By Mike Whitney
06/10/08 '"ICH" -- - Years from today, when the current financial crisis is over, historians are likely to agree that it would have been far better if the Bush administration had declared a state of emergency earlier in the process so that the necessary steps could have taken to avoid a complete financial meltdown. The media could have been used to bring the American people up to date on market-related developments and educated in the bizarre language of structured finance. Knowledge is power; and power can prevent panic.
Now we're in a terrible fix. People are scared and removing their money from the banks and money markets which is intensifying the freeze in the credit markets and driving stocks into the ground like a tent stake. Meanwhile, our leaders are "caught in the headlights", still believing they can "finesse" their way through the biggest economic cataclysm since the Great Depression. It's madness.
If something is not done to increase the flow of credit immediately, the stock market will tumble, unemployment will spike, and many businesses will grind to a standstill. We could be just days away from a severe shock to the system. Secretary of the Treasury Henry Paulson's $700 billion bailout does not focus on the fundamental problems and is likely to fail. At best, it puts off the day of reckoning for a few weeks or months. Contingency plans should be put in place so the country does not have to undergo post-Katrina bedlam.
Does Congress have any idea of the mess they've made by passing the Bailout bill? Do they even read the papers or are they so isolated in their Capital Hill bubble-world that they're entirely clueless? Did any Senator or congressman even notice, that while they were busy mortgaging off America's future, the stock market was plummeting to new lows? Between the time the ballots were cast on Paulson's bailout, and the announcement of the final tally (which was approved by a generous margin) the market went from a 310 point gain to a 157 point loss; a whopping 467 plunge in less than two hours.
Thus spake the Market: "Paulson's bill is a fraud!"
Listen up, Congress: This massive trillion dollar deleveraging process cannot be stopped. The system is purging credit excesses which are unsustainable. The levies you're building with this $700 billion bill may plug a few holes, but it won't stop the flood. Economist Ludwig von Mises put it like this:
"There is no means of avoiding the final collapse of a boom brought on by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
The best course of action is to soften the blow as much as possible for underwater homeowners and let the market correct as it should. Otherwise the dollar will be torn to shreds.
Look around; the six year Bush economic boom is vanishing before our eyes. Manufacturing is contracting, wages are stagnant, good paying jobs are headed overseas, unemployment is rising, and the middle class has shrunk every year since Bush took office. Is this the miracle of the "Washington consensus" and neoliberalism? The prosperity of the Bush era is as fake as the weapons of mass destruction; it's all smoke and mirrors. The Federal Reserve created the massive equity bubble in housing and finance through its low interest monetary policies. Cheap money is the rich man's method of social engineering; swift and lethal. The public be-damned. Now that the bubble is bursting, Congress needs to decide what it can do to soften the hard landing. Paulson's bill does not do that. In fact, even Paulson's supporters admit it's a flop. Here's what Martin Feldstein had to say in a Wall Street Journal editorial:
"The recent financial recovery plan that Congress enacted will not rebuild lending and credit flows. That requires a program to stop a downward overshooting of house prices and the resulting mortgage defaults....The prospect of a downward spiral of house prices depresses the value of mortgage-backed securities and therefore the capital and liquidity of financial institutions. Experts say that an additional 10% to 15% decline in house prices is needed to get back to the prebubble level. That decline would double the number of homes with negative equity, raising the total to 40% of all homes with mortgages. The mortgages of five million homeowners would then exceed the value of their homes by 30% or more, which could prompt millions of defaults." (Martin Feldstein, "The Problem is still Falling house Prices", WS Journal)
Get it? Feldstein doesn't give a hoot about the struggling homeowner who is worried-sick about losing his home in foreclosure. He just wants to make sure that the banks get their blood-money back, and the only way they can do that is by putting a floor under housing prices so mortgage-backed securities (MBS) and all the other derivatives that are gunking-up the financial system begin to stabilize. Even though the article is little more than a paean to human greed; it does admit that Paulson's bailout falls short of its objectives. It won't work.
Not only that, but it elevates G-Sax ex-chairman to Finance Czar, with almost unlimited powers to buy whatever toxic "structured" garbage he wants without any real oversight. Who will stop the Treasury Secretary if he decides to waste the taxpayers money on the full range of impaired assets including complex derivatives, collateralized debt obligations (CDOs), low-rated MBS, or even credit default swaps (CDS), which were sold in unregulated trading and which are oftentimes nothing more than side-bets made by speculators with no direct connection to the housing market?
Is that what Congress approved? What if he decides to spend the whole $700 billion buying back mortgage-backed bonds from China and Europe, leaving US banks still underwater? (except for Goldman, of course) It's possible; especially if he thinks China will stop purchasing our debt if we don't back up our worthless bonds with cold hard cash.
This bailout has DISASTER written all over it.
Consider this from a September 29 report in the Washington Post:
“Twenty of the nation's largest financial institutions owned a combined total of $2.3 trillion in mortgages as of June 30. They owned another $1.2 trillion of mortgage-backed securities. And they reported selling another $1.2 trillion in mortgage-related investments on which they retained hundreds of billions of dollars in potential liability, according to filings the firms made with regulatory agencies. The numbers do not include investments derived from mortgages in more complicated ways, such as collateralized debt obligations.” (from Paul Craig Roberts, "Can a Bailout Succeed", counterpunch.org)
So, how does Paulson expect to recapitalize the banks--which are loaded up with $2.4 trillion in mortgage-related investments--when congress's bill allocates a paltry $700 billion for the rescue plan? It's impossible. Just as it is impossible to keep prices artificially high with this kind of government buy-back program. These structured investments were vastly overpriced to begin with due to the fact that the market was hyperinflated with the Fed's low interest credit. As Doug Noland said, "This Credit onslaught fostered huge distortions to the level and pattern of spending throughout the entire economy. It is today impossible both to generate sufficient Credit and to main previous patterns of spending. Economic upheaval and adjustment are today unavoidable." (Doug Noland's Credit Bubble Bulletin)
Yes, and "economic upheaval" leads to political upheaval and blood in the streets. Is that what Bush wants; a chance to deploy his North Com. troops within the United states to put down demonstrations of middle class people fighting for bread crumbs?
In less than 8 years, the Financial Sector Debt tripled, mortgage debt doubled, and financial borrowing rose 75 percent. Why? Was it because the US was producing more goods that the world wanted? Was it because production rose sharply or demand doubled?
No, it was because of asset-inflation; a chimera created by the illusionists at the Federal Reserve and the investment banks. That's the source of the massive credit expansion which is presently collapsing and pushing the world towards another Great Depression. As Henry Liu said in his article “Liquidity Boom and Looming Crisis” in the Asia Times:
"Unlike real physical assets, virtual financial mirages that arise out of thin air can evaporate again into thin air without warning. As inflation picks up, the liquidity boom and asset inflation will draw to a close, leaving a hollowed economy devoid of substance. …A global financial crisis is inevitable”
The man who is most responsible for the current meltdown, Alan Greenspan, even admitted that he spotted the humongous equity bubble early on but refused to do anything about it. Here's a clip from an article by Maestro in the Wall Street Journal:
"The value of equities traded on the world's major stock exchanges has risen to more than $50 trillion, double what it was in 2002. Sharply rising home prices erupted into major housing bubbles world-wide, Japan and Germany (for differing reasons) being the only principal exceptions." ("The Roots of the Mortgage Crisis", Alan Greenspan, Wall Street Journal)
This admission proves Greenspan's culpability. If he knew that stock prices had doubled their value in just 3 years, then he also knew that equities had not risen due to increases in productivity or demand.(market forces) The only reasonable explanation for the asset inflation is the deeply-flawed monetary policies of the Fed. As his own mentor, Milton Friedman famously stated, "Inflation is always and everywhere a monetary phenomenon". Any capable economist would have known that the explosion in housing and equities prices was a sign of uneven inflation. Now the bubble has popped and the tremors are likely to be felt through the global economy.
No one in Congress has the foggiest idea of what is going on in the economy. They're all in La-la Land. The credit markets are paralyzed. The capital-starved banks are dramatically cutting back on lending and making it nearly impossible for consumers to borrow or businesses to even carry out daily operations like payroll. The commercial paper market has slowed to a crawl, forcing cash strapped companies to try and access existing credit lines or sell corporate bonds. Money market rates are soaring but wary depositors keep withdrawing their money putting more pressure on financial institutions. The whole system is wading through quicksand. The banking system is breaking apart before our eyes. The $700 billion "rescue package" will not relieved the situation at all. In fact, the various rates (like Libor, Libor-OIS spread, or the TED spread) which indicate the amount of stress in interbank lending have stayed at record highs signaling huge dislocations in the near future. Are we headed for an October stock market crash?
This is from the Times Online:
"US banks borrowed a record $367.8 billion (£208 billion) a day from the Federal Reserve in the week ended October 1. Data from the US central bank shows how much financial institutions are relying on the Fed in its role as lender of last resort as short-term funding becomes almost impossible to find elsewhere. Banks' discount window borrowings averaged $367.80 billion per day in the week ended October 1, nearly double the previous record daily average of $187.75 billion last week."
$368 billion a day, just to keep the banking system from collapsing. Did they forget to mention that on FOX News?
And, yes; the Fed has started up the printing presses as everyone feared from the beginning. This tidbit appeared on the op-ed page of Saturday's Wall Street Journal:
"Thursday, the Federal Reserve released the latest data on its balance sheet, which has ballooned by some $500 billion to $1.5 trillion in the past month. That may sound alarming, but it beats cutting interest rates across the board to prop up the banks. Those extra Fed assets and liabilities can be worked off as the crisis passes without the long-term inflationary impact of pushing interest rates still further into negative territory. By lending freely in a bank run until they stop running, the Fed can make banks pay for their desire for safety while contributing to financial stability." (Wall Street Journal)
"$1.5 trillion"? But the Fed's balance sheet is only $900 billion. Where is the extra money coming from? Gutenberg, no doubt.
Rep. Peter DeFazio made an impassioned plea on the floor of the House in a failed effort to stop Paulson's bailout. It's a good summary of the bill's shortcomings as well as an indictment of its author:
Rep. Peter DeFazio: "This $700 billion bill is not aimed at the real economy in America. Not one penny of it will go to Main Street. It is aimed solely at the froth on Wall Street, the speculators on Wall Street, the non productive people on Wall Street the certifiably smart , masters of the universe, like Secretary of the Treasury Henry Paulson who created these weapons of financial destruction and now, lit the fuse by claiming there would be worldwide economic collapse if we didn't pass this bill to bail out Wall Street....I believe there are simpler answers. I just came from a meeting with William Isaacs who was head of the FDIC, they deal with banks. Mr. Paulson was a speculator on Wall Street; he deals with speculation. He doesn't understand regulative banking. (What is happening is) there is a tremendous amount of pressure being applied by some very powerful creditors such as the People's Republic of China who own a lot of this junk ($450 billion) and they want their money back or they're threatening us. That is not a good reason for going ahead with this faulty proposal. It does not deal with the underlying problems in housing.
If we don't deal with the foreclosures and the deteriorating values, then, when the values drop another 5 or 10 percent, we're going to find there's another trillion dollars in junk securities out there and we will have already maxed out our credit and more people will have already lost their jobs. People are not spending because they are afraid they will lose their jobs. Their wages haven't increased. They are worried about the real economy, not the Wall Street economy. This bill will not solve the underlying problems.
There is a cheaper, low cost alternative. The FDIC should declare an emergency. That would give them the power to assess the same guarantee to all bank depositors. (According to Isaacs) That would immediately free up all interbank lending. It would immediately bring a flood of foreign deposits into the US because we would be a safe haven for depositors. But Isaacs is a regulator; a regulator with experience who piloted this country out of the savings and loans crisis and saved us a bunch of money. He's not a big-time Wall Street speculator who came down here and got appointed by George Bush with three-quarters of a billion dollars in his pocket from money he had made creating these financial weapons of mass destruction. So, we are listening to the wrong guy here...Don't be stampeded!" (Watch the whole 5 minute video http://www.infowars.com/?p=5056)
DeFazio is exactly right, especially about Paulson. As the New York Times article on Friday, "Agency’s ’04 Rule Let Banks Pile Up New Debt, and Risk", points out, Paulson, as chairman of Goldman Sachs, was one of the leaders of the five investment banks, who duped the SEC into loosening the rules on capital requirements which created the problems we are now facing.
According to the Times:
(The Big 5 investment banks) "wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments."
This is the crux of the matter. Paulson polluted the system by bending the rules for the prudent leveraging of assets so he and his dodgy friends could maximize their profits. It's all about the bottom line. Paulson walked away with hundreds of millions of dollars in a scam that has now put the nation's economic future at risk.
Last year the five Wall Street behemoths had "combined assets of more than $4 trillion". Now, everyone can see that it was all froth created through extreme leveraging that was intentionally ignored by S.E.C. boss Chris Cox. Now the banks are getting clobbered by short-sellers that are going from one financial institution to the next making them prove that they are sufficiently capitalized. They know its all a smokescreen, so they are saying, "Show me the money". One by one, the investment banks have fallen by the wayside. If the SEC was really operating in the public's interest, they'd being thumbing through G-Sax and Morgan Stanley's balance sheets right now making them prove that they're solvent. Instead, Cox has declared a moratorium on short selling while the investment banks have positioned themselves to get multi-million dollar taxpayer treats for their crappy assets. Where's the justice?
As for Paulson's "No Banker Left Behind" boondoggle; it is not an effective way to recapitalize the banks and it doesn't fix the systemic problems in the credit markets. All it does is put the US at greater risk of losing its Triple A rating. If that happens it will be impossible to attract foreign capital which would be the equivalent of detonating a nuclear bomb in every city in the country. This is not the time to be putting more chips on the table like a riverboat gambler. It's time to show judgment and restraint, otherwise this whole thing will blow up. Emergency measures should be thoroughly examined so that liquidity is provided for the credit markets as fast as possible. The markets are already in meltdown-mode.
"Real" economists--not the ideological hacks and loose cannons in the Bush administration--understand the fundamental problems and have generally agreed on a solution. It is a difficult issue, but one that anyone can grasp if they make the effort. Watch this 8 minute video with Nobel Prize winning economist, Joseph Stiglitz, http://www.cnbc.com/id/15840232?video=874100965&play=1
Stiglitz says: "There is a growing consensus among economists that any bail-out based on Paulson's plan won't work. If so, the huge increase in the national debt and the realization that even $700bn is not enough to rescue the US economy will erode confidence further and aggravate its weakness.
Stiglitz's point is proven by the fact that the Dow Jones cratered after reports circulated that the House had passed the bailout. Paulson's fiasco has not calmed the markets at all; in fact, investors have begun to race for the exits. Confidence is draining from the system faster than the deposits in the dwindling money market accounts.
Stiglitz adds:
"This is not a good bill...It is based on "trickle down" economics which says that is you throw enough money at Wall Street and than some of it will go into ways that help the economy, but it is not really doing what needs to be done to recapitalize the banking system, stem the hemorrhaging of foreclosures, and deal with the growing unemployment..... We have seen these problems with banks before we know how to repair them. (Stiglitz worked with the World Bank during many similar crises) So why didn't they use these "tried and proven" methods? They (Paulson) decided that rather than a capital injection; they would try the almost impossible task of buying up all these bad assets, millions of mortgages and complex products, and hope that this will somehow solve the problem. It doesn't fix the big hole in the banks balance sheets, unless they vastly overpay for these products (Mortgage-backed securities)"
This isn't rocket science. Many of the economists who disapproved of the bill have been through this drill before and they know what to do. The way to proceed is to have the US Treasury buy preferred shares in the banks that are not already technically insolvent. (The insolvent banks will have to be unwound by the FDIC) This will give the banks the capital they need to continue operations while protecting the taxpayer who gets an equity share with "upside potential" when the bank starts making profits again.
This is how one goes about recapitalizing the banking system IF that is the real intention. Paulson's phony-baloney operation suggests he has something else up his sleeve; some ulterior motive like rewarding his friends on Wall Street with boatloads of taxpayer money or buying-back the toxic mortgages from foreign investors so they don't stop buying US debt. Here's how Bloomberg's Jonathan Weil sums it up:
"If the government wants to save dying banks before they take others down with them, it should choose the clean and direct path: Inject capital into them. Take ownership stakes in return. And, where that's not feasible, seize them and sell their assets in an orderly way, just as the Resolution Trust Corp. did after the 1980s savings-and-loan crisis.
Infusing capital directly, though, was too simple for Paulson. It lacked subterfuge. He decided the way to save the financial system from the evils of structured finance was through more structured finance.
Instead of asking Congress to let Treasury recapitalize needy banks, he proposed buying some of their troubled assets at above-market prices. This would have let other banks create phony capital by writing up the values of similar assets on their own balance sheets, using Treasury's prices as their guide. Small Wonder.
In short, Paulson's plan was one part robbery (with the banks doing the robbing) and one part accounting sleight of hand. No wonder House members rejected it.(at first)
If Paulson or congressional leaders devise a Plan B, they should look to the example of Fortis, Belgium's biggest financial-services company. This week, the governments of Belgium, the Netherlands and Luxembourg invested 11.2 billion euros ($16.3 billion) in Fortis. In exchange, they got ownership of almost half its banking business.
That's how a government intervention is supposed to work. The company gets fresh capital, which has the added benefit of not being fake. The buyers get equity. Legacy shareholders get slammed with dilution. And if the company recovers, the government can sell shares to the public later, maybe even at a profit." (Jonathan Weil, Bloomberg News)
Direct capital injections is the best way to recapitalize the banks and save the taxpayer money. Paulson's plan is just more flim-flam intended to reflate the value of sketchy assets. So far, investors and taxpayers are equally skeptical about the bill's prospects. Interbank lending remains clogged and the VIX, the "fear gauge", is still rising to record levels. Paulson hasn't fooled anyone.
This bill does nothing to reduce foreclosures, reassure the markets, decrease unemployment, unfreeze the bond market, increase consumer spending, or put a floor under the stumbling dollar. All it does is hand out a few ripe plums to Paulson's buddies on Wall Street while (temporarily) soothing the frayed nerves of China's Finance Minister. That doesn't mean that China will be increasing its stash of US Treasuries or other US financial assets anytime soon. As the saying goes: "Fool me once, shame on you. Fool me twice, ..."
Worst of all, Paulson's bailout bill wastes precious resources on a plan that is considerably wide of the mark. These problems have to be dealt with quickly to avert a larger catastrophe. Here's how Nouriel Roubini sees it:
"It is now clear that the US financial system - and now even the system of financing of the corporate sector - is now in cardiac arrest and at a risk of a systemic financial meltdown. I don’t use these words lightly...The Commercial paper market is shut down...Corporations have no access to long or short term credit markets. Brokers are increasingly not dealing with each other. The interbank market is seizing up...This cannot continue for more than a few days. It is the economic equivalent to cardiac arrest." (Nouriel Roubini's Global EconoMonitor)
The levies have already broken, and the water is flooding into the city. The Federal Reserve will be forced to act. Expect an emergency rate cut of 50 basis points or more in the next 10 days coordinated with cuts in the other G-7 countries. Also, expect another bailout by the time Obama or McCain take office. As the French premier, Francois Fillon, warned on Saturday the world is “on the edge of the abyss”.
tirsdag den 7. oktober 2008
Down the Road to Serfdom By Ann Berg
06/10/08 "Anti War" -- -Threatening an imminent economic collapse, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke have bamboozled Congress into enacting the most brazen confiscatory scheme ever concocted by government. The scheme would have American taxpayers fork over $700 billion of their cash to help recapitalize some of the country's biggest banks – the same banks that recently larded their bigwigs with $62 billion in bonuses.
Sensing a pushback by the world's dollar-surplus regions – Asia and the Mideast – to finance the largest debtor economy, the U.S. government will now plunder its own countrymen to keep capital running "uphill." As with most statist remedies, it is being marketed as a boon for Main Street, tantalizing its inhabitants with the prospect of profits wafting westward from those malodorous Wall Street investments. However, Congress has inured the Treasury from accountability and legal recourse, giving Paulson dictatorial power over the nation's financial sector. Rather than let this bloated segment of the economy shrink and consolidate, Paulson and his successor will extend it unlimited life support, bloodletting everything else, in a final ruin of the nation.
The problem that is vexing the financial system, we are told, is the pile of mortgage-backed securities held by financial institutions. These have lost value as the underlying assets – the actual homes – have plummeted in value. But this is a fraud. This precipitating event no more caused the financial fiasco than the murder of someone named Ferdinand provoked World War I, as taught in elementary school.
Remember the war? Not just the current and future wars, but the one that gave us the fiat monetary system: the war in Vietnam. Prior to that calamity the world operated under the Bretton Woods monetary system, a post-World War II arrangement that pegged all currencies to the dollar and made only the dollar convertible to gold, thereby ensuring the dollar's reserve currency status. During the 1950s, the system seemed invulnerable as U.S. gold reserves exceeded foreign liabilities by threefold. By 1970, however, as the U.S. inflated its money supply to fund the Southeast Asian conflict, the monetary position of the U.S. reversed, with foreign liabilities exceeding gold reserves fivefold. When France demanded gold for dollars at the statutory rate of $35/oz., President Nixon shut the gold window for good. As a result, currencies went from a fixed to a floating (and pegged) rate system in 1973. It has vexed economists ever since.
This system of fiat currencies has given peculiar leverage to the U.S. dollar. As the world's reserve currency, the dollar has preserved faith in its purchasing power among its holders, including foreign central banks. This faith and willingness to buy U.S. low-yield debt instruments such as Treasuries has enabled the U.S. public and private sectors to go on the largest borrowing binge the world has ever seen, manifesting in the gargantuan twin deficits of budget and trade. These imbalances would never have occurred under a gold standard. Credit would have been constrained by statutory levels of gold reserves in the banking system, instead of being created out of thin air by the 40-1 leverage levels granted by the SEC in 2004 to the five now defunct investment banks. Also, the huge influx of imported goods would have halted due to inflationary pressures in the exporting countries – a phenomenon deemed the "price-specie flow mechanism" by 18th century philosopher David Hume.
Robert Mundell, a Nobel Prize-winning economist who sparred with Milton Friedman over floating rates vs. the gold standard, had this to say about fiat currencies:
"The present international monetary system neither manages the interdependence of currencies nor stabilizes prices. Instead of relying on the equilibrium produced by [gold's] automaticity, the superpower has to resort to 'bashing' its trading partners, which it treats as enemies."
So here we are: a phony monetary system, $3 trillion wasted on wars, and a citizenry mired in debt. And what does Congress do? It adds more debt – a trillion dollars, just for starters, since once starting down this slippery slope, it won't be able to stop. It then gives the Treasury the green light to buy securities that are trading as low as 20 cents on the dollar at the hold-to-maturity value, i.e., par! Not surprisingly it has engaged in a media blitz to "sell" this boondoggle, convincing the taxpayer that this bucket of dross will one day turn to platinum. Sensing that working stiffs are a little perturbed about the fleecing, it has leapt to the offense: "No, this is not a bailout of Wall Street. This is a rescue plan for Main Street." By embracing the mortgage waste dump, U.S. citizens are supposedly saving jobs and retirement dreams. They are told that interest-free car loans will stream from dealerships and refi windows will again beckon, even to those with homes worth half the value of mortgage paper.
With Congress granting the Treasury (along with an "oversight" board) almost unlimited power over the country's financial landscape, the U.S. has terminated its democracy and is well on the Road to Serfdom. As Friedrich Hayek explained in 1944, "Economic control is not merely control of a sector of human life that can be separated from the rest; it is the control of the means for all our ends. And whoever has sole control of the means must also determine which ends are to be served, which values are to be rated higher and which lower – in short, what men should believe and strive for."
Farewell, America.
Ann Berg has spent a 30-year career in commodities and capital markets as a trader, consultant, and writer. While a commodity futures trader and Director of the Chicago Board of Trade, she advised foreign governments, NGOs (the United Nations, World Bank), think tanks (Catalyst Institute), and multinational and foreign corporations on a variety market-related issues. She was also a frequent conference speaker at international derivatives markets forums. In recent years, she has contributed articles to several commodities/capital markets publications, including Futures Magazine, Traders Source, Financial Exchange, and the Financial Times editorial page. Berg is also an artist. She is currently working on a body of work entitled The Unknown Unknowns – The Things You Don’t Know You Don’t Know, which explores U.S. national security policy.
Sensing a pushback by the world's dollar-surplus regions – Asia and the Mideast – to finance the largest debtor economy, the U.S. government will now plunder its own countrymen to keep capital running "uphill." As with most statist remedies, it is being marketed as a boon for Main Street, tantalizing its inhabitants with the prospect of profits wafting westward from those malodorous Wall Street investments. However, Congress has inured the Treasury from accountability and legal recourse, giving Paulson dictatorial power over the nation's financial sector. Rather than let this bloated segment of the economy shrink and consolidate, Paulson and his successor will extend it unlimited life support, bloodletting everything else, in a final ruin of the nation.
The problem that is vexing the financial system, we are told, is the pile of mortgage-backed securities held by financial institutions. These have lost value as the underlying assets – the actual homes – have plummeted in value. But this is a fraud. This precipitating event no more caused the financial fiasco than the murder of someone named Ferdinand provoked World War I, as taught in elementary school.
Remember the war? Not just the current and future wars, but the one that gave us the fiat monetary system: the war in Vietnam. Prior to that calamity the world operated under the Bretton Woods monetary system, a post-World War II arrangement that pegged all currencies to the dollar and made only the dollar convertible to gold, thereby ensuring the dollar's reserve currency status. During the 1950s, the system seemed invulnerable as U.S. gold reserves exceeded foreign liabilities by threefold. By 1970, however, as the U.S. inflated its money supply to fund the Southeast Asian conflict, the monetary position of the U.S. reversed, with foreign liabilities exceeding gold reserves fivefold. When France demanded gold for dollars at the statutory rate of $35/oz., President Nixon shut the gold window for good. As a result, currencies went from a fixed to a floating (and pegged) rate system in 1973. It has vexed economists ever since.
This system of fiat currencies has given peculiar leverage to the U.S. dollar. As the world's reserve currency, the dollar has preserved faith in its purchasing power among its holders, including foreign central banks. This faith and willingness to buy U.S. low-yield debt instruments such as Treasuries has enabled the U.S. public and private sectors to go on the largest borrowing binge the world has ever seen, manifesting in the gargantuan twin deficits of budget and trade. These imbalances would never have occurred under a gold standard. Credit would have been constrained by statutory levels of gold reserves in the banking system, instead of being created out of thin air by the 40-1 leverage levels granted by the SEC in 2004 to the five now defunct investment banks. Also, the huge influx of imported goods would have halted due to inflationary pressures in the exporting countries – a phenomenon deemed the "price-specie flow mechanism" by 18th century philosopher David Hume.
Robert Mundell, a Nobel Prize-winning economist who sparred with Milton Friedman over floating rates vs. the gold standard, had this to say about fiat currencies:
"The present international monetary system neither manages the interdependence of currencies nor stabilizes prices. Instead of relying on the equilibrium produced by [gold's] automaticity, the superpower has to resort to 'bashing' its trading partners, which it treats as enemies."
So here we are: a phony monetary system, $3 trillion wasted on wars, and a citizenry mired in debt. And what does Congress do? It adds more debt – a trillion dollars, just for starters, since once starting down this slippery slope, it won't be able to stop. It then gives the Treasury the green light to buy securities that are trading as low as 20 cents on the dollar at the hold-to-maturity value, i.e., par! Not surprisingly it has engaged in a media blitz to "sell" this boondoggle, convincing the taxpayer that this bucket of dross will one day turn to platinum. Sensing that working stiffs are a little perturbed about the fleecing, it has leapt to the offense: "No, this is not a bailout of Wall Street. This is a rescue plan for Main Street." By embracing the mortgage waste dump, U.S. citizens are supposedly saving jobs and retirement dreams. They are told that interest-free car loans will stream from dealerships and refi windows will again beckon, even to those with homes worth half the value of mortgage paper.
With Congress granting the Treasury (along with an "oversight" board) almost unlimited power over the country's financial landscape, the U.S. has terminated its democracy and is well on the Road to Serfdom. As Friedrich Hayek explained in 1944, "Economic control is not merely control of a sector of human life that can be separated from the rest; it is the control of the means for all our ends. And whoever has sole control of the means must also determine which ends are to be served, which values are to be rated higher and which lower – in short, what men should believe and strive for."
Farewell, America.
Ann Berg has spent a 30-year career in commodities and capital markets as a trader, consultant, and writer. While a commodity futures trader and Director of the Chicago Board of Trade, she advised foreign governments, NGOs (the United Nations, World Bank), think tanks (Catalyst Institute), and multinational and foreign corporations on a variety market-related issues. She was also a frequent conference speaker at international derivatives markets forums. In recent years, she has contributed articles to several commodities/capital markets publications, including Futures Magazine, Traders Source, Financial Exchange, and the Financial Times editorial page. Berg is also an artist. She is currently working on a body of work entitled The Unknown Unknowns – The Things You Don’t Know You Don’t Know, which explores U.S. national security policy.
Det Frie Marked og Eksakt Videnskab.
USA har aldrig været et frit marked. Allerede den første "substantive legislation passed by the first Congress." - The Tariff Act of 1789 - under George Washington, var en protektionistisk lovgivning som skulle beskytte amerikanske producenter mod konkurrence fra teknologisk højere udviklede industrier i Europa.
Senator for Kentucky, Henry "The Great Compromiser" Clay, udtalte 43 år senere i 1832 at "The call for free trade, is as unavailing as the cry of a spoiled child ... It has never existed; it will never exist."
Derfor virker det ærlig talt også lidt som grundlagsløs snak, når nogle taler om godheden af det selv-regulerende marked, for hvis alle markeder man hidtil har kendt til har været underlagt politisk styring har der jo aldrig eksisteret noget selv-regulerende marked i samfund af en kompleksitet som er blot relativt sammenlignelig med nutidens, og derfor er det rent teoretisk. Man TROR det vil virke sådan. Det lyder ret hokus-pokus i mine ører.
Økonomi - når vi taler om denne størrelsesorden - er ikke nogen eksakt videnskab, idet man ikke transkulturelt kan replikere forskningsresultater i kontrollerede miljøer som det er tilfældet indenfor naturvidenskaben, hvorfor den såkaldte videnskabelige metode - hypotetiser, test, publicer, repliker - ikke kan anvendes på økonomiske forhold der involverer millioner. Forskningsresultaterne er relative til tiden og kulturen de foregår i - dvs. ineksakte. Hvad der var virksomt og uvirksomt i 1930erne forstås (måske) i retrospekt og vil ikke med nogen som helst nødvendighed være enten virksomt eller uvirksomt i dag, i modsætning til de eksakte videnskabers forskningsresultater, hvor en forsøgsopstilling der virkede i 1930erne også vil virke i dag. Når vi taler om økonomi i denne skala er der vel mestendels tale om mere eller mindre kvalificerede gæt.
Senator for Kentucky, Henry "The Great Compromiser" Clay, udtalte 43 år senere i 1832 at "The call for free trade, is as unavailing as the cry of a spoiled child ... It has never existed; it will never exist."
Derfor virker det ærlig talt også lidt som grundlagsløs snak, når nogle taler om godheden af det selv-regulerende marked, for hvis alle markeder man hidtil har kendt til har været underlagt politisk styring har der jo aldrig eksisteret noget selv-regulerende marked i samfund af en kompleksitet som er blot relativt sammenlignelig med nutidens, og derfor er det rent teoretisk. Man TROR det vil virke sådan. Det lyder ret hokus-pokus i mine ører.
Økonomi - når vi taler om denne størrelsesorden - er ikke nogen eksakt videnskab, idet man ikke transkulturelt kan replikere forskningsresultater i kontrollerede miljøer som det er tilfældet indenfor naturvidenskaben, hvorfor den såkaldte videnskabelige metode - hypotetiser, test, publicer, repliker - ikke kan anvendes på økonomiske forhold der involverer millioner. Forskningsresultaterne er relative til tiden og kulturen de foregår i - dvs. ineksakte. Hvad der var virksomt og uvirksomt i 1930erne forstås (måske) i retrospekt og vil ikke med nogen som helst nødvendighed være enten virksomt eller uvirksomt i dag, i modsætning til de eksakte videnskabers forskningsresultater, hvor en forsøgsopstilling der virkede i 1930erne også vil virke i dag. Når vi taler om økonomi i denne skala er der vel mestendels tale om mere eller mindre kvalificerede gæt.
mandag den 6. oktober 2008
Deregulering af banksektoren
Franklin Delano Roosevelt sagde i sin tiltrædelsestale d.4. maj 1933:
Mere om deregulering i The Guardian.
http://www.guardian.co.uk/business/2008/sep/15/lehmanbrothers.marketturmoil1
Glass Steagal Act
Gramm-Leach-Bliley Act
Hele den omtalte økonom Robert Kuttner's testimony ved kongressen kan læse her.
First of all, let me assert my firm belief that the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror, which paralyzes needed efforts to convert retreat into advance. […]
We face our common difficulties. They concern, thank God, only material things. […] The withered leaves of industrial enterprise lie on every side. Farmers find no markets for their produce. And the savings of many years in thousands of families are gone. More important, a host of unemployed citizens face the grim problem of existence, and an equally great number toil with little return. Only a foolish optimist can deny the dark realities of the moment. […]
Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men. […]
Yes, the money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths. […]
This nation is asking for action, and action now. […]
There must be a strict supervision of all banking and credits and investments. There must be an end to speculation with other people’s money. And there must be provision for an adequate but sound currency.
These, my friends, are the lines of attack. I shall presently urge upon a new Congress in special session detailed measures for their fulfillment, and I shall seek the immediate assistance of the forty-eight states.
How deregulation created the world's financial powerhouse
DAVID BUIK
In the early 1960s, there were just 400 stockbrokers and a handful of jobbers with Wedd Durlacher and Ackroyd & Smithers trading stocks and shares on a gentlemanly basis on the floor of the Stock Exchange in Threadneedle Street.
But this world was about to change. Banks from the US, Europe and Japan opened branches in their droves in the 1970s, and activity increased when exchange controls were abolished in 1980. The Thatcher government was determined to break down as many trade barriers as possible with a view to stimulating an economy that had been ravaged by inflation under the Wilson and Callaghan administrations.
By the mid-1980s there were more than 300 trading banks in London. Privatisations were lucrative for merchant banks, and adding buoyant insurance, shipping and commodity markets to the equation made London a boom town.
In 1986, Big Bang, the Conservatives' deregulation of the stock market, changed the City for ever. Intended to develop a competitive finance centre by breaking the old boys' network and introducing the principles of the free market, it succeeded in creating arguably the world's most important banking hub. Price cartels became unacceptable and a code of conduct - draconian by previous standards - was introduced.
The Serious Fraud Office made sure the code was implemented by bringing Ernest Saunders, Gerald Ronson, Anthony Parnes and Jack Lyons to book over the Guinness affair. Suddenly, the US investment banks ruled a market-making society by openly challenging the established UK banks, making acquisitions in areas and products that had previously been denied them.
Within three years there were far fewer trading establishments, replaced instead by larger conglomerates. The only UK successes of Big Bang were Warburg, which bought Mullens, Rowe & Pitman and Ackroyd, and to a lesser extent Barclays, which acquired Wedd and de Zoete & Bevan.
Cazenove, Schroders and NM Rothschild sought, correctly, independence. It was the big foreign banks that started to dominate proceedings. The City of London was bulging with new office premises. Technology took hold and London's Stock Exchange went screen-based.
The unlisted securities market was dispensed and the alternative investment market came a decade later. The advent of trading financial futures at Liffe, which opened its doors at the Royal Exchange in 1982, triggered the explosion of the most sophisticated derivative markets in the world. Suddenly, there wasn't enough room in the City.
In the past decade, as technology has improved, Canary Wharf has become home to many banks, while fund managers and hedge fund managers have moved to the West End. Their pre-eminence since the Iraq war has seen them seek out prestigious premises more becoming of their place in financial society.
David Buik is a money manager with BGC Partners
Mere om deregulering i The Guardian.
”Beginning in the 1980s or earlier, the US banking sector lobbied Washington to repeal the Glass-Steagall Act, a statute that had been on the books since the 1930s. Glass-Steagall was part of a package of banking reforms put in place by president Franklin D Roosevelt to restore trust in the banking system.
After the Great Crash of 1929, Wall Street was vilified for misleading the masses. Congress introduced legislation that diluted the power of big financial institutions, splitting up commercial and investment banking into separate functions. According to the act, commercial banks were not allowed to use depositors' money to finance profit-making investments other than loans.
But the US banking sector argued that Glass-Steagall was hampering its ability to compete with rivals in Europe and Asia, which were increasing in size through a series of mergers. US banks put pressure on Congress to deregulate so they could use complex financial instruments that held out the promise of higher financial rewards.
The other argument for deregulation was that customers would be able to buy financial products from one company. This one-stop shop, the banks argued, would allow them to make more money by cross-selling their products to customers. While banking lobbyists piled on the pressure in the corridors of Congress, the US banking sector created facts on the ground.
When Citibank completed its merger with Travelers in October 1998, the deal drove a coach and horses through Glass-Steagall. One year later, banking's equivalent of the Wall of Jericho came crashing down. In 1999, Glass-Steagall was repealed, together with the bank holding company, a mechanism that was introduced in 1956 and provided the basis for modern US banking.
Glass-Steagall was replaced under the Clinton administration by the Gramm-Leach Financial Modernisation Act. This blurred the lines between the commercial banks that made their money through loans, and the more risky ventures of investment banks. The new bill ended the rules that limited the ability of banks to underwrite securities, which prevented them from engaging in new lines of business such as insurance.
As Robert Kuttner, an economics expert, testified before Congress last year:
"Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s — lending to speculators, packaging and securitising credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s."
The repeal of Glass-Steagall coincided with low interest rates that put pressure on financial institutions to seek higher returns through more arcane financial instruments. Wall Street investment banks, with their appetite for risk, led the charge.
Bear Stearns and Lehman Brothers became heavily involved in property, underwriting billions in mortgage-backed securities and investing in commercial property. Bear Stearns had the fortune to be rescued by JP Morgan from its ill-fated foray into the sub-prime market.
Not so Lehman. In the UK, Northern Rock came a cropper by borrowing money to fund its loans and mortgages. When borrowing dried up because of the credit crunch, the Rock had to be bailed out by the Bank of England.
US banks — particularly investment banks — are in difficulty because they were granted what they wished for. Left to their own devices, several have managed to ruin themselves and create havoc in the international financial system. Wall Street bankers may be wishing that regulators had kept them on a tighter leash, not least because fewer of them would be out of a job today.”
http://www.guardian.co.uk/business/2008/sep/15/lehmanbrothers.marketturmoil1
Glass Steagal Act
Gramm-Leach-Bliley Act
Hele den omtalte økonom Robert Kuttner's testimony ved kongressen kan læse her.
søndag den 5. oktober 2008
How Multinational Corporations Avoid Paying Their Taxes
Drug companies and other multinational companies based in the U.S. systematically avoid paying tax in the U.S. on their profits. The companies elect to realize profits in low-tax countries and because of this the rest of us have to pay billions of unnecessary taxes to make up for the shortfall, writes Peter Rost, an ex-pharmaceutical executive.
By Peter Rost
11/22/06 "Information Clearing House" -- -- The biggest tax scam on earth has a very innocent sounding name. It is called “transfer prices.” That almost sounds boring. It is, however, anything but boring. Abuse of transfer prices is a key tool multinational corporations use to fool the U.S. and other jurisdictions to think that they have virtually no profit; hence, they shouldn’t pay any taxes.
Corporations involved in this scam are “model corporate citizens,” or so they would like us to believe. The truth is that they rob us all blind. The money we lose can be estimated in the tens of billions, or possibly hundreds of billions of dollars every year. We all end up paying higher taxes because rich corporations make sure they don’t.
But don’t take my word for this.
A few weeks ago U.K.-based GlaxoSmithKline (GSK), one of the largest pharmaceutical companies in the world, together with the Internal Revenue Service (IRS) announced that GSK will pay $3.4 billion to the IRS to settle a transfer pricing dispute dating back 17 years. The IRS alleges that GSK improperly shifted profits from their U.S. to the U.K. entity.
And U.K. pharmaceutical companies are not alone with these kinds of problems. Merck, one of the largest U.S. drug companies, also this month disclosed that they face four separate tax disputes in the U.S. and Canada with potential liabilities of $5.6 billion. Out of that amount, Merck disclosed that the Canada Revenue Agency issued the company a notice for $1.8 billion in back taxes and interest “related to certain inter-company pricing matters.” And according to the IRS, one of the schemes Merck used to cheat American tax payers was by setting up a subsidiary in tax-friendly Bermuda. Merck then quietly transferred patents for several blockbuster drugs to the new subsidiary and then paid the subsidiary for use of the patents. The arrangement in effect allowed some of the profits to disappear into Merck’s own “Bermuda triangle.”
I have described many more ways the global drug industry cheats and defrauds our government in my recent book, “The Whistleblower, Confessions of a Healthcare Hitman.” In this article, however, I’m going to focus on how they, and other rich multinationals, use the tax system to defraud us.
So what’s going on here, how have multinational drug companies been able to gouge us for years selling expensive drugs and then avoid paying tax on their astronomical profits?
The answer is simple. For companies in certain businesses, such as pharmaceuticals, it is very easy to simply “invent” the price a company charges their U.S. business for buying the company’s product which they manufacture in another country. And if they charge enough, poof; all the profit vanishes from the US, or Canada, or any other regular jurisdiction and end up in a corporate tax-haven. And that means American and Canadian tax payers don’t get their fair share.
Many multinational corporations essentially have two sets of bookkeeping. One set, with artificially inflated transfer prices is what they use to prepare local tax returns, and show auditors in high-tax jurisdictions, and another set of books, in which management can see the true profit and lost statement, based on real cost of goods, are used for the executives to determine the actual performance of their various operations.
Of course, not every multinational industry can do this as easily as the drug industry. It would be difficult to motivate $6,000 toilet seats. But the drug industry, where real cost of goods to manufacture drugs is usually around 5% of selling price, has a lot of room to artificially increase that cost of goods to 50% or 75% of selling price. This money is then accumulated in corporate tax-havens where the drugs are manufactured, such as Puerto Rico and Ireland. Puerto Rico has for many years attracted lots of pharmaceutical plants and Ireland is the new destination for such facilities, not because of the skilled labor or the beautiful scenery or the great beer—but because of the low taxes. Ireland has, in fact, one of the world’s lowest corporate tax rates with a maximum rate of 12.5 percent.
In Puerto Rico, over a quarter of the country’s gross domestic product already comes from pharmaceutical manufacturing. That shouldn’t be surprising. According to the U.S. Federal Tax Reform Act of 1976, manufacturers are permitted to repatriate profits from Puerto Rico to the U.S. free of U.S. federal taxes. And by the way, the Puerto Rico withholding tax is only 10%.
Of course, no company should have to pay more tax than they are legally obligated to, and they are entitled to locate to any low-tax jurisdiction. The problem starts when they use fraudulent transfer pricing and other tricks to artificially shift their income from the U.S. to a tax-haven. According to current OECD guidelines transfer prices should be based upon the arm’s length principle – that means the transfer price should be the same as if the two companies involved were indeed two independents, not part of the same corporate structure. Reality is that standard operating procedure for multinationals is to consistently violate this rule. And why shouldn’t they? After all, it takes 17 years for them to pay up, per the GSK example above, even when they get caught.
Another industry which successfully exploits overseas tax strategies to cheat us all is the hi-tech industry. In fact, Microsoft Corp. recently shaved at least $500 million from its annual tax bill using a similar strategy to the one the drug industry has used for so many years. Microsoft has set up a subsidiary in Ireland, called Round Island One Ltd. This company pays more than $300 million in taxes to this small island country with only 4 million inhabitants, and most of this comes from licensing fees for copyrighted software, originally developed in the U.S. Interesting thing is, at the same time, Round Island paid a total of just under $17 million in taxes to about 20 other countries, with more than 300 million people. The result of this was that Microsoft's world-wide tax rate plunged to 26 percent in 2004, from 33 percent the year before. Almost half of the drop was due to “foreign earnings taxed at lower rates,” according to a Microsoft financial filing. And this is how Microsoft has radically reduced its corporate taxes in much of Europe and been able to shield billions of dollars from U.S. taxation.
But remember, this is only one example. Most of the other tech companies are doing the same thing. Google recently also set up an Irish operation that the firm credited in a SEC filing with reducing its tax rate.
Here’s how this is done in the software industry and any other industry with valuable intellectual property. A company takes a great, patented, American product and then develops a new generation. Then, of course, the old product disappears. Some, or all, of the cost and development work for the new product takes place in Ireland, or at least, so the company claims. The ownership of the new generation product and all income from licensing can then legally be shared between the U.S. parent company and the offshore corporation or transferred outright to the tax-haven. The deal, to pass IRS scrutiny, has to be made using the “arms-length principle.” Reality is that the IRS has no way of controlling all these transactions.
Unfortunately those of us working and paying tax in the U.S. can’t relocate our jobs and our income to Ireland or another tax haven. So we have to make up the income shortfall. In the U.S. we have a highly educated society with a very qualified workforce, partly supported by our tax payers. This helps us generate breakthrough products. But once a company has a successful product, they have every incentive to move the second generation of a successful product overseas, to Ireland and a few other corporate tax havens.
There is only one problem for U.S. companies with this strategy, and that is that if they repatriate this money to the U.S. they have to pay full corporate taxes. In fact, according to BusinessWeek, U.S. multinational corporations have built up profits of as much as $750 billion overseas, much of it in tax havens such as the Ireland, Bahamas, and Singapore to avoid the stiff 35% levy they'd face if they repatriated the funds back into the U.S.
But of course, Congress, which is basically paid for by our multinational corporations, generously provided for a one-time provision in the corporate tax code, so that they could repatriate profits earned before 2003, and held in foreign subsidiaries, at an effective 5.25% tax rate.
And so the game goes on.
In the end, multinational corporations live in a global world which allows them to pretty much send their money to corporate tax havens at will, and then repatriate this money almost tax free, with the help of the U.S. Congress.
The people left holding the bag are you and me. If you want to know learn more about the corruption in the drug industry, read my new book, "The Whistleblower, Confessions of a Healthcare Hitman."
Peter Rost, M.D., is a former Vice President of Pfizer. He became well known in 2004 when he emerged as the first drug company executive to speak out in favor of reimportation of drugs. He is the author of “The Whistleblower, Confessions of a Healthcare Hitman" See: http://the-whistleblower-by-peter-rost.blogspot.com/
By Peter Rost
11/22/06 "Information Clearing House" -- -- The biggest tax scam on earth has a very innocent sounding name. It is called “transfer prices.” That almost sounds boring. It is, however, anything but boring. Abuse of transfer prices is a key tool multinational corporations use to fool the U.S. and other jurisdictions to think that they have virtually no profit; hence, they shouldn’t pay any taxes.
Corporations involved in this scam are “model corporate citizens,” or so they would like us to believe. The truth is that they rob us all blind. The money we lose can be estimated in the tens of billions, or possibly hundreds of billions of dollars every year. We all end up paying higher taxes because rich corporations make sure they don’t.
But don’t take my word for this.
A few weeks ago U.K.-based GlaxoSmithKline (GSK), one of the largest pharmaceutical companies in the world, together with the Internal Revenue Service (IRS) announced that GSK will pay $3.4 billion to the IRS to settle a transfer pricing dispute dating back 17 years. The IRS alleges that GSK improperly shifted profits from their U.S. to the U.K. entity.
And U.K. pharmaceutical companies are not alone with these kinds of problems. Merck, one of the largest U.S. drug companies, also this month disclosed that they face four separate tax disputes in the U.S. and Canada with potential liabilities of $5.6 billion. Out of that amount, Merck disclosed that the Canada Revenue Agency issued the company a notice for $1.8 billion in back taxes and interest “related to certain inter-company pricing matters.” And according to the IRS, one of the schemes Merck used to cheat American tax payers was by setting up a subsidiary in tax-friendly Bermuda. Merck then quietly transferred patents for several blockbuster drugs to the new subsidiary and then paid the subsidiary for use of the patents. The arrangement in effect allowed some of the profits to disappear into Merck’s own “Bermuda triangle.”
I have described many more ways the global drug industry cheats and defrauds our government in my recent book, “The Whistleblower, Confessions of a Healthcare Hitman.” In this article, however, I’m going to focus on how they, and other rich multinationals, use the tax system to defraud us.
So what’s going on here, how have multinational drug companies been able to gouge us for years selling expensive drugs and then avoid paying tax on their astronomical profits?
The answer is simple. For companies in certain businesses, such as pharmaceuticals, it is very easy to simply “invent” the price a company charges their U.S. business for buying the company’s product which they manufacture in another country. And if they charge enough, poof; all the profit vanishes from the US, or Canada, or any other regular jurisdiction and end up in a corporate tax-haven. And that means American and Canadian tax payers don’t get their fair share.
Many multinational corporations essentially have two sets of bookkeeping. One set, with artificially inflated transfer prices is what they use to prepare local tax returns, and show auditors in high-tax jurisdictions, and another set of books, in which management can see the true profit and lost statement, based on real cost of goods, are used for the executives to determine the actual performance of their various operations.
Of course, not every multinational industry can do this as easily as the drug industry. It would be difficult to motivate $6,000 toilet seats. But the drug industry, where real cost of goods to manufacture drugs is usually around 5% of selling price, has a lot of room to artificially increase that cost of goods to 50% or 75% of selling price. This money is then accumulated in corporate tax-havens where the drugs are manufactured, such as Puerto Rico and Ireland. Puerto Rico has for many years attracted lots of pharmaceutical plants and Ireland is the new destination for such facilities, not because of the skilled labor or the beautiful scenery or the great beer—but because of the low taxes. Ireland has, in fact, one of the world’s lowest corporate tax rates with a maximum rate of 12.5 percent.
In Puerto Rico, over a quarter of the country’s gross domestic product already comes from pharmaceutical manufacturing. That shouldn’t be surprising. According to the U.S. Federal Tax Reform Act of 1976, manufacturers are permitted to repatriate profits from Puerto Rico to the U.S. free of U.S. federal taxes. And by the way, the Puerto Rico withholding tax is only 10%.
Of course, no company should have to pay more tax than they are legally obligated to, and they are entitled to locate to any low-tax jurisdiction. The problem starts when they use fraudulent transfer pricing and other tricks to artificially shift their income from the U.S. to a tax-haven. According to current OECD guidelines transfer prices should be based upon the arm’s length principle – that means the transfer price should be the same as if the two companies involved were indeed two independents, not part of the same corporate structure. Reality is that standard operating procedure for multinationals is to consistently violate this rule. And why shouldn’t they? After all, it takes 17 years for them to pay up, per the GSK example above, even when they get caught.
Another industry which successfully exploits overseas tax strategies to cheat us all is the hi-tech industry. In fact, Microsoft Corp. recently shaved at least $500 million from its annual tax bill using a similar strategy to the one the drug industry has used for so many years. Microsoft has set up a subsidiary in Ireland, called Round Island One Ltd. This company pays more than $300 million in taxes to this small island country with only 4 million inhabitants, and most of this comes from licensing fees for copyrighted software, originally developed in the U.S. Interesting thing is, at the same time, Round Island paid a total of just under $17 million in taxes to about 20 other countries, with more than 300 million people. The result of this was that Microsoft's world-wide tax rate plunged to 26 percent in 2004, from 33 percent the year before. Almost half of the drop was due to “foreign earnings taxed at lower rates,” according to a Microsoft financial filing. And this is how Microsoft has radically reduced its corporate taxes in much of Europe and been able to shield billions of dollars from U.S. taxation.
But remember, this is only one example. Most of the other tech companies are doing the same thing. Google recently also set up an Irish operation that the firm credited in a SEC filing with reducing its tax rate.
Here’s how this is done in the software industry and any other industry with valuable intellectual property. A company takes a great, patented, American product and then develops a new generation. Then, of course, the old product disappears. Some, or all, of the cost and development work for the new product takes place in Ireland, or at least, so the company claims. The ownership of the new generation product and all income from licensing can then legally be shared between the U.S. parent company and the offshore corporation or transferred outright to the tax-haven. The deal, to pass IRS scrutiny, has to be made using the “arms-length principle.” Reality is that the IRS has no way of controlling all these transactions.
Unfortunately those of us working and paying tax in the U.S. can’t relocate our jobs and our income to Ireland or another tax haven. So we have to make up the income shortfall. In the U.S. we have a highly educated society with a very qualified workforce, partly supported by our tax payers. This helps us generate breakthrough products. But once a company has a successful product, they have every incentive to move the second generation of a successful product overseas, to Ireland and a few other corporate tax havens.
There is only one problem for U.S. companies with this strategy, and that is that if they repatriate this money to the U.S. they have to pay full corporate taxes. In fact, according to BusinessWeek, U.S. multinational corporations have built up profits of as much as $750 billion overseas, much of it in tax havens such as the Ireland, Bahamas, and Singapore to avoid the stiff 35% levy they'd face if they repatriated the funds back into the U.S.
But of course, Congress, which is basically paid for by our multinational corporations, generously provided for a one-time provision in the corporate tax code, so that they could repatriate profits earned before 2003, and held in foreign subsidiaries, at an effective 5.25% tax rate.
And so the game goes on.
In the end, multinational corporations live in a global world which allows them to pretty much send their money to corporate tax havens at will, and then repatriate this money almost tax free, with the help of the U.S. Congress.
The people left holding the bag are you and me. If you want to know learn more about the corruption in the drug industry, read my new book, "The Whistleblower, Confessions of a Healthcare Hitman."
Peter Rost, M.D., is a former Vice President of Pfizer. He became well known in 2004 when he emerged as the first drug company executive to speak out in favor of reimportation of drugs. He is the author of “The Whistleblower, Confessions of a Healthcare Hitman" See: http://the-whistleblower-by-peter-rost.blogspot.com/
Study says most corporations pay no U.S. income taxes
Tue Aug 12, 2008 12:54pm EDT
WASHINGTON (Reuters) - Most U.S. and foreign corporations doing business in the United States avoid paying any federal income taxes, despite trillions of dollars worth of sales, a government study released on Tuesday said.
The Government Accountability Office said 72 percent of all foreign corporations and about 57 percent of U.S. companies doing business in the United States paid no federal income taxes for at least one year between 1998 and 2005.
More than half of foreign companies and about 42 percent of U.S. companies paid no U.S. income taxes for two or more years in that period, the report said.
During that time corporate sales in the United States totaled $2.5 trillion, according to Democratic Sens. Carl Levin of Michigan and Byron Dorgan of North Dakota, who requested the GAO study.
The report did not name any companies. The GAO said corporations escaped paying federal income taxes for a variety of reasons including operating losses, tax credits and an ability to use transactions within the company to shift income to low tax countries.
With the U.S. budget deficit this year running close to the record $413 billion that was set in 2004 and projected to hit a record $486 billion next year, lawmakers are looking to plug holes in the U.S. tax code and generate more revenues.
Dorgan in a statement called the report "a shocking indictment of the current tax system." Levin said it made clear that "too many corporations are using tax trickery to send their profits overseas and avoid paying their fair share in the United States."
The study showed about 28 percent of large foreign corporations, those with more than $250 million in assets, doing business in the United States paid no federal income taxes in 2005 despite $372 billion in gross receipts, the senators said. About 25 percent of the largest U.S. companies paid no federal income taxes in 2005 despite $1.1 trillion in gross sales that year, they said.
(Reporting by Donna Smith, Editing by David Wiessler)
WASHINGTON (Reuters) - Most U.S. and foreign corporations doing business in the United States avoid paying any federal income taxes, despite trillions of dollars worth of sales, a government study released on Tuesday said.
The Government Accountability Office said 72 percent of all foreign corporations and about 57 percent of U.S. companies doing business in the United States paid no federal income taxes for at least one year between 1998 and 2005.
More than half of foreign companies and about 42 percent of U.S. companies paid no U.S. income taxes for two or more years in that period, the report said.
During that time corporate sales in the United States totaled $2.5 trillion, according to Democratic Sens. Carl Levin of Michigan and Byron Dorgan of North Dakota, who requested the GAO study.
The report did not name any companies. The GAO said corporations escaped paying federal income taxes for a variety of reasons including operating losses, tax credits and an ability to use transactions within the company to shift income to low tax countries.
With the U.S. budget deficit this year running close to the record $413 billion that was set in 2004 and projected to hit a record $486 billion next year, lawmakers are looking to plug holes in the U.S. tax code and generate more revenues.
Dorgan in a statement called the report "a shocking indictment of the current tax system." Levin said it made clear that "too many corporations are using tax trickery to send their profits overseas and avoid paying their fair share in the United States."
The study showed about 28 percent of large foreign corporations, those with more than $250 million in assets, doing business in the United States paid no federal income taxes in 2005 despite $372 billion in gross receipts, the senators said. About 25 percent of the largest U.S. companies paid no federal income taxes in 2005 despite $1.1 trillion in gross sales that year, they said.
(Reporting by Donna Smith, Editing by David Wiessler)
The party's over for Iceland
Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland's currency, is in freefall and is rated just above those of Zimbabwe and Turkmenistan
The snow has arrived early in Reykjavik after an unusually long and warm summer. The freeze has brought out the ghostly green haze of the aurora borealis - the Northern Lights - the shape of which shifts dramatically across the tiny city's black skies.
The bars and restaurants of Iceland's capital are packed, the Range Rovers and BMWs are parked nose to tail all along the streets of the central 101 district, and music is pumping from a black stretch Hummer limousine cruising by.
'What can we do? Its difficult times but we've spent all day talking about it, watching the news getting worse and worse. We had to go out and be with friends. Maybe it's like the party at the end of the world,' says Egill Tomasson, 32, sitting in the Kaffeebarinn bar.
Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland's currency, is in freefall and is rated just above those of Zimbabwe and Turkmenistan. One of the country's three independent banks has been nationalised, another is asking customers for money, and the discredited government and officials from the central bank have been huddled behind closed doors for three days with still no sign of a plan. International banks won't send any more money and supplies of foreign currency are running out.
People talk about whether a new emergency unity government is needed and if the EU would fast-track the country to membership. On Friday the queues at the banks were huge, as people moved savings into the most secure accounts. Yesterday people were buying up supplies of olive oil and pasta after a supermarket spokesman announced on Friday night that they had no means of paying the foreign currency advances needed to import more foodstuffs.
This North Atlantic volcanic island, which is the size of Cuba, with a population of 320,000 - the size of Coventry's - is an unlikely player on the global financial stage. It is famous for its fish, geysers and for winning the UN's 2007 'best country to live in' poll. But Iceland built its extraordinary wealth on the crest of the worldwide credit boom and now the crunch is sweeping it away, bankrupting a people for whom the past eight years have been, for most of them and by their own admission, one long party.
The nation's celebrated rags-to-riches story began in the Nineties when free market reforms, fish quota cash and a stock market based on stable pension funds allowed Icelandic entrepreneurs to go out and sweep up international credit. Britain and Denmark were favourite shopping haunts, and in 2004 alone Icelanders spent £894m on shares in British companies. In just five years, the average Icelandic family saw its wealth increase by 45 per cent.
But, as a result of the international banking crisis, the billionaires who own everything from West Ham United football club to the Somerfield supermarket chain, Hamleys toy shops and the House of Fraser, are in trouble and the country is drowning in debt.
Iceland's cheap labour force, the Poles and Lithuanians, have left already - there's little point in sending home such a worthless currency, and the tourist season is over. Iceland is on its own.
In the Kaffeebarinn, Egill Tomasson isn't drinking because he has a music festival to organise. Iceland Airwaves takes place in a fortnight, when more than 100 Icelandic bands and 50 foreign ones will play in venues around the city over four days. Most of the tickets have been sold in krona, but the international acts need to be paid in euros, which is going to cost the organisers dearly.
'People here are going to need this festival,' says Tomasson. 'This crisis has been a heavy blow. And many people should have a bad conscience for what has happened. Someone should be prosecuted, they have sucked Iceland dry, taken the money and ran, and left us totally in the shit. People I know who have gone to the UK or the US to study have found their grants worthless, they are stranded.'
Like many his age, Tomasson has only a vague memory of harder times, before the boom that brought Iceland the highest per capita wealth in the world. Older islanders call them the 'Krutt-kynslotin' - the cuddly generation. Eco-aware, earnest but pampered, they drift from organic café to bar, listening to the music of Björk and Sigur Rós, islanders who have made it big abroad. 'They will have to get their hands dirty now,' says chef Siggi Hall, Iceland's answer to Gordon Ramsay, with an effusive vocabulary to match.
'That's good though, they are the I-generation; iPods, iPhones, everything starts with I. Well, we will have to go back to the basics now. Icelanders are risk-takers, but hard working, they will have to downsize. We will have to eat haddock and Icelandic lamb and forget these imports of goose livers and Japanese soy sauce. When everyone was extremely rich in Iceland - you know, last month, it was with money that they never have earned. Now those who were extremely rich are just normally rich, but they think they are poor. They were spoilt, spending billions.'
Hall is due to open his new restaurant on 17 October, but insists the crisis is not worrying him. 'I had been losing customers because people were flying off to Copenhagen and London and New York for the weekend, to eat out. Now they will stay in Iceland, but they will still eat out. People need to eat.'
Outside the city's Hofdahollin car showroom, looking a little rumpled for men trying to sell new and used cars for £35,000 and up, owner Runar Olafsson and his top salesman are sharing a Marlboro. They are not expecting any customers today. 'A few years ago we couldn't get enough top-end cars and we started importing them. We were selling 120, 140, a month. But it turned around so fast,' says Olafsson. 'It's so dramatic, just in one month. We have already seen two dealers go down.
'Customers would come in and we would apply for credit online for them, a 100 per cent loan, and they can drive away in their new Range Rover. It took ten minutes, it was very easy. But 60 to 70 per cent of those loans were in foreign currency, Japanese yen or Swiss francs, and they have gone up 90 per cent as the krona burns. A car worth 5 million krona now has a 9 million loan on it; how are people going to make those payments?'
Foreign currency loans are a problem for homeowners, too. 'Loans have been very cheap, house prices rose and there was a lot of good-quality housebuilding. But the building has halted, nothing is being finished, nothing is selling. The interest rates are staggering. What people are doing now is swapping houses if they want to go bigger or smaller. That is what is keeping us afloat,' says estate agent Ingolfur Gissurarson. His mobile goes off - the ringtone is A Hard Day's Night by the Beatles. 'I changed it to suit the times,' he smiles.
Blame it on the Vikings. Icelanders like to hark back to their ancestors, the rebel Vikings who, as the nation's most revered daughter Björk once explained, 'couldn't deal with authority in Norway. So they flew off in this mad ocean in a wooden boat which is pretty hardcore, North Atlantic in the year 800. And they found this island full of snow ... yeeeah!'
'The Icelandic psyche is an important part of all of this,' says Hellgrimur Helgason, who writes an outspoken newspaper column which exposes feuds between Iceland's ruling class and its entrepreneurs. He is also the author of 101 Reykjavik, a popular novel populated by 'Krutt-kynslotin' characters.
'Before the market reforms the country had stagnated, no one thought Icelanders could be businessmen. We were poor fishermen or farmers, so it had an incredible effect on confidence when we saw these young men out buying up British and Danish companies. Everyone grabbed at the new opportunities like children. Really, it was no surprise that Hamleys toy shop was one of the first purchases.'
Gunnghilder Sveinbjarna and her friend, Anna Lara Magnusdottir, are ordering their second bottle of red wine in the Philippe Starck-designed interior of Reykjavik's Bar 5. Tonight the young women are feeling no pain.
'We come out at the weekend to forget our children and our problems, and this time we will drink extra hard to make sure we forget the economic crisis too,' says Gunnghilder, raising a glass. 'Tomorrow the sore head.'
The door to Hell
• Iceland is known as the Land of the Midnight Sun because in summer there are almost 24 hours of daylight.
• There are 15 active volcanoes in Iceland, including Mount Hekla, long believed to be the entrance to Hell.
• More books are published per capita in Iceland than in any other country.
• Many Icelanders still practise the old Viking religion of Norse mythology.
• Icelanders drink more Coca-Cola than anyone else in the world.
The British connection
• Iceland's biggest bank, Kaupthing, has investments in Costcutter, Somerfield, Jane Norman and the Laurel Pub Company which manages the Slug & Lettuce chain. It jointly owns Kaupthing Edge, an internet savings bank with 150,000 British savers.
• Baugur, an Icelandic international investment company, has significant stakes in Iceland supermarkets, Moss Bros, French Connection, Woolworths, Saks, Whittard of Chelsea, Goldsmiths, House of Fraser, Whistles and Oasis.
The snow has arrived early in Reykjavik after an unusually long and warm summer. The freeze has brought out the ghostly green haze of the aurora borealis - the Northern Lights - the shape of which shifts dramatically across the tiny city's black skies.
The bars and restaurants of Iceland's capital are packed, the Range Rovers and BMWs are parked nose to tail all along the streets of the central 101 district, and music is pumping from a black stretch Hummer limousine cruising by.
'What can we do? Its difficult times but we've spent all day talking about it, watching the news getting worse and worse. We had to go out and be with friends. Maybe it's like the party at the end of the world,' says Egill Tomasson, 32, sitting in the Kaffeebarinn bar.
Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland's currency, is in freefall and is rated just above those of Zimbabwe and Turkmenistan. One of the country's three independent banks has been nationalised, another is asking customers for money, and the discredited government and officials from the central bank have been huddled behind closed doors for three days with still no sign of a plan. International banks won't send any more money and supplies of foreign currency are running out.
People talk about whether a new emergency unity government is needed and if the EU would fast-track the country to membership. On Friday the queues at the banks were huge, as people moved savings into the most secure accounts. Yesterday people were buying up supplies of olive oil and pasta after a supermarket spokesman announced on Friday night that they had no means of paying the foreign currency advances needed to import more foodstuffs.
This North Atlantic volcanic island, which is the size of Cuba, with a population of 320,000 - the size of Coventry's - is an unlikely player on the global financial stage. It is famous for its fish, geysers and for winning the UN's 2007 'best country to live in' poll. But Iceland built its extraordinary wealth on the crest of the worldwide credit boom and now the crunch is sweeping it away, bankrupting a people for whom the past eight years have been, for most of them and by their own admission, one long party.
The nation's celebrated rags-to-riches story began in the Nineties when free market reforms, fish quota cash and a stock market based on stable pension funds allowed Icelandic entrepreneurs to go out and sweep up international credit. Britain and Denmark were favourite shopping haunts, and in 2004 alone Icelanders spent £894m on shares in British companies. In just five years, the average Icelandic family saw its wealth increase by 45 per cent.
But, as a result of the international banking crisis, the billionaires who own everything from West Ham United football club to the Somerfield supermarket chain, Hamleys toy shops and the House of Fraser, are in trouble and the country is drowning in debt.
Iceland's cheap labour force, the Poles and Lithuanians, have left already - there's little point in sending home such a worthless currency, and the tourist season is over. Iceland is on its own.
In the Kaffeebarinn, Egill Tomasson isn't drinking because he has a music festival to organise. Iceland Airwaves takes place in a fortnight, when more than 100 Icelandic bands and 50 foreign ones will play in venues around the city over four days. Most of the tickets have been sold in krona, but the international acts need to be paid in euros, which is going to cost the organisers dearly.
'People here are going to need this festival,' says Tomasson. 'This crisis has been a heavy blow. And many people should have a bad conscience for what has happened. Someone should be prosecuted, they have sucked Iceland dry, taken the money and ran, and left us totally in the shit. People I know who have gone to the UK or the US to study have found their grants worthless, they are stranded.'
Like many his age, Tomasson has only a vague memory of harder times, before the boom that brought Iceland the highest per capita wealth in the world. Older islanders call them the 'Krutt-kynslotin' - the cuddly generation. Eco-aware, earnest but pampered, they drift from organic café to bar, listening to the music of Björk and Sigur Rós, islanders who have made it big abroad. 'They will have to get their hands dirty now,' says chef Siggi Hall, Iceland's answer to Gordon Ramsay, with an effusive vocabulary to match.
'That's good though, they are the I-generation; iPods, iPhones, everything starts with I. Well, we will have to go back to the basics now. Icelanders are risk-takers, but hard working, they will have to downsize. We will have to eat haddock and Icelandic lamb and forget these imports of goose livers and Japanese soy sauce. When everyone was extremely rich in Iceland - you know, last month, it was with money that they never have earned. Now those who were extremely rich are just normally rich, but they think they are poor. They were spoilt, spending billions.'
Hall is due to open his new restaurant on 17 October, but insists the crisis is not worrying him. 'I had been losing customers because people were flying off to Copenhagen and London and New York for the weekend, to eat out. Now they will stay in Iceland, but they will still eat out. People need to eat.'
Outside the city's Hofdahollin car showroom, looking a little rumpled for men trying to sell new and used cars for £35,000 and up, owner Runar Olafsson and his top salesman are sharing a Marlboro. They are not expecting any customers today. 'A few years ago we couldn't get enough top-end cars and we started importing them. We were selling 120, 140, a month. But it turned around so fast,' says Olafsson. 'It's so dramatic, just in one month. We have already seen two dealers go down.
'Customers would come in and we would apply for credit online for them, a 100 per cent loan, and they can drive away in their new Range Rover. It took ten minutes, it was very easy. But 60 to 70 per cent of those loans were in foreign currency, Japanese yen or Swiss francs, and they have gone up 90 per cent as the krona burns. A car worth 5 million krona now has a 9 million loan on it; how are people going to make those payments?'
Foreign currency loans are a problem for homeowners, too. 'Loans have been very cheap, house prices rose and there was a lot of good-quality housebuilding. But the building has halted, nothing is being finished, nothing is selling. The interest rates are staggering. What people are doing now is swapping houses if they want to go bigger or smaller. That is what is keeping us afloat,' says estate agent Ingolfur Gissurarson. His mobile goes off - the ringtone is A Hard Day's Night by the Beatles. 'I changed it to suit the times,' he smiles.
Blame it on the Vikings. Icelanders like to hark back to their ancestors, the rebel Vikings who, as the nation's most revered daughter Björk once explained, 'couldn't deal with authority in Norway. So they flew off in this mad ocean in a wooden boat which is pretty hardcore, North Atlantic in the year 800. And they found this island full of snow ... yeeeah!'
'The Icelandic psyche is an important part of all of this,' says Hellgrimur Helgason, who writes an outspoken newspaper column which exposes feuds between Iceland's ruling class and its entrepreneurs. He is also the author of 101 Reykjavik, a popular novel populated by 'Krutt-kynslotin' characters.
'Before the market reforms the country had stagnated, no one thought Icelanders could be businessmen. We were poor fishermen or farmers, so it had an incredible effect on confidence when we saw these young men out buying up British and Danish companies. Everyone grabbed at the new opportunities like children. Really, it was no surprise that Hamleys toy shop was one of the first purchases.'
Gunnghilder Sveinbjarna and her friend, Anna Lara Magnusdottir, are ordering their second bottle of red wine in the Philippe Starck-designed interior of Reykjavik's Bar 5. Tonight the young women are feeling no pain.
'We come out at the weekend to forget our children and our problems, and this time we will drink extra hard to make sure we forget the economic crisis too,' says Gunnghilder, raising a glass. 'Tomorrow the sore head.'
The door to Hell
• Iceland is known as the Land of the Midnight Sun because in summer there are almost 24 hours of daylight.
• There are 15 active volcanoes in Iceland, including Mount Hekla, long believed to be the entrance to Hell.
• More books are published per capita in Iceland than in any other country.
• Many Icelanders still practise the old Viking religion of Norse mythology.
• Icelanders drink more Coca-Cola than anyone else in the world.
The British connection
• Iceland's biggest bank, Kaupthing, has investments in Costcutter, Somerfield, Jane Norman and the Laurel Pub Company which manages the Slug & Lettuce chain. It jointly owns Kaupthing Edge, an internet savings bank with 150,000 British savers.
• Baugur, an Icelandic international investment company, has significant stakes in Iceland supermarkets, Moss Bros, French Connection, Woolworths, Saks, Whittard of Chelsea, Goldsmiths, House of Fraser, Whistles and Oasis.
Europe fights financial storm as bank deal collapses
PARIS (AFP) — The leaders of Europe's four main economic powers vowed to protect fragile banks in their fight against the global credit crisis as the biggest rescue in German financial history collapsed.
France, Germany, Britain and Italy put on a united front, promising a more coordinated approach to the credit crunch, although Germany's Chancellor Angela Merkel insisted states would mainly act individually.
President Nicolas Sarkozy, who hosted Merkel and prime ministers Gordon Brown of Britain and Silvio Berlusconi of Italy, did not dispute this point, but said a new "doctrine" had been agreed.
Sarkozy said the four had agreed to punish failing bank executives and to call for a rapid meeting of the Group of Eight world industrialised powers to marshall a global response to the financial crisis.
"We have agreed to make a solemn engagement as heads of state and government to support banking and financial institutions faced with the crisis," Sarkozy said at a joint news conference following the three-hour meeting.
"Each government will operate with its own methods and means, but in a coordinated manner. In a way, we have devised a doctrine," he added.
Brown agreed: "Where action has to be taken we will continue to do whatever is necessary to preserve the stability of the financial system."
"The message to families and businesses is that, as our central banks are already doing, liquidity will be assured in order to preserve confidence and stability," he promised.
There was no public disagreement between the leaders, after a week in which officials in Paris and Berlin sparred in anonymous press briefings, but in Merkel emphasised countries' individual reponsibilities.
"Each country must take its responsibilities at a national level," she said.
Brown said after the meeting that leaders had agreed to ask for the early release of 32 billion euros in European funds to help small businesses weather the global finance crisis.
"This crisis that has come from America has affected all businesses, so we agreed to ask the European Investment Bank to frontload 25 billion pounds (44 billion dollars) of finance for small business loans," Brown said.
Despite efforts to present a united front amid differences emerged over just how much public finance rules, enshrined in the Stability and Growth Pact, could be eased.
"The application of the Stability and Growth Pact should reflect the exceptional circumstances that we find ourselves in," Sarkozy said.
The French leader has long sought more leeway on the European Union's public finance rules, with France struggling to keep its deficit to less than three percent of output as required by the pact.
However, Germany, which is counting on wiping out its deficit entirely this year, has consistently resisted French calls for more wiggle room on public finances.
Luxembourg premier Jean-Claude Juncker, the chairman of eurozone finance ministers, insisted that leaders had agreed in Paris that the pact had to be respected "in its entirety" despite the financial crisis.
"We're not going to let the deficits run up, that would be a bad policy," Juncker said.
With tax revenues falling amid sharply slowing economic activity, public finances are coming under growing strain and raising fears that the three-percent deficit level will be increasingly difficult to respect.
Despite cracks in their unity over deficit rules, leaders agreed that the European Commission should show flexibility when it considers state aid decisions in the crisis-struck banking sector.
"In the current circumstances, we stress the need for the commission to continue to act quickly and apply flexibility in state aid decisions, continuing to uphold the principles of the single market," they said.
The scale of the financial storm was brought home when, during the summit, the German bank Hypo Real Estate (HRE) announced that a planned 35-billion-euro (48-billion-dollar) buy-out had collapsed.
A consortium of banks was to have led the biggest rescue in German history and its failure could wreak havoc when financial markets reopen on Monday.
Germany's Interior Minister Wolfgang Schaeuble has warned that the financial crisis could have political repercussions, noting how Adolf Hitler rose to power after the 1929 Wall Street crash.
"The consequences of that depression was Adolf Hitler and, indirectly, World War II and Auschwitz," the minister was quoted as saying in Der Spiegel's latest edition to appear Monday.
HRE said in a statement that it was "determining the consequences" after its suitors had "refused to provide liquidity lines".
It was problems like those at HRE, the British banks Northern Rock and Bradford and Bingley, Dutch-Belgian giant Fortis and the Franco-Belgian Dexia that forced Sarkozy to call the mini summit in Paris.
The Belgian government was said to be considering totally nationalising the Belgian part of Fortis or selling assets to BNP Paribas of France. The Dutch government has nationalised Fortis' Dutch assets.
French officials had this week floated the idea of a joint 300 billion euro (480 billion dollar) fund to bail out failing European banks, on the model of the 700 billion dollar package approved Friday by US President George W. Bush.
Germany and Britain shot this down, however, and there was no talk of such an idea at the Paris summit.
There was no disagreement, however, over the need for careless bankers to take their share of the blame for the credit crunch.
"In the case of a public support to a bank in distress, each member state present here has decided that those executives who failed will be sanctioned and the shareholders bear the weight of the intervention," Sarkozy said.
Sarkozy also said bonus structures for top executives should be "revisited".
France, Germany, Britain and Italy put on a united front, promising a more coordinated approach to the credit crunch, although Germany's Chancellor Angela Merkel insisted states would mainly act individually.
President Nicolas Sarkozy, who hosted Merkel and prime ministers Gordon Brown of Britain and Silvio Berlusconi of Italy, did not dispute this point, but said a new "doctrine" had been agreed.
Sarkozy said the four had agreed to punish failing bank executives and to call for a rapid meeting of the Group of Eight world industrialised powers to marshall a global response to the financial crisis.
"We have agreed to make a solemn engagement as heads of state and government to support banking and financial institutions faced with the crisis," Sarkozy said at a joint news conference following the three-hour meeting.
"Each government will operate with its own methods and means, but in a coordinated manner. In a way, we have devised a doctrine," he added.
Brown agreed: "Where action has to be taken we will continue to do whatever is necessary to preserve the stability of the financial system."
"The message to families and businesses is that, as our central banks are already doing, liquidity will be assured in order to preserve confidence and stability," he promised.
There was no public disagreement between the leaders, after a week in which officials in Paris and Berlin sparred in anonymous press briefings, but in Merkel emphasised countries' individual reponsibilities.
"Each country must take its responsibilities at a national level," she said.
Brown said after the meeting that leaders had agreed to ask for the early release of 32 billion euros in European funds to help small businesses weather the global finance crisis.
"This crisis that has come from America has affected all businesses, so we agreed to ask the European Investment Bank to frontload 25 billion pounds (44 billion dollars) of finance for small business loans," Brown said.
Despite efforts to present a united front amid differences emerged over just how much public finance rules, enshrined in the Stability and Growth Pact, could be eased.
"The application of the Stability and Growth Pact should reflect the exceptional circumstances that we find ourselves in," Sarkozy said.
The French leader has long sought more leeway on the European Union's public finance rules, with France struggling to keep its deficit to less than three percent of output as required by the pact.
However, Germany, which is counting on wiping out its deficit entirely this year, has consistently resisted French calls for more wiggle room on public finances.
Luxembourg premier Jean-Claude Juncker, the chairman of eurozone finance ministers, insisted that leaders had agreed in Paris that the pact had to be respected "in its entirety" despite the financial crisis.
"We're not going to let the deficits run up, that would be a bad policy," Juncker said.
With tax revenues falling amid sharply slowing economic activity, public finances are coming under growing strain and raising fears that the three-percent deficit level will be increasingly difficult to respect.
Despite cracks in their unity over deficit rules, leaders agreed that the European Commission should show flexibility when it considers state aid decisions in the crisis-struck banking sector.
"In the current circumstances, we stress the need for the commission to continue to act quickly and apply flexibility in state aid decisions, continuing to uphold the principles of the single market," they said.
The scale of the financial storm was brought home when, during the summit, the German bank Hypo Real Estate (HRE) announced that a planned 35-billion-euro (48-billion-dollar) buy-out had collapsed.
A consortium of banks was to have led the biggest rescue in German history and its failure could wreak havoc when financial markets reopen on Monday.
Germany's Interior Minister Wolfgang Schaeuble has warned that the financial crisis could have political repercussions, noting how Adolf Hitler rose to power after the 1929 Wall Street crash.
"The consequences of that depression was Adolf Hitler and, indirectly, World War II and Auschwitz," the minister was quoted as saying in Der Spiegel's latest edition to appear Monday.
HRE said in a statement that it was "determining the consequences" after its suitors had "refused to provide liquidity lines".
It was problems like those at HRE, the British banks Northern Rock and Bradford and Bingley, Dutch-Belgian giant Fortis and the Franco-Belgian Dexia that forced Sarkozy to call the mini summit in Paris.
The Belgian government was said to be considering totally nationalising the Belgian part of Fortis or selling assets to BNP Paribas of France. The Dutch government has nationalised Fortis' Dutch assets.
French officials had this week floated the idea of a joint 300 billion euro (480 billion dollar) fund to bail out failing European banks, on the model of the 700 billion dollar package approved Friday by US President George W. Bush.
Germany and Britain shot this down, however, and there was no talk of such an idea at the Paris summit.
There was no disagreement, however, over the need for careless bankers to take their share of the blame for the credit crunch.
"In the case of a public support to a bank in distress, each member state present here has decided that those executives who failed will be sanctioned and the shareholders bear the weight of the intervention," Sarkozy said.
Sarkozy also said bonus structures for top executives should be "revisited".
Officials Refuse to Provide Details on Secret Previous Bailout
Fed Made $30 Billion Deal to Manage Assets of the Collapsed Bear Sterns
By JUSTIN ROOD
October 1, 2008 — ABC News
Top government officials are refusing to provide details on a secretive deal it made to manage billions in assets from an earlier bailout.
Sen. Charles Grassley, R-Iowa, has been pressing top officials for months to provide details on a deal the Federal Reserve made for a private firm to manage $30 billion in financial assets from the collapsed investment bank Bear Stearns, as part of an arrangement to facilitate J.P. Morgan Chase's purchase of the bank in March.
The Federal Reserve announced at the time that it had contracted with BlackRock Financial Management Inc. to manage the assets. Since then, it has declined to share any further details on the arrangement with anyone not reporters, not the public, and not Sen. Grassley.
"When will I receive answers to the rest of my questions posed two-and-half months ago?" Grassley wrote to Fed chairman Ben Bernanke and Treasury Secretary Henry Paulson Sept. 23, asking for an update on the value of the assets and other details of the deal.
In his letter, Grassley pointedly noted his need for timely answers in light of "the continuing financial crisis where more transparency is being promised," and the urgent press from the administration for lawmakers to approve a massive bailout program.
Grassley's office confirmed to ABC News Wednesday afternoon it had not received any new information on the deal.
A spokesman for the Federal Reserve said he did not know the status of any congressional request. The spokesman, Andrew Williams, declined to share any information on the arrangement with BlackRock, saying, "Our general principle is we don't disclose contracts we make with outside contractors."
A spokeswoman for BlackRock also declined to speak about the deal. "As a matter of policy we don't comment on client activity or client accounts," said BlackRock's Bobbie Collins.
http://abcnews.go.com/Blotter/story?id=5930875
Smoke, mirrors ... and how a handful of missed mortgage payments started the global financial crisis
Last week, something happened which I never expected to see in my lifetime. There was a general run on the entire British banking system, something that hasn't happened before, even in wartime. Ordinary people started moving their money around from bank to bank in fear that they might lose their cash. Millions of pounds were flowing across the Irish sea for the safe haven of the Irish government's recently-announced 100% depositor guarantee. The UK's banks were on the verge of losing public trust, and public trust is the one thing that banks need to survive.
We are witnessing what the commentator Martin Wolf of the Financial Times calls "the disintegration of the financial system". But how did we get here? How did a few dodgy sub-prime mortgages in American inner cities lead to what is beginning to look like the collapse of capitalism?
This is the great unanswered question in the midst of this extraordinary crisis, as banks implode one after the other across the world. We hear endless talk these days about "de-leveraging", "derivatives", "collateralised debt obligation" and "credit default swaps" most of which is completely incomprehensible - and very often designed to be. A lot of what has been going on is essentially fraudulent. But underneath all the jargon is a fundamental truth about banking: that it is based on a kind of confidence trick.
It's called "fractional reserve banking". Alone among commercial institutions, banks are allowed to create value out of nothing - in other words, they are allowed to lend out money they don't have.
To explain more fully: at any one time a bank may have, say, £1 billion in assets, but it will have lent out at least £10bn. That £10bn will yield interest, earning money for the bank - but it's interest on money the bank doesn't actually own, that is not based on deposits in its accounts. Magic. Money for nothing.
But this magic only works if the debtors the bank has lent to don't default on their loans and that the savers who have placed deposits in a bank do not all try to take them out all at once. If they did, then the bank would rapidly become insolvent, because of the £9bn it has lent out that it never had in the first place. That's what started to happen last week: the confidence trick began to fail.
Banking practice dates from medieval times when kings and aristocrats deposited their gold with goldsmiths for safekeeping. The goldsmiths noted that the owners didn't all ask for all the precious metals back at the same time, so they started to lend it out. This is why, until very recently, bank notes "promised to pay the bearer on demand" a sum of sterling silver. It was all based on precious metals. But not any more.
Currency ceased to be linked to precious metals in 1971 when America abandoned the gold standard and ordained that, instead, the world should regard their dollar as being "as good as gold" and use it as the universal medium of exchange. This is called "fiat" money, and some economists believe that it is the root of all evil because, with no intrinsic value, governments cannot resist printing more and more of it, thus devaluing their currency.
The prevailing view nowadays among economists is that central banks can maintain the value of their currencies by manipulating interest rates up or down to control inflation. But this depends on the willingness of the banks to do so.
It also depends on the wisdom and prudence of the banks who manufacture this magic stuff called credit. For the past 20 years, central banks have seen economic growth as more important than combating inflation, and banks have thrown prudence to the winds.
After the 1987 crash, central banks cut interest rates and economic life resumed. Again in the late 1990s, after the Asian financial crisis and the near-collapse of the hedge fund Long Term Capital Management, banks cut interest rates again. After the dotcom crash in 2001, the US Federal Reserve, followed by the Bank of England, cut rates dramatically yet again, and kept them low for the next three years, stimulating house price bubbles in both countries.
At the same time, the bankers made saving money a loser's game - interest rates were held below the rate of inflation, so anyone who saved actually lost money.
The bankers knew perfectly what they were doing - the former Bank of England governor, Sir Eddie George, told a Commons Select Committee two years ago that the housing boom was "unsustainable" but that he and Gordon Brown deliberately inflated it to prevent a recession. Unfortunately, it got a bit out of hand.
The other problem with central banks always cutting interest rates was that this encourages the banks to stop behaving themselves. Huge institutions, including Lehman Brothers and HBOS, started to think they were invincible, masters of the universe, "too big to fail".
Banks like HBOS piled into property, believing that house prices would never fall, and if they did, the Bank of England would slash interest rates and house prices would rise again.
Banks like Northern Rock stopped bothering about the boring business of attracting deposits from savers and started borrowing money on the international money markets to fund ever more ludicrous mortgage lending - such as their 125% so-called "suicide" loans. Northern Rock was still selling these "together" loans six months after it was nationalised.
This confidence that central banks would ride to the rescue led banks to take bigger and bigger risks. Instead of lending 10 times the value of its underlying assets, investment banks including Lehman started lending out 30 times their asset value. This is called leveraging, and allowed the hedge funds and private equity groups financed by Lehman to go on buying sprees across corporate world. They were getting colossal quantities of almost free money.
"Leveraged buy-outs" (LBOs) became the name of the corporate game. Groups of investors would get together, target a company - for instance, the AA in the UK - borrow to buy it, load it up with more debt, sell it, and move on.
Hedge funds flipped multi-billion companies the way amateur property speculators in California flipped houses.
But it was all based on credit, and the dark side of credit is debt. All of this leveraging works only as long as the underlying assets retain their value. Using leverage seemed like free money. But when assets decline in value, the ugly side of debt appears in the form of "de-leveraging".
If a bank has loaned out 30 times its assets, it has loaned out £3 trillion on the basis of only £100bn in reserves. If those assets lose half their value, the bank finds itself in the hole to the tune of £1.5trn.
Greatly simplified, this is what has happened in the last year. A class of complex paper assets called "securities", which are based on the value of residential mortgages, started to lose their value as US house prices started to slide. The banks suddenly stopped trading these mortgage-backed securities because they were afraid of the potential losses that might show up if they did.
These assets included the now-infamous sub-prime loans - money lent to Americans who couldn't possibly pay, in what was essentially fraudulent behaviour - which were packaged up into "collateralised debt obligations" and sold on to other banks and governments who didn't really know what they were buying.
THAT'S about where we stood at the time of the collapse of Northern Rock in August 2007. A general panic among banks froze inter-bank lending. Governments then stepped in, first to nationalise Northern Rock, then to pump billions of so-called "liquidity" loans into the system. In essence, the Bank of England agreed to exchange valuable Treasury bonds for dodgy mortgage assets. The banks could then use these Treasury bonds as a kind of currency, because everyone accepted their value was underwritten by the government - ie, by you and me.
But then something else happened. Huge Wall Street investment banks such as Bear Stearns started to discover that their assets were declining even more rapidly than expected, and investors started withdrawing their funds from them, causing a kind of bank run. To prevent widespread defaults, the US government stepped in and forced another bank, JP Morgan, to buy Bear at a fraction of its value. But this didn't stop the contagion.
Within the space of six months all the big investment banks on Wall Street had collapsed or been merged with other institutions in one of the greatest banking crashes of all time.
Then the big mortgage banks on either side of the pond started to go under - including IndyMac, Washington Mutual, Wachovia, HBOS and Bradford & Bingley. The two huge state-supported US mortgage banks, Freddie Mac and Fannie Mae - responsible for $5trn in mortgages - had to be nationalised, along with the world's largest insurance company, AIG.
Banks which had previously handled hundreds of trillions of investments were finding that they were becoming insolvent almost overnight.
Because of the global reach of these companies, this became a crash even more severe than the series of banking failures that led to the Great Depression in the 1930s.
We are now reaching what might be called the terminal stage in this crisis. The contagion has spread through the entire banking structure of the West. It has moved from a crisis of liquidity to a crisis of insolvency and, finally, to a crisis of confidence in the banking system - everyone wants their money out because no-one trusts their banks. The essential trust that allowed the goldsmiths to lend on the basis of their borrowed gold has begun to evaporate.
To prevent Ireland's banks going bust, the Taoiseach last week decided to guarantee all of the deposits in Irish banks, even though it would be impossible for the Irish government to pay up if everyone withdrew. Money is now flooding out of British banks to this "safe haven", causing fury in the UK.
So, what made the collapse quite so catastrophic that even hundreds of billions of pounds in liquidity loans was not enough to staunch the flow? Well, the answer appears to lie in what is called the "shadow banking system". This refers to the unregulated dealing by banks in what are called "derivatives" - these are financial instruments which don't have a value in themselves, but relate to a future value.
Originally, derivatives were things like pork belly futures - essentially bets on the value of that year's cull of hogs. But a hugely complex market evolved in the trading of derivatives called credit default swaps, which are like insurance policies taken out on corporate debt. In the space of five years the value of credit default swap contracts rose to $62trn, larger than the combined value of all the world's stock markets. The Bank for International Settlement in Basel calculated that the total value of all derivatives in the world last year amounted to some $500trn.
The market in these "over-the-counter" derivatives is unregulated, and traders are allowed to make bets and enter into contracts without having assets to back them up. The derivatives banks thought they had removed the risk by using complex mathematical formulae which seemed to indicate that they could so finely calculate the likelihood of making a loss that they could insure against it.
These derivatives and the mathematics underlying them are immensely complicated and very few people understand them. Indeed, it has emerged that the people who devised them didn't seem to understand them either, because the whole derivatives pyramid is now collapsing.
But through all the confusion the simple essential fact is that banks have hugely over-lent, their assets are declining, debtors are defaulting and their losses, multiplied by complex derivatives and de-leveraging, have become almost incalculable. The banks have had to cut back their lending drastically to build up their capital reserves, and they are now appealing to governments for direct injections of capital.
This is what the $700bn Troubled Asset Relief Programme was all about - using taxpayers money to try to shore up banking capital by buying their worthless assets. But the trouble with this scheme, devised by the former Goldman Sachs boss Henry Paulson, who is now the US treasury secretary, is that no-one really knows how big the losses of the banks are because of this huge amorphous cloud of impenetrable derivatives contracts.
But the story isn't over there. Not only did the banks lend too much and binge on dodgy derivatives, they based most of their devilish formulae on a presumption that house prices always go up. Now, statistically speaking, this is arguably the case - over time, house prices have always risen in the long run.
However, in the short run, the graph can be a very lumpy one, with rises and big falls. For some reason, the banks forgot this, and thought that the bubble in house prices that was ignited by the 2001 interest rate cuts would continue forever.
This was utter madness. House prices are now falling to trend - which means to their historic values. This means a reduction of something like 30%-50%, because the graph of prices always overshoots on the upside and downside. Look at any historical table of house prices and this is blindingly obvious - but for some reason the banks believed that the laws of economics had been suspended by their brilliant mathematics.
So now what happens? Well, as house prices continue to fall - as fall they must - the value of the assets in companies like HBOS will continue to be marked down. This is why Lloyds TSB shareholders are very reluctant to take on HBOS at any price, because it is stuffed with dodgy mortgages which are falling in value. The banks all hoped that by now the central banks would have cut interest rates and people would all have started buying houses again. But house prices are simply too high and have to fall, even with cuts in interest rates. The banks know this, which is why they are refusing to lend unless people can put up large deposits.
This creates a vicious circle which can only be resolved by the assets being revalued. House prices must come down; the banks' assets must be repriced; insolvent banks must be closed; interest rates must encourage saving; consumers will have to stop borrowing to spend and everyone will have to start paying their debts.
It's a tall order, and governments across the world are in denial. But the only way out of this mess is some very hard medicine. The longer governments and banks put off swallowing it, the longer the slump will last.
http://www.informationclearinghouse.info/
We are witnessing what the commentator Martin Wolf of the Financial Times calls "the disintegration of the financial system". But how did we get here? How did a few dodgy sub-prime mortgages in American inner cities lead to what is beginning to look like the collapse of capitalism?
This is the great unanswered question in the midst of this extraordinary crisis, as banks implode one after the other across the world. We hear endless talk these days about "de-leveraging", "derivatives", "collateralised debt obligation" and "credit default swaps" most of which is completely incomprehensible - and very often designed to be. A lot of what has been going on is essentially fraudulent. But underneath all the jargon is a fundamental truth about banking: that it is based on a kind of confidence trick.
It's called "fractional reserve banking". Alone among commercial institutions, banks are allowed to create value out of nothing - in other words, they are allowed to lend out money they don't have.
To explain more fully: at any one time a bank may have, say, £1 billion in assets, but it will have lent out at least £10bn. That £10bn will yield interest, earning money for the bank - but it's interest on money the bank doesn't actually own, that is not based on deposits in its accounts. Magic. Money for nothing.
But this magic only works if the debtors the bank has lent to don't default on their loans and that the savers who have placed deposits in a bank do not all try to take them out all at once. If they did, then the bank would rapidly become insolvent, because of the £9bn it has lent out that it never had in the first place. That's what started to happen last week: the confidence trick began to fail.
Banking practice dates from medieval times when kings and aristocrats deposited their gold with goldsmiths for safekeeping. The goldsmiths noted that the owners didn't all ask for all the precious metals back at the same time, so they started to lend it out. This is why, until very recently, bank notes "promised to pay the bearer on demand" a sum of sterling silver. It was all based on precious metals. But not any more.
Currency ceased to be linked to precious metals in 1971 when America abandoned the gold standard and ordained that, instead, the world should regard their dollar as being "as good as gold" and use it as the universal medium of exchange. This is called "fiat" money, and some economists believe that it is the root of all evil because, with no intrinsic value, governments cannot resist printing more and more of it, thus devaluing their currency.
The prevailing view nowadays among economists is that central banks can maintain the value of their currencies by manipulating interest rates up or down to control inflation. But this depends on the willingness of the banks to do so.
It also depends on the wisdom and prudence of the banks who manufacture this magic stuff called credit. For the past 20 years, central banks have seen economic growth as more important than combating inflation, and banks have thrown prudence to the winds.
After the 1987 crash, central banks cut interest rates and economic life resumed. Again in the late 1990s, after the Asian financial crisis and the near-collapse of the hedge fund Long Term Capital Management, banks cut interest rates again. After the dotcom crash in 2001, the US Federal Reserve, followed by the Bank of England, cut rates dramatically yet again, and kept them low for the next three years, stimulating house price bubbles in both countries.
At the same time, the bankers made saving money a loser's game - interest rates were held below the rate of inflation, so anyone who saved actually lost money.
The bankers knew perfectly what they were doing - the former Bank of England governor, Sir Eddie George, told a Commons Select Committee two years ago that the housing boom was "unsustainable" but that he and Gordon Brown deliberately inflated it to prevent a recession. Unfortunately, it got a bit out of hand.
The other problem with central banks always cutting interest rates was that this encourages the banks to stop behaving themselves. Huge institutions, including Lehman Brothers and HBOS, started to think they were invincible, masters of the universe, "too big to fail".
Banks like HBOS piled into property, believing that house prices would never fall, and if they did, the Bank of England would slash interest rates and house prices would rise again.
Banks like Northern Rock stopped bothering about the boring business of attracting deposits from savers and started borrowing money on the international money markets to fund ever more ludicrous mortgage lending - such as their 125% so-called "suicide" loans. Northern Rock was still selling these "together" loans six months after it was nationalised.
This confidence that central banks would ride to the rescue led banks to take bigger and bigger risks. Instead of lending 10 times the value of its underlying assets, investment banks including Lehman started lending out 30 times their asset value. This is called leveraging, and allowed the hedge funds and private equity groups financed by Lehman to go on buying sprees across corporate world. They were getting colossal quantities of almost free money.
"Leveraged buy-outs" (LBOs) became the name of the corporate game. Groups of investors would get together, target a company - for instance, the AA in the UK - borrow to buy it, load it up with more debt, sell it, and move on.
Hedge funds flipped multi-billion companies the way amateur property speculators in California flipped houses.
But it was all based on credit, and the dark side of credit is debt. All of this leveraging works only as long as the underlying assets retain their value. Using leverage seemed like free money. But when assets decline in value, the ugly side of debt appears in the form of "de-leveraging".
If a bank has loaned out 30 times its assets, it has loaned out £3 trillion on the basis of only £100bn in reserves. If those assets lose half their value, the bank finds itself in the hole to the tune of £1.5trn.
Greatly simplified, this is what has happened in the last year. A class of complex paper assets called "securities", which are based on the value of residential mortgages, started to lose their value as US house prices started to slide. The banks suddenly stopped trading these mortgage-backed securities because they were afraid of the potential losses that might show up if they did.
These assets included the now-infamous sub-prime loans - money lent to Americans who couldn't possibly pay, in what was essentially fraudulent behaviour - which were packaged up into "collateralised debt obligations" and sold on to other banks and governments who didn't really know what they were buying.
THAT'S about where we stood at the time of the collapse of Northern Rock in August 2007. A general panic among banks froze inter-bank lending. Governments then stepped in, first to nationalise Northern Rock, then to pump billions of so-called "liquidity" loans into the system. In essence, the Bank of England agreed to exchange valuable Treasury bonds for dodgy mortgage assets. The banks could then use these Treasury bonds as a kind of currency, because everyone accepted their value was underwritten by the government - ie, by you and me.
But then something else happened. Huge Wall Street investment banks such as Bear Stearns started to discover that their assets were declining even more rapidly than expected, and investors started withdrawing their funds from them, causing a kind of bank run. To prevent widespread defaults, the US government stepped in and forced another bank, JP Morgan, to buy Bear at a fraction of its value. But this didn't stop the contagion.
Within the space of six months all the big investment banks on Wall Street had collapsed or been merged with other institutions in one of the greatest banking crashes of all time.
Then the big mortgage banks on either side of the pond started to go under - including IndyMac, Washington Mutual, Wachovia, HBOS and Bradford & Bingley. The two huge state-supported US mortgage banks, Freddie Mac and Fannie Mae - responsible for $5trn in mortgages - had to be nationalised, along with the world's largest insurance company, AIG.
Banks which had previously handled hundreds of trillions of investments were finding that they were becoming insolvent almost overnight.
Because of the global reach of these companies, this became a crash even more severe than the series of banking failures that led to the Great Depression in the 1930s.
We are now reaching what might be called the terminal stage in this crisis. The contagion has spread through the entire banking structure of the West. It has moved from a crisis of liquidity to a crisis of insolvency and, finally, to a crisis of confidence in the banking system - everyone wants their money out because no-one trusts their banks. The essential trust that allowed the goldsmiths to lend on the basis of their borrowed gold has begun to evaporate.
To prevent Ireland's banks going bust, the Taoiseach last week decided to guarantee all of the deposits in Irish banks, even though it would be impossible for the Irish government to pay up if everyone withdrew. Money is now flooding out of British banks to this "safe haven", causing fury in the UK.
So, what made the collapse quite so catastrophic that even hundreds of billions of pounds in liquidity loans was not enough to staunch the flow? Well, the answer appears to lie in what is called the "shadow banking system". This refers to the unregulated dealing by banks in what are called "derivatives" - these are financial instruments which don't have a value in themselves, but relate to a future value.
Originally, derivatives were things like pork belly futures - essentially bets on the value of that year's cull of hogs. But a hugely complex market evolved in the trading of derivatives called credit default swaps, which are like insurance policies taken out on corporate debt. In the space of five years the value of credit default swap contracts rose to $62trn, larger than the combined value of all the world's stock markets. The Bank for International Settlement in Basel calculated that the total value of all derivatives in the world last year amounted to some $500trn.
The market in these "over-the-counter" derivatives is unregulated, and traders are allowed to make bets and enter into contracts without having assets to back them up. The derivatives banks thought they had removed the risk by using complex mathematical formulae which seemed to indicate that they could so finely calculate the likelihood of making a loss that they could insure against it.
These derivatives and the mathematics underlying them are immensely complicated and very few people understand them. Indeed, it has emerged that the people who devised them didn't seem to understand them either, because the whole derivatives pyramid is now collapsing.
But through all the confusion the simple essential fact is that banks have hugely over-lent, their assets are declining, debtors are defaulting and their losses, multiplied by complex derivatives and de-leveraging, have become almost incalculable. The banks have had to cut back their lending drastically to build up their capital reserves, and they are now appealing to governments for direct injections of capital.
This is what the $700bn Troubled Asset Relief Programme was all about - using taxpayers money to try to shore up banking capital by buying their worthless assets. But the trouble with this scheme, devised by the former Goldman Sachs boss Henry Paulson, who is now the US treasury secretary, is that no-one really knows how big the losses of the banks are because of this huge amorphous cloud of impenetrable derivatives contracts.
But the story isn't over there. Not only did the banks lend too much and binge on dodgy derivatives, they based most of their devilish formulae on a presumption that house prices always go up. Now, statistically speaking, this is arguably the case - over time, house prices have always risen in the long run.
However, in the short run, the graph can be a very lumpy one, with rises and big falls. For some reason, the banks forgot this, and thought that the bubble in house prices that was ignited by the 2001 interest rate cuts would continue forever.
This was utter madness. House prices are now falling to trend - which means to their historic values. This means a reduction of something like 30%-50%, because the graph of prices always overshoots on the upside and downside. Look at any historical table of house prices and this is blindingly obvious - but for some reason the banks believed that the laws of economics had been suspended by their brilliant mathematics.
So now what happens? Well, as house prices continue to fall - as fall they must - the value of the assets in companies like HBOS will continue to be marked down. This is why Lloyds TSB shareholders are very reluctant to take on HBOS at any price, because it is stuffed with dodgy mortgages which are falling in value. The banks all hoped that by now the central banks would have cut interest rates and people would all have started buying houses again. But house prices are simply too high and have to fall, even with cuts in interest rates. The banks know this, which is why they are refusing to lend unless people can put up large deposits.
This creates a vicious circle which can only be resolved by the assets being revalued. House prices must come down; the banks' assets must be repriced; insolvent banks must be closed; interest rates must encourage saving; consumers will have to stop borrowing to spend and everyone will have to start paying their debts.
It's a tall order, and governments across the world are in denial. But the only way out of this mess is some very hard medicine. The longer governments and banks put off swallowing it, the longer the slump will last.
http://www.informationclearinghouse.info/
Former IMF economist warns of global recession
Washington, October 04, 2008
Simon Johnson, the former chief economist of the International Monetary Fund, warned of a global recession as a result of the devastating financial crisis that has struck the United States and Europe.
Johnson said the $700-billion rescue package passed by the US Congress and signed by President George W. Bush Friday was only a "stop-gap measure" that would not prevent a serious contraction of the world's largest economy.
"The US is clearly heading into, at best, a fairly severe recession," said Johnson, who left the IMF earlier this year and is now a senior fellow at the Peterson Institute for International Economics, a Washington-based think tank.
Johnson said he expected "a recession, not a depression" at the global level, adding that international action was "tremendously important" to restore confidence in credit markets. Banks have severely cut lending to each other and to consumers out of fear for
their own capital positions.
"At this moment, it is absolutely about a crisis of confidence. But the good news is you can end a crisis of confidence quite quickly," Johnson said.
He said the international community could start with a strong statement during meetings next week of the Group of Seven (G7) industrial nations and IMF members in Washington, and criticized some of the "finger-pointing" by European nations over a mess created by Wall Street.
"There's plenty of time for recrimination later, but right now we have to act quickly," said Johnson.
The US rescue package, which allows the government to buy up to $700 billion in damaged mortgage assets that have decimated the balance sheets of financial institutions, was a "positive step" in stabilizing the banking system.
"They really understand that the situation in the US today is serious and needs to be addressed," he said.
But Johnson said much more had to be done in the coming weeks and months to address the housing crisis at the centre of the turmoil, as well as to recapitalize banks in both the US and Europe.
"For $700 billion you get a band-aid but you don't get a solution," Johnson said. "Congress is way behind the curve. They need to have hearings, they need to have alternatives."
For starters, the US had to begin helping homeowners restructure their mortgages "much more aggressively" in order to arrest a "death spiral" of plunging home prices and record foreclosures in the housing market.
Johnson also called for a second fiscal stimulus package in the US to boost spending and help ease the economic downturn. A first set of tax rebates was handed out by the government in the first half of the year.
For Europe, where some countries are already facing a contraction of their economies, Johnson called on the European Central Bank to sharply reduce interest rates in order to improve lending conditions in their economies.
He also pushed for the European Union to harmonize its level of guarantees for bank deposits. The US rescue package boosted bank savings guarantees from $100,000 to $250,000.
Britain and Greece also raised their deposit guarantees Friday, while Ireland this week offered blanket coverage for all savings held in the country's six main banks - a move the European Commission said distorted competition.
"Within the European Union, there's clearly a need for more coordination," Johnson said.
http://www.hindustantimes.com/StoryPage/Print.aspx?Id=0b3230eb-
Simon Johnson, the former chief economist of the International Monetary Fund, warned of a global recession as a result of the devastating financial crisis that has struck the United States and Europe.
Johnson said the $700-billion rescue package passed by the US Congress and signed by President George W. Bush Friday was only a "stop-gap measure" that would not prevent a serious contraction of the world's largest economy.
"The US is clearly heading into, at best, a fairly severe recession," said Johnson, who left the IMF earlier this year and is now a senior fellow at the Peterson Institute for International Economics, a Washington-based think tank.
Johnson said he expected "a recession, not a depression" at the global level, adding that international action was "tremendously important" to restore confidence in credit markets. Banks have severely cut lending to each other and to consumers out of fear for
their own capital positions.
"At this moment, it is absolutely about a crisis of confidence. But the good news is you can end a crisis of confidence quite quickly," Johnson said.
He said the international community could start with a strong statement during meetings next week of the Group of Seven (G7) industrial nations and IMF members in Washington, and criticized some of the "finger-pointing" by European nations over a mess created by Wall Street.
"There's plenty of time for recrimination later, but right now we have to act quickly," said Johnson.
The US rescue package, which allows the government to buy up to $700 billion in damaged mortgage assets that have decimated the balance sheets of financial institutions, was a "positive step" in stabilizing the banking system.
"They really understand that the situation in the US today is serious and needs to be addressed," he said.
But Johnson said much more had to be done in the coming weeks and months to address the housing crisis at the centre of the turmoil, as well as to recapitalize banks in both the US and Europe.
"For $700 billion you get a band-aid but you don't get a solution," Johnson said. "Congress is way behind the curve. They need to have hearings, they need to have alternatives."
For starters, the US had to begin helping homeowners restructure their mortgages "much more aggressively" in order to arrest a "death spiral" of plunging home prices and record foreclosures in the housing market.
Johnson also called for a second fiscal stimulus package in the US to boost spending and help ease the economic downturn. A first set of tax rebates was handed out by the government in the first half of the year.
For Europe, where some countries are already facing a contraction of their economies, Johnson called on the European Central Bank to sharply reduce interest rates in order to improve lending conditions in their economies.
He also pushed for the European Union to harmonize its level of guarantees for bank deposits. The US rescue package boosted bank savings guarantees from $100,000 to $250,000.
Britain and Greece also raised their deposit guarantees Friday, while Ireland this week offered blanket coverage for all savings held in the country's six main banks - a move the European Commission said distorted competition.
"Within the European Union, there's clearly a need for more coordination," Johnson said.
http://www.hindustantimes.com/StoryPage/Print.aspx?Id=0b3230eb-
Wall Street Meltdown Primer
Walden Bello, Foreig Policy in Focus, September 26, 2008.
Many on Wall Street and the rest of us are still digesting the momentous events of the last 10 days. Between one and three trillion dollars worth of financial assets have evaporated. Wall Street has been effectively nationalized. The Federal Reserve and the Treasury Department are making all the major strategic decisions in the financial sector and, with the rescue of the American International Group (AIG), the U.S. government now runs the world’s biggest insurance company. At $700 billion, the biggest bailout since the Great Depression is being desperately cobbled together to save the global financial system.
The usual explanations no longer suffice. Extraordinary events demand extraordinary explanations. But first…
Is the worst over?
No. If anything is clear from the contradictory moves of the last week — allowing Lehman Brothers to collapse while taking over AIG, and engineering Bank of America’s takeover of Merrill Lynch — there’s no strategy to deal with the crisis, just tactical responses. It’s like the fire department’s response to a conflagration.
The $700 billion buyout of banks’ bad mortgaged-backed securities is mainly a desperate effort to shore up confidence in the system, preventing the erosion of trust in the banks and other financial institutions and avoiding a massive bank run such as the one that triggered the Great Depression of 1929.
Did greed cause the collapse of global capitalism’s nerve center?
Good old-fashioned greed certainly played a part. This is what Klaus Schwab, the organizer of the World Economic Forum, the yearly global elite jamboree in the Swiss Alps, meant when he said in an interview earlier this year: “We have to pay for the sins of the past.”
Was this a case of Wall Street outsmarting itself?
Definitely. Financial speculators outsmarted themselves by creating more and more complex financial contracts like derivatives that would securitize and make money from all forms of risk — including such exotic futures instruments as “credit default swaps” that enable investors to bet on the odds that the banks’ own corporate borrowers would not be able to pay their debts! This is the unregulated multi-trillion dollar trade that brought down AIG.
On December 17, 2005, when International Financing Review (IFR) announced its 2005 Annual Awards — one of the securities industry's most prestigious awards programs — it had this to say: "[Lehman Brothers] not only maintained its overall market presence, but also led the charge into the preferred space by...developing new products and tailoring transactions to fit borrowers' needs…Lehman Brothers is the most innovative in the preferred space, just doing things you won't see elsewhere."
Was it lack of regulation?
Yes. Everyone acknowledges by now that Wall Street’s capacity to innovate and turn out more and more sophisticated financial instruments had run far ahead of government’s regulatory capability. This wasn’t because the government was incapable of regulating but because the dominant neoliberal, laissez-faire attitude prevented government from devising effective regulatory mechanisms.
But isn’t there something more that is happening?
We’re seeing the intensification of one of the central crises or contradictions of global capitalism: the crisis of overproduction, also known as overaccumulation or overcapacity.
In other words, capitalism has a tendency to build up tremendous productive capacity that outruns the population’s capacity to consume owing to social inequalities that limit popular purchasing power, thus eroding profitability.
But what does the crisis of overproduction have to do with recent events?
Plenty. But to understand the connections, we must go back in time to the so-called Golden Age of Contemporary Capitalism, the period from 1945 to 1975.
This was a time of rapid growth both in the center economies and in the underdeveloped economies — one that was partly triggered by the massive reconstruction of Europe and East Asia after the devastation of World War II, and partly by the new socio-economic arrangements institutionalized under the new Keynesian state. Key among the latter were strong state controls over market activity, aggressive use of fiscal and monetary policy to minimize inflation and recession, and a regime of relatively high wages to stimulate and maintain demand.
So what went wrong?
This period of high growth came to an end in the mid-1970s, when the center economies were seized by stagflation, meaning the coexistence of low growth with high inflation, which wasn’t supposed to happen under neoclassical economics.
Stagflation, however, was but a symptom of a deeper cause: the reconstruction of Germany and Japan and the rapid growth of industrializing economies like Brazil, Taiwan, and South Korea added tremendous new productive capacity and increased global competition. Meanwhile social inequality within countries and between countries globally limited the growth of purchasing power and demand, thus eroding profitability. The massive increase in the price of oil aggravated this trend in the 1970s.
How did capitalism try to solve the crisis of overproduction?
Capital tried three escape routes from the conundrum of overproduction: neoliberal restructuring, globalization, and financialization.
What was neoliberal restructuring all about?
Neoliberal restructuring took the form of Reaganism and Thatcherism in the North and structural adjustment in the South. The aim was to invigorate capital accumulation, and this was to be done by 1) removing state constraints on the growth, use, and flow of capital and wealth; and 2) redistributing income from the poor and middle classes to the rich on the theory that the rich would then be motivated to invest and reignite economic growth.
This formula redistributed income to the rich and gutted the incomes of the poor and middle classes. It thus restricted demand while not necessarily inducing the rich to invest more in production.
In fact, neoliberal restructuring, which was generalized in the North and South during the 1980s and 1990s, had a poor record in terms of growth: global growth averaged 1.1% in the 1990s and 1.4% in the 1980s, whereas it averaged 3.5% in the 1960s and 2.4% in the 1970s, when state interventionist policies were dominant. Neoliberal restructuring couldn’t shake off stagnation.
How was globalization a response to the crisis?
The second escape route global capital took to counter stagnation was “extensive accumulation” or globalization. This was the rapid integration of semi-capitalist, non-capitalist, or precapitalist areas into the global market economy. Rosa Luxemburg, the famous German revolutionary economist, saw this long ago as necessary to shore up the rate of profit in the metropolitan economies: by gaining access to cheap labor, by gaining new, albeit limited, markets, by gaining new sources of cheap agricultural and raw material products, and by bringing into being new areas for investment in infrastructure. Integration is accomplished via trade liberalization, removing barriers to the mobility of global capital and abolishing barriers to foreign investment.
China is, of course, the most prominent case of a non-capitalist area that was integrated into the global capitalist economy over the last 25 years.
To counter their declining profits, many Fortune 500 corporations have moved a significant part of their operations to China to take advantage of the so-called “China Price” — the cost advantage of China’s seemingly inexhaustible cheap labor. By the middle of the first decade of the 21st century, roughly 40-50% of the profits of U.S. corporations were derived from their operations and sales abroad, especially China.
Why didn’t globalization surmount the crisis?
This escape route from stagnation has exacerbated the problem of overproduction because it adds to productive capacity. A tremendous amount of manufacturing capacity has been added in China over the last 25 years, and this has had a depressing effect on prices and profits. Not surprisingly, by around 1997, the profits of U.S. corporations stopped growing. According to one index, the profit rate of the Fortune 500 went from 7.15% in 1960-69 to 5.3% in 1980-90 to 2.29% in 1990-99 to 1.32% in 2000-2002.
What about financialization?
Given the limited gains in countering the depressive impact of overproduction via neoliberal restructuring and globalization, the third escape route became very critical for maintaining and raising profitability: financialization.
In the ideal world of neoclassical economics, the financial system is the mechanism by which the savers or those with surplus funds are joined with the entrepreneurs who have need of their funds to invest in production. In the real world of late capitalism, with investment in industry and agriculture yielding low profits owing to overcapacity, large amounts of surplus funds are circulating and being invested and reinvested in the financial sector. The financial sector has thus turned on itself.
The result is an increased bifurcation between a hyperactive financial economy and a stagnant real economy. As one financial executive notes, “there has been an increasing disconnect between the real and financial economies in the last few years. The real economy has grown…but nothing like that of the financial economy — until it imploded.”
What this observer doesn’t tell us is that the disconnect between the real and the financial economy isn’t accidental. The financial economy has exploded precisely to make up for the stagnation owing to overproduction of the real economy.
What were the problems with financialization as an escape route?
The problem with investing in financial sector operations is that it is tantamount to squeezing value out of already created value. It may create profit, yes, but it doesn’t create new value. Only industry, agricultural, trade, and services create new value. Because profit is not based on value that is created, investment operations become very volatile and the prices of stocks, bonds, and other forms of investment can depart very radically from their real value. For instance, in the 1990s, prices of stock in Internet startups skyrocketed, driven mainly by upwardly spiraling financial valuations rooted in theoretical expectations of future profitability. Share prices crashed in 2000 and 2001 when this strategy got completely out of hand. Profits then depend on taking advantage of upward price departures from the value of commodities, then selling before reality enforces a “correction.” Corrections are really a return to more realistic values. The radical rise of asset prices far beyond any credible value is what what fosters financial bubbles.
Why is financialization so volatile?
With profitability depending on speculative coups, it’s not surprising that the finance sector lurches from one bubble to another, or from one speculative mania to another.
And because it’s driven by speculative mania, finance-driven capitalism has experienced scores of financial crises since capital markets were deregulated and liberalized in the 1980s.
Prior to the current Wall Street meltdown, the most explosive of these were the string of emerging markets crises and the U.S.tech stock bubble’s implosion in 2000 and 2001. The emerging markets crises primarily included the Mexican financial crisis of 1994-95, the Asian financial crisis of 1997-1998, the Russian financial crisis in 1998, and the Argentine financial collapse that occurred in 2001 and 2002, but they also rocked other countries including Brazil and Turkey.
One of President Bill Clinton’s Treasury Secretaries, Wall Streeter Robert Rubin, predicted five years ago that “future financial crises are almost surely inevitable and could be even more severe.”
How do bubbles form, grow, and burst?
Let’s first use the Asian financial crisis of 1997-98, as an example. First, capital account and financial liberalization took place Thailand and other countries at the urging of the International Monetary Fund (IMF) and the U.S. Treasury Department. Then came the entry of foreign funds seeking quick and high returns, meaning they went to real estate and the stock market. This overinvestment made stock and real estate prices fall, leading to the panicked withdrawal of funds. In 1997, $100 billion fled the East Asian economies over the course of just a few weeks.
That capital flight led to an IMF bailout of foreign speculators. The resulting collapse of the real economy produced a recession throughout East Asia in 1998. Despite massive destabilization, international financial institutions opposed efforts to impose both national and global regulation of financial system on ideological grounds.
What about the current bubble? How did it form?
The current Wall Street collapse has its roots in the technology-stock bubble of the late 1990s, when the price of the stocks of Internet startups skyrocketed, then collapsed in 2000 and 2001, resulting in the loss of $7 trillion worth of assets and the recession of 2001-2002.
The Fed’s loose money policies under Alan Greenspan encouraged the technology bubble. When it collapsed into a recession, Greenspan, to try to counter a long recession, cut the prime rate to a 45-year low of one percent in June 2003 and kept it there for over a year. This had the effect of encouraging another bubble — in real estate.
As early as 2002, progressive economists such as Dean Baker of the Center for Economic Policy Research were warning about the real estate bubble and the predictable severity of its impending collapse. However, as late as 2005, then-Council of Economic Adviser Chairman and now Federal Reserve Board Chairman Ben Bernanke attributed the rise in U.S. housing prices to “strong economic fundamentals” instead of speculative activity. Is it any wonder that he was caught completely off guard when the subprime mortgage crisis broke in the summer of 2007?
And how did it grow?
According to investor and philanthropist George Soros: “Mortgage institutions encouraged mortgage holders to refinance their mortgages and withdraw their excess equity. They lowered their lending standards and introduced new products, such as adjustable mortgages (ARMs), ‘interest-only’ mortgages, and promotional teaser rates.” All this encouraged speculation in residential housing units. House prices started to rise in double-digit rates. This served to reinforce speculation, and the rise in house prices made the owners feel rich; the result was a consumption boom that has sustained the economy in recent years.”
The subprime mortgage crisis wasn’t a case of supply outrunning real demand. The “demand” was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that has flooded the United States in the last decade. Big-ticket mortgages were aggressively sold to millions who could not normally afford them by offering low “teaser” interest rates that would later be readjusted to jack up payments from the new homeowners.
But how could subprime mortgages going sour turn into such a big problem?
Because these assets were then “securitized” with other assets into complex derivative products called “collateralized debt obligations” (CDOs). The mortgage originators worked with different layers of middlemen who understated risk so as to offload them as quickly as possible to other banks and institutional investors. These institutions in turn offloaded these securities onto other banks and foreign financial institutions.
When the interest rates were raised on the subprime loans, adjustable mortgage, and other housing loans, the game was up. There are about six million subprime mortgages outstanding, 40% of which will likely go into default in the next two years, Soros estimates.
And five million more defaults from adjustable rate mortgages and other “flexible loans” will occur over the next several years. These securities, the value of which run into the trillions of dollars, have already been injected, like virus, into the global financial system.
But how could Wall Street titans collapse like a house of cards?
For Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, and Bear Stearns, the losses represented by these toxic securities simply overwhelmed their reserves and brought them down. And more are likely to fall once their books — since lots of these holdings are recorded “off the balance sheet” — are corrected to reflect their actual holdings.
And many others will join them as other speculative operations such as credit cards and different varieties of risk insurance seize up. The American International Group (AIG) was felled by its massive exposure in the unregulated area of credit default swaps, derivatives that make it possible for investors to bet on the possibility that companies will default on repaying loans. According to Soros, such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the U.S. government bond market. The huge size of the assets that could go bad if AIG collapsed made Washington change its mind and intervene after it let Lehman Brothers collapse.
What’s going to happen now?
There will be more bankruptcies and government takeovers. Wall Street’s collapse will deepen and prolong the U.S. recession. This recession will translate into an Asian recession. After all, China’s main foreign market is the United States, and China in turn imports raw materials and intermediate goods that it uses for its U.S. exports from Japan, Korea, and Southeast Asia. Globalization has made “decoupling” impossible. The United States, China, and East Asia in general are like three prisoners bound together in a chain-gang.
In a nutshell…?
The Wall Street meltdown is not only due to greed and to the lack of government regulation of a hyperactive sector. This collapse stems ultimately from the crisis of overproduction that has plagued global capitalism since the mid-1970s.
The financialization of investment activity has been one of the escape routes from stagnation, the other two being neoliberal restructuring and globalization. With neoliberal restructuring and globalization providing limited relief, financialization became attractive as a mechanism to shore up profitability. But financialization has proven to be a dangerous road. It has led to speculative bubbles that produce temporary prosperity for a few but ultimately end up in corporate collapse and in recession in the real economy.
The key questions now are: How deep and long will this recession be? Does the U.S. economy need another speculative bubble to drag itself out of this recession? And if it does, where will the next bubble form? Some people say the military-industrial complex or the “disaster capitalism complex” that Naomi Klein writes about will be the next bubble. But that’s another story.
Many on Wall Street and the rest of us are still digesting the momentous events of the last 10 days. Between one and three trillion dollars worth of financial assets have evaporated. Wall Street has been effectively nationalized. The Federal Reserve and the Treasury Department are making all the major strategic decisions in the financial sector and, with the rescue of the American International Group (AIG), the U.S. government now runs the world’s biggest insurance company. At $700 billion, the biggest bailout since the Great Depression is being desperately cobbled together to save the global financial system.
The usual explanations no longer suffice. Extraordinary events demand extraordinary explanations. But first…
Is the worst over?
No. If anything is clear from the contradictory moves of the last week — allowing Lehman Brothers to collapse while taking over AIG, and engineering Bank of America’s takeover of Merrill Lynch — there’s no strategy to deal with the crisis, just tactical responses. It’s like the fire department’s response to a conflagration.
The $700 billion buyout of banks’ bad mortgaged-backed securities is mainly a desperate effort to shore up confidence in the system, preventing the erosion of trust in the banks and other financial institutions and avoiding a massive bank run such as the one that triggered the Great Depression of 1929.
Did greed cause the collapse of global capitalism’s nerve center?
Good old-fashioned greed certainly played a part. This is what Klaus Schwab, the organizer of the World Economic Forum, the yearly global elite jamboree in the Swiss Alps, meant when he said in an interview earlier this year: “We have to pay for the sins of the past.”
Was this a case of Wall Street outsmarting itself?
Definitely. Financial speculators outsmarted themselves by creating more and more complex financial contracts like derivatives that would securitize and make money from all forms of risk — including such exotic futures instruments as “credit default swaps” that enable investors to bet on the odds that the banks’ own corporate borrowers would not be able to pay their debts! This is the unregulated multi-trillion dollar trade that brought down AIG.
On December 17, 2005, when International Financing Review (IFR) announced its 2005 Annual Awards — one of the securities industry's most prestigious awards programs — it had this to say: "[Lehman Brothers] not only maintained its overall market presence, but also led the charge into the preferred space by...developing new products and tailoring transactions to fit borrowers' needs…Lehman Brothers is the most innovative in the preferred space, just doing things you won't see elsewhere."
Was it lack of regulation?
Yes. Everyone acknowledges by now that Wall Street’s capacity to innovate and turn out more and more sophisticated financial instruments had run far ahead of government’s regulatory capability. This wasn’t because the government was incapable of regulating but because the dominant neoliberal, laissez-faire attitude prevented government from devising effective regulatory mechanisms.
But isn’t there something more that is happening?
We’re seeing the intensification of one of the central crises or contradictions of global capitalism: the crisis of overproduction, also known as overaccumulation or overcapacity.
In other words, capitalism has a tendency to build up tremendous productive capacity that outruns the population’s capacity to consume owing to social inequalities that limit popular purchasing power, thus eroding profitability.
But what does the crisis of overproduction have to do with recent events?
Plenty. But to understand the connections, we must go back in time to the so-called Golden Age of Contemporary Capitalism, the period from 1945 to 1975.
This was a time of rapid growth both in the center economies and in the underdeveloped economies — one that was partly triggered by the massive reconstruction of Europe and East Asia after the devastation of World War II, and partly by the new socio-economic arrangements institutionalized under the new Keynesian state. Key among the latter were strong state controls over market activity, aggressive use of fiscal and monetary policy to minimize inflation and recession, and a regime of relatively high wages to stimulate and maintain demand.
So what went wrong?
This period of high growth came to an end in the mid-1970s, when the center economies were seized by stagflation, meaning the coexistence of low growth with high inflation, which wasn’t supposed to happen under neoclassical economics.
Stagflation, however, was but a symptom of a deeper cause: the reconstruction of Germany and Japan and the rapid growth of industrializing economies like Brazil, Taiwan, and South Korea added tremendous new productive capacity and increased global competition. Meanwhile social inequality within countries and between countries globally limited the growth of purchasing power and demand, thus eroding profitability. The massive increase in the price of oil aggravated this trend in the 1970s.
How did capitalism try to solve the crisis of overproduction?
Capital tried three escape routes from the conundrum of overproduction: neoliberal restructuring, globalization, and financialization.
What was neoliberal restructuring all about?
Neoliberal restructuring took the form of Reaganism and Thatcherism in the North and structural adjustment in the South. The aim was to invigorate capital accumulation, and this was to be done by 1) removing state constraints on the growth, use, and flow of capital and wealth; and 2) redistributing income from the poor and middle classes to the rich on the theory that the rich would then be motivated to invest and reignite economic growth.
This formula redistributed income to the rich and gutted the incomes of the poor and middle classes. It thus restricted demand while not necessarily inducing the rich to invest more in production.
In fact, neoliberal restructuring, which was generalized in the North and South during the 1980s and 1990s, had a poor record in terms of growth: global growth averaged 1.1% in the 1990s and 1.4% in the 1980s, whereas it averaged 3.5% in the 1960s and 2.4% in the 1970s, when state interventionist policies were dominant. Neoliberal restructuring couldn’t shake off stagnation.
How was globalization a response to the crisis?
The second escape route global capital took to counter stagnation was “extensive accumulation” or globalization. This was the rapid integration of semi-capitalist, non-capitalist, or precapitalist areas into the global market economy. Rosa Luxemburg, the famous German revolutionary economist, saw this long ago as necessary to shore up the rate of profit in the metropolitan economies: by gaining access to cheap labor, by gaining new, albeit limited, markets, by gaining new sources of cheap agricultural and raw material products, and by bringing into being new areas for investment in infrastructure. Integration is accomplished via trade liberalization, removing barriers to the mobility of global capital and abolishing barriers to foreign investment.
China is, of course, the most prominent case of a non-capitalist area that was integrated into the global capitalist economy over the last 25 years.
To counter their declining profits, many Fortune 500 corporations have moved a significant part of their operations to China to take advantage of the so-called “China Price” — the cost advantage of China’s seemingly inexhaustible cheap labor. By the middle of the first decade of the 21st century, roughly 40-50% of the profits of U.S. corporations were derived from their operations and sales abroad, especially China.
Why didn’t globalization surmount the crisis?
This escape route from stagnation has exacerbated the problem of overproduction because it adds to productive capacity. A tremendous amount of manufacturing capacity has been added in China over the last 25 years, and this has had a depressing effect on prices and profits. Not surprisingly, by around 1997, the profits of U.S. corporations stopped growing. According to one index, the profit rate of the Fortune 500 went from 7.15% in 1960-69 to 5.3% in 1980-90 to 2.29% in 1990-99 to 1.32% in 2000-2002.
What about financialization?
Given the limited gains in countering the depressive impact of overproduction via neoliberal restructuring and globalization, the third escape route became very critical for maintaining and raising profitability: financialization.
In the ideal world of neoclassical economics, the financial system is the mechanism by which the savers or those with surplus funds are joined with the entrepreneurs who have need of their funds to invest in production. In the real world of late capitalism, with investment in industry and agriculture yielding low profits owing to overcapacity, large amounts of surplus funds are circulating and being invested and reinvested in the financial sector. The financial sector has thus turned on itself.
The result is an increased bifurcation between a hyperactive financial economy and a stagnant real economy. As one financial executive notes, “there has been an increasing disconnect between the real and financial economies in the last few years. The real economy has grown…but nothing like that of the financial economy — until it imploded.”
What this observer doesn’t tell us is that the disconnect between the real and the financial economy isn’t accidental. The financial economy has exploded precisely to make up for the stagnation owing to overproduction of the real economy.
What were the problems with financialization as an escape route?
The problem with investing in financial sector operations is that it is tantamount to squeezing value out of already created value. It may create profit, yes, but it doesn’t create new value. Only industry, agricultural, trade, and services create new value. Because profit is not based on value that is created, investment operations become very volatile and the prices of stocks, bonds, and other forms of investment can depart very radically from their real value. For instance, in the 1990s, prices of stock in Internet startups skyrocketed, driven mainly by upwardly spiraling financial valuations rooted in theoretical expectations of future profitability. Share prices crashed in 2000 and 2001 when this strategy got completely out of hand. Profits then depend on taking advantage of upward price departures from the value of commodities, then selling before reality enforces a “correction.” Corrections are really a return to more realistic values. The radical rise of asset prices far beyond any credible value is what what fosters financial bubbles.
Why is financialization so volatile?
With profitability depending on speculative coups, it’s not surprising that the finance sector lurches from one bubble to another, or from one speculative mania to another.
And because it’s driven by speculative mania, finance-driven capitalism has experienced scores of financial crises since capital markets were deregulated and liberalized in the 1980s.
Prior to the current Wall Street meltdown, the most explosive of these were the string of emerging markets crises and the U.S.tech stock bubble’s implosion in 2000 and 2001. The emerging markets crises primarily included the Mexican financial crisis of 1994-95, the Asian financial crisis of 1997-1998, the Russian financial crisis in 1998, and the Argentine financial collapse that occurred in 2001 and 2002, but they also rocked other countries including Brazil and Turkey.
One of President Bill Clinton’s Treasury Secretaries, Wall Streeter Robert Rubin, predicted five years ago that “future financial crises are almost surely inevitable and could be even more severe.”
How do bubbles form, grow, and burst?
Let’s first use the Asian financial crisis of 1997-98, as an example. First, capital account and financial liberalization took place Thailand and other countries at the urging of the International Monetary Fund (IMF) and the U.S. Treasury Department. Then came the entry of foreign funds seeking quick and high returns, meaning they went to real estate and the stock market. This overinvestment made stock and real estate prices fall, leading to the panicked withdrawal of funds. In 1997, $100 billion fled the East Asian economies over the course of just a few weeks.
That capital flight led to an IMF bailout of foreign speculators. The resulting collapse of the real economy produced a recession throughout East Asia in 1998. Despite massive destabilization, international financial institutions opposed efforts to impose both national and global regulation of financial system on ideological grounds.
What about the current bubble? How did it form?
The current Wall Street collapse has its roots in the technology-stock bubble of the late 1990s, when the price of the stocks of Internet startups skyrocketed, then collapsed in 2000 and 2001, resulting in the loss of $7 trillion worth of assets and the recession of 2001-2002.
The Fed’s loose money policies under Alan Greenspan encouraged the technology bubble. When it collapsed into a recession, Greenspan, to try to counter a long recession, cut the prime rate to a 45-year low of one percent in June 2003 and kept it there for over a year. This had the effect of encouraging another bubble — in real estate.
As early as 2002, progressive economists such as Dean Baker of the Center for Economic Policy Research were warning about the real estate bubble and the predictable severity of its impending collapse. However, as late as 2005, then-Council of Economic Adviser Chairman and now Federal Reserve Board Chairman Ben Bernanke attributed the rise in U.S. housing prices to “strong economic fundamentals” instead of speculative activity. Is it any wonder that he was caught completely off guard when the subprime mortgage crisis broke in the summer of 2007?
And how did it grow?
According to investor and philanthropist George Soros: “Mortgage institutions encouraged mortgage holders to refinance their mortgages and withdraw their excess equity. They lowered their lending standards and introduced new products, such as adjustable mortgages (ARMs), ‘interest-only’ mortgages, and promotional teaser rates.” All this encouraged speculation in residential housing units. House prices started to rise in double-digit rates. This served to reinforce speculation, and the rise in house prices made the owners feel rich; the result was a consumption boom that has sustained the economy in recent years.”
The subprime mortgage crisis wasn’t a case of supply outrunning real demand. The “demand” was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that has flooded the United States in the last decade. Big-ticket mortgages were aggressively sold to millions who could not normally afford them by offering low “teaser” interest rates that would later be readjusted to jack up payments from the new homeowners.
But how could subprime mortgages going sour turn into such a big problem?
Because these assets were then “securitized” with other assets into complex derivative products called “collateralized debt obligations” (CDOs). The mortgage originators worked with different layers of middlemen who understated risk so as to offload them as quickly as possible to other banks and institutional investors. These institutions in turn offloaded these securities onto other banks and foreign financial institutions.
When the interest rates were raised on the subprime loans, adjustable mortgage, and other housing loans, the game was up. There are about six million subprime mortgages outstanding, 40% of which will likely go into default in the next two years, Soros estimates.
And five million more defaults from adjustable rate mortgages and other “flexible loans” will occur over the next several years. These securities, the value of which run into the trillions of dollars, have already been injected, like virus, into the global financial system.
But how could Wall Street titans collapse like a house of cards?
For Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, and Bear Stearns, the losses represented by these toxic securities simply overwhelmed their reserves and brought them down. And more are likely to fall once their books — since lots of these holdings are recorded “off the balance sheet” — are corrected to reflect their actual holdings.
And many others will join them as other speculative operations such as credit cards and different varieties of risk insurance seize up. The American International Group (AIG) was felled by its massive exposure in the unregulated area of credit default swaps, derivatives that make it possible for investors to bet on the possibility that companies will default on repaying loans. According to Soros, such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the U.S. government bond market. The huge size of the assets that could go bad if AIG collapsed made Washington change its mind and intervene after it let Lehman Brothers collapse.
What’s going to happen now?
There will be more bankruptcies and government takeovers. Wall Street’s collapse will deepen and prolong the U.S. recession. This recession will translate into an Asian recession. After all, China’s main foreign market is the United States, and China in turn imports raw materials and intermediate goods that it uses for its U.S. exports from Japan, Korea, and Southeast Asia. Globalization has made “decoupling” impossible. The United States, China, and East Asia in general are like three prisoners bound together in a chain-gang.
In a nutshell…?
The Wall Street meltdown is not only due to greed and to the lack of government regulation of a hyperactive sector. This collapse stems ultimately from the crisis of overproduction that has plagued global capitalism since the mid-1970s.
The financialization of investment activity has been one of the escape routes from stagnation, the other two being neoliberal restructuring and globalization. With neoliberal restructuring and globalization providing limited relief, financialization became attractive as a mechanism to shore up profitability. But financialization has proven to be a dangerous road. It has led to speculative bubbles that produce temporary prosperity for a few but ultimately end up in corporate collapse and in recession in the real economy.
The key questions now are: How deep and long will this recession be? Does the U.S. economy need another speculative bubble to drag itself out of this recession? And if it does, where will the next bubble form? Some people say the military-industrial complex or the “disaster capitalism complex” that Naomi Klein writes about will be the next bubble. But that’s another story.
lørdag den 4. oktober 2008
US Military spending relative to other countries
The United States and its close allies are responsible for approximately two-thirds of all military spending on Earth (of which, in turn, the U.S. is responsible for the majority), and spend 57 times more than the seven so-called "rogue" nations combined (Cuba, Iran, Iraq, Libya, North Korea, Sudan and Syria). Military spending accounts for more than half of the United States' federal discretionary spending, which is all of the U.S. government's money not spoken for by pre-existing obligations.
"Of all the enemies to public liberty war is, perhaps, the most to be dreaded because it comprises and develops the germ of every other. War is the parent of armies; from these proceed debts and taxes … known instruments for bringing the many under the domination of the few.… No nation could preserve its freedom in the midst of continual warfare." James Madison, Political Observations, 1795
The Wall Street Mega Bailout: Bad News for the World's Hungry
by Annie Shattuck and Eric Holt-Giménez [Food First/Institute for Food and Development Policy]
Rising food prices are proving deadly for the world's poor. Reeling under a combination of speculation, high oil prices, agrofuels and a weak dollar, one in every six people on earth are going hungry this year. Fully half the world is now at risk of hunger and malnutrition. The current financial crisis that threatens to spread globally can only mean disaster for the world's poor. The crisis is not limited to the developing world. In the United States food stamp enrollment is at an all time high. The 35 million people living below the poverty line-now joined by the 50 million near-poor are turning to the nation's food banks in record numbers. There, pickings are getting slimmer, as food programs strain under a combination of high food prices and shrinking donations.
Unfortunately, the unprecedented $700 billion Wall Street bailout will do nothing to alleviate this festering disaster-in fact, it may make things worse. How? The bailout will increase the U.S.'s national debt to over $11 trillion, calling into question the very creditworthiness of the U.S. Treasury. Debt and uncertainty will further drive down the value of the dollar. A weak dollar means high food prices to consumers because when the dollar decreases in value it takes more dollars to buy the same quantity of food. Though a low dollar might initially stimulate exports, a falling dollar will send food prices steadily upwards. Food prices have already increased 127% since the dollar began to lose value in 2001. The conservative CATO Institute estimates that up to 55% of this year's increase in rice prices was caused by the falling dollar alone.
If the bailout goes through, the poor will pay for Wall Street's greed with empty bellies. There is no consensus among economists that the bail out will fix the financial crisis. If it fails, we will be hit twice: once with rising costs for basic needs like food, heating and transportation, and again with job losses and less economic opportunity.
The massive cash transfer to Wall Street is likely just the beginning of more taxpayer bloodletting. Regardless, simply granting banks billions in corporate welfare doesn't begin to address the root causes of the food or the financial crises. In the long run, the bail out will do nothing to limit the role of index investors in commodities, nothing to reduce food or finance monopolies, and nothing to stabilize the rising prices of food and fuel currently squeezing poor and working families. A bailout is simply what it sounds like: an emergency measure with no attempt at reform.
The FAO estimates it will take $30 billion a year to eliminate global hunger. For the price of the bailout, we could make sure no one on earth goes hungry for the next 23 years. We could re-build food systems as engines for local economic growth. Instead of exacerbating global hunger, for $700 billion dollars we could fully fund the millennium development goals to eradicate global poverty, the root cause of hunger.
Decades of free market fundamentalism has left food systems around the world in tatters and our financial systems poised on the edge of disaster. Instead of throwing money at a system in crisis, we need to use the crisis as an opportunity to fundamentally restructure both food and finance. We need to re-regulate the financial services industry, re-establish national grain reserves, and use anti-trust legislation to break up the power of the oligopolies holding us hostage. Instead of considering a $700 billion dollar gift to financiers, Congress needs to jettison the laissez-faire policies that let Wall Street spin out of control in the first place.
Rising food prices are proving deadly for the world's poor. Reeling under a combination of speculation, high oil prices, agrofuels and a weak dollar, one in every six people on earth are going hungry this year. Fully half the world is now at risk of hunger and malnutrition. The current financial crisis that threatens to spread globally can only mean disaster for the world's poor. The crisis is not limited to the developing world. In the United States food stamp enrollment is at an all time high. The 35 million people living below the poverty line-now joined by the 50 million near-poor are turning to the nation's food banks in record numbers. There, pickings are getting slimmer, as food programs strain under a combination of high food prices and shrinking donations.
Unfortunately, the unprecedented $700 billion Wall Street bailout will do nothing to alleviate this festering disaster-in fact, it may make things worse. How? The bailout will increase the U.S.'s national debt to over $11 trillion, calling into question the very creditworthiness of the U.S. Treasury. Debt and uncertainty will further drive down the value of the dollar. A weak dollar means high food prices to consumers because when the dollar decreases in value it takes more dollars to buy the same quantity of food. Though a low dollar might initially stimulate exports, a falling dollar will send food prices steadily upwards. Food prices have already increased 127% since the dollar began to lose value in 2001. The conservative CATO Institute estimates that up to 55% of this year's increase in rice prices was caused by the falling dollar alone.
If the bailout goes through, the poor will pay for Wall Street's greed with empty bellies. There is no consensus among economists that the bail out will fix the financial crisis. If it fails, we will be hit twice: once with rising costs for basic needs like food, heating and transportation, and again with job losses and less economic opportunity.
The massive cash transfer to Wall Street is likely just the beginning of more taxpayer bloodletting. Regardless, simply granting banks billions in corporate welfare doesn't begin to address the root causes of the food or the financial crises. In the long run, the bail out will do nothing to limit the role of index investors in commodities, nothing to reduce food or finance monopolies, and nothing to stabilize the rising prices of food and fuel currently squeezing poor and working families. A bailout is simply what it sounds like: an emergency measure with no attempt at reform.
The FAO estimates it will take $30 billion a year to eliminate global hunger. For the price of the bailout, we could make sure no one on earth goes hungry for the next 23 years. We could re-build food systems as engines for local economic growth. Instead of exacerbating global hunger, for $700 billion dollars we could fully fund the millennium development goals to eradicate global poverty, the root cause of hunger.
Decades of free market fundamentalism has left food systems around the world in tatters and our financial systems poised on the edge of disaster. Instead of throwing money at a system in crisis, we need to use the crisis as an opportunity to fundamentally restructure both food and finance. We need to re-regulate the financial services industry, re-establish national grain reserves, and use anti-trust legislation to break up the power of the oligopolies holding us hostage. Instead of considering a $700 billion dollar gift to financiers, Congress needs to jettison the laissez-faire policies that let Wall Street spin out of control in the first place.
Adam Smith i Wealth of Nations.
“The proposal of any new law or regulation of commerce which comes from this order [profit takers], ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.”
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