housing prices to a level that
will continue to oblige new home buyers to go so deeply into debt that they
must pay some 40 percent of their take-home pay on housing.
Remember when President Bush and Alan Greenspan informed the American people
that there was no money left to pay Social Security (not to mention Medicare)
because at some future date (a decade from now? 20 years? 40 years?) the system
might run a deficit of what now seems to be merely a trivial trillion dollars
spread over many, many years. The moral was that if we cant figure out how to
pay, lets plow the program under right now.
Mr. Bush and Greenspan did have a helpful solution, of course. The Treasury
could turn Social Security and medical insurance money over to Bear Stearns,
Lehman Brothers and their brethren to invest at the magic of compound
interest.
What would have happened to U.S. Social Security had this been done? Perhaps we
should view the past two weeks events as having assigned to Wall Street
gamblers all the money that has been set aside since the Greenspan Commission
in 1983 shifted the tax burden onto FICA wage withholding. It is not retirees
who are being rescued, but the Wall Street investors who signed papers saying
that they could afford to lose their money. The Republican slogan this November
should be Gambling insurance, not health insurance.
This is not how the much-vaunted Road to Serfdom was mapped out to be.
Frederick Hayek and his Chicago Boys insisted that serfdom would come from
government planning and regulation. This view turned upside down the classical
and Progressive Era reformers who depicted government as acting as societys
brain, its steering mechanism to shape markets and free them from income
without playing a necessary role in production. The theory of democracy rested
on the assumption that voters would act in their self-interest. Market
reformers made a kindred happy assumption that consumers, savers and investors
would promote economic growth by acting with full knowledge and understanding
of the dynamics at work. But the Invisible Hand turned out to be accounting
fraud, junk mortgage lending, insider dealing and a failure to relate the
soaring debt overhead to the ability of debtors to pay all of this mess
seemingly legitimized by computerized trading models,
and now blessed by the Treasury.
Michael Hudson is a former Wall Street economist specializing in the balance of
payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase &
Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990
he helped established the worlds first sovereign debt fund for Scudder Stevens
& Clark. Dr. Hudson was Dennis Kucinichs 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) He can be reached via his website, [EMAIL PROTECTED] com
[Non-text portions of this message have been removed]
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