Transforming the Global Economy: Solutions for a Sustainable World
Susan George
6 October 2008
The current financial crisis provides the ideal opportunity to implement tax reforms that would finance the conversion to eco-friendly industry: an environmental Keynesianism that would pull the world out of economic ruin and social chaos while getting the runaway global financial system under control, argues Susan George.
Please first let me congratulate the organisers of Schumacher North for their initiative in bringing this lecture series and other activities of the Schumacher Society to Leeds. It’s an honour to be here and especially to share the platform with two brilliant people whom I greatly admire. I also want to thank the organisers for the privilege of honouring the memory of Dr Schumacher, a man far ahead of his time who bequeathed to us a lasting legacy. It’s a challenge to be worthy of that heritage in a lecture bearing his name.
But I intend to try. My talk today will concern the stage I’ve arrived at in a kind of reflexion in progress—I don’t mean a book, although it may well become that as well—but an effort to make sense of the fast moving events in our battered world and an attempt to think about them in a more unified way.
Philosophically speaking, the thing-in-itself, the isolated object whether it’s an electron, a human cell, an organism, a single word —even a human being--makes sense only in the context of its relationships, its place in its physical, linguistic or social environment . Margaret Thatcher once famously said, “There is no such thing as society”. She thus perfectly embodied the foundations of the neo-liberal ideological programme which should, ideally, prevent us from even thinking about ourselves and others in our natural and social context. We must be taught to believe that we are not citizens or members of a social body but discrete, individual consumers. We are entirely responsible for our own destinies and if we fall by the wayside for whatever reason—illness, job loss, accident, failure, whatever—it’s our own fault. We should have foreseen the case and planned for it. We have no responsibility for other people either. Solidarity is a banished word. Nor are we accountable for the state of the planet—homo sapiens is the only important species and humans are isolated if not immune from natural, physical laws. That’s the essence of the neo-liberal spirit: “You’re on your own” as Barack Obama has been saying to Americans to encapsulate the philosophy of his opponents.
If you are well-schooled in neo-liberalism, you will never join a social movement, never engage in a struggle against an unjust action of the government, never contribute to an effort to protect the natural world because not only will you make a fool of yourself, not only will your effort fail, but even if successful it will lead eventually to oppression, even totalitarianism, as Thatcher’s mentor Professor Friedrich von Hayek argued. And, as he also taught, economic freedom is superior to every other kind of freedom, whether political, religious or intellectual.
I believe to the contrary that our only hope lies in understanding everything we confront today as a link in an ever-more-complex chain, as an element in a system. The danger with this approach of course is to become lost and frustrated in the syndrome of “Everything is connected to everything”. That’s true, everything is connected to everything, but we still have an enormous task ahead in trying to identify the priority connections, to understand how they work together and what we can do to change them, because they definitely do need changing. I will argue that the present connections are dysfunctional, they have become perverse: they form a system that worsens the human condition and irrevocably damages the planet. But there is hope, because what has been constructed by humans can also be dismantled by them.
All this may sound rather vague so let’s get down to specifics. To make matters more concrete, I’d like to talk now about the most obvious crises we face collectively today, why they are all linked and why the solutions to them must be linked as well.
The first of these crises is social—the crisis of mass poverty and growing inequality within individual countries and between the rich and poor countries. The second is the financial crisis that Wall Street, the City and the public authorities refused to see coming because they were living in bubble-land. It began with the subprime affair in the United States but has spread inexorably like a lava flow in the US and elsewhere, threatening to plunge the global economy into a prolonged period of stagnation as severe as the Great Depression. Every day while I was writing this lecture at home, a new financial institution went down the drain or on the block and the end is not yet in sight. The third crisis, most ominous of all, is that of climate change and species destruction. It is accelerating faster than most scientists, much less governments, thought possible, causing many to ask if we have not already entered the era of the runaway greenhouse effect.
Each of these crises—social, financial, environmental--is negatively linked to the others, they intensify each other with negative feedback; they lead to worst-case scenarios. Let us take just a few examples of these perverse interactions.
The poverty-inequality crisis is a good place to start. This crisis is well documented; no one seriously denies the numbers. The World Bank recently recognised that it had grossly underestimated—by about 400 million—the numbers of the very poor, and even then its figures stop at the year 2005 and don’t include recent upheavals in food and energy costs that have swelled the ranks of the impoverished. Even more important, however, is the fact that for the first time in human history, there is no excuse for mass poverty and deprivation. Taking this assertion seriously already helps to point us towards a solution.
Most scholars and institutions concerned with such issues focus on poverty per se but I think it’s more useful and enlightening to focus on wealth. It may not be obvious to everyone that the world is actually awash in money. Most of it is still in North America and Europe but the numbers of the seriously rich on other continents are catching up fast. Those who have the money know very well how to keep it and, with their hired help, the battalions of lawyers, accountants and lobbyists, they are busy salting away their profits in tax havens, finding loopholes and protected investments, lobbying fiercely in parliaments and ministries against regulations on banks and financial markets. As you can see, I began by talking about poverty but I am already touching on the links with the financial crisis.
How many of you knew that ten million people, according to the latest Merrill-Lynch World Wealth Report, together boast investable, liquid funds of more than $40 trillion? That’s 40.000 billion or 40 followed by 12 zeroes. This wealth is above and beyond the value of their houses, cars, yachts, wine or art collections and so on and it is equivalent to about three times the GDP of either the United States or Europe. You might like another simple calculation. Assume that you have one billion dollars, which is the cut-off point for the latest Forbes magazine list of 1125 truly rich individuals in the world. If despite your billion you are such a dim-witted investor that you get only a five percent return on your fortune, you will still have to spend $137.000 every day of the year in sheer consumption or you will automatically become richer. My point is that cash is abundant and there’s no shortage of available wealth.
We also know a great deal about inequality. The UN World Institute for Development Economic Research, WIDER, estimates total world household assets at about $125 trillion. This is about three times world GDP and unsurprisingly, the top two percent of the world captures more than half of that wealth. The top 10 percent, which certainly includes many of us here, hold 85 percent, while the bottom half of humanity is obliged to stumble along with barely 1 percent. All you need to be classed in the top half of humanity is a meagre $2200 in total assets—that includes your house, your land or items like your car or your refrigerator--hardly a princely sum. If all household assets were divided equally—impossible and probably not even desirable to achieve—everyone on earth could have a share of $26.000. So again, money as such isn’t the problem.
In all the countries where 90 percent of the world’s population lives, inequalities have increased especially since the 1980s. At this point in the argument, the neo-liberals usually jump in to remind us that rising tides lifting all boats. They admit that inequalities have grown, but still argue that the poor are better off than they were. It seems almost rude to remind them in turn that falling tides have the opposite effect, they swamp and strand the more fragile boats and that is where the tide of the financial crisis is now taking us.
The real point, however, is not the absolute numbers but the fact that inequality makes the economy and also the natural environment worse for everyone, rich or poor. Two experienced academics, Tony Addison and Giovanni Andrea Cornia, put it this way: “Inequality has risen in many countries over the last two decades [and] little progress can be made in poverty reduction when inequality is high and rising....Contrary to earlier theories of development, high inequality tends to reduce economic growth and therefore poverty reduction through growth.”
Although it’s true that economic growth has reduced poverty, particularly in China, one must also ask “At what cost?” China has now overtaken the United States in greenhouse gas emissions and frighteningly has hardly even begun its transition to the automobile society. China also requires at least 10 times as much energy as the more mature industrial societies to produce a unit of GDP.
Growth certainly isn’t the answer ecologically, but even economically it fails the test because the benefits accrue almost entirely to the top of society. That is Cornia and Addison’s main point.
We have also learned in the past few months that it is entirely possible to push tens of millions of poor people off the ledge where they had just gained a foothold and send them back into the depths of poverty. Food riots, most of them urban, in at least thirty different countries have revealed another scary new phenomenon: the worldwide food crisis. Until now, food shortages and famines tended to be local, but so many societies have accepted neo-liberal trade mantras and become dependent on world markets for their basic daily staples that today a sudden spurt in prices is felt from Haiti to Egypt to Bangladesh.
The neo-liberal institutions like the World Bank, the WTO and the European Commission continue to pretend that poverty reduction will result from more growth and more trade. They fail to mention that both growth and trade will reinforce the environmental crisis. The food and energy crises have in turn strong links to the financial crisis, since speculation has been an important factor in both. Food and energy are also intimately linked to the climate crisis as one can see instantly when one thinks of carbon-loaded fossil fuels or of agro-fuels taking vast amounts of land away from food production.
At this point in the discussion, especially when one is speaking to concerned, engaged, decent people like those likely to be found at a Schumacher lecture, someone will raise two highly pertinent questions. The first is this: “ Isn’t there a point where people with huge fortunes say ‘enough is enough’ and start sharing?” Some do—Bill Gates and Warren Buffet are oft- cited examples. But as a class, I’m sorry to say that the answer is no. We know a lot about poverty lines but there is no such thing as a wealth line and the word “ enough “ is not part of the vocabulary of this class. You needn’t believe me. Listen to the expert who said “All for ourselves and nothing for other people seems in every age of the world to have been the vile maxim of the masters of mankind.” That was not Karl Marx but Adam Smith, in his classic 1776 treatise on capitalism, the Wealth of Nations. Little has changed since then.
The second question is “But why don’t the neo-liberal institutions, like the World Bank, the International Monetary Fund, the World Trade Organisation, the European Commission and the US government recognise that their policies have failed? Why do they keep on pushing them wherever and whenever they can?” The answer is not just that institutions are always loath to admit their mistakes, especially when these have killed and ruined so many millions. It is also that these policies have not failed.
To the contrary, they have produced exactly the results they were intended to produce. They have made a tiny fraction of international society rich beyond imagining, they have kept many dependent countries dependent in a new, less visible sort of colonial relationship and they have made so-called free trade, privatisation and unfettered capitalism the rule in countries that previously wanted little or nothing to do with them. Furthermore, they have imposed their policies with relatively little organised protest because their ideology has been expertly produced, packaged and delivered. Ideology can alas have a far stronger influence than facts. This is why we must fight on the practical front, of course, but also -- I happen to believe primarily -- fight the battle of ideas.
In any event, the massive funds belonging to rich people who already have most of the material goods they need or want are generally devoted to more or less speculative investments. Hedge funds, for example, are estimated to be sitting on about three trillion dollars, even today when so many investments have suffered melt-down. The financial institutions have been frantically innovating, particularly over the last decade. The entire incentive structure of the banking and finance industry has become perverse: the large institutions know perfectly well that they are “too big to fail”, consequently they also know that no matter how risky their actions, they will be bailed out by the public purse and has become all too plain. Beforehand, top management takes the money and runs.
Between the years 2000 and 2006, average annual profits of the financial sector in Great Britain averaged 20 percent—that is, two or three times the profit rate of other sectors of the economy. Huge bonuses, especially in the US and the UK, went to a handful of people, intensifying inequalities, whereas millions further down the ladder have lost their jobs and often their homes. Such profits were themselves clearly not sustainable because at some point, financial gain must be based not just on speculation but on the real economy.
Now that the bailouts are coming thick and fast, we have before us a singular example of socialism for the rich, the well-connected and Wall Street, in which the profits are grabbed by the usual suspects and the losses, tremendous losses, are billed to taxpayers. The United States has in effect nationalised these institutions and their debts--without getting anything from the financial industry in exchange.
As the sub-prime crisis has continued to ooze like a giant oil spill over the whole economy, speculators have searched for alternative profitable areas and created the food-price bubble trouble in which we now find ourselves. What happens then? The resource-poor, the world’s hungry, grab whatever they can, they chop down trees, kill animals and overexploit what little land they may have. Poverty is bad news for nature. But so is wealth. Even though there are far fewer of them, the rich cause much greater environmental damage with their dinosaurian ecological footprints. People who use the population argument to explain the multiple crises and who see in population control the solution are missing a crucial point—it’s not so much the number of people, although numbers are important, as their relative weight.
Furthermore, as we have repeatedly witnessed, the frequency and the fury of storms provoked by global warming hit the poor and the poorer regions of the globe hardest. There is worse to come. We have not even begun to comprehend the perils of climate change, including vastly increased numbers of environmental refugees who will crowd the planet due to droughts, flooding and crop failures. The Pentagon is already working on how to stem this tide by countering by whatever means necessary the refugees frantic efforts to reach more favourable lands. Government planning for this perfectly predictable phenomenon is limited to increased surveillance and security responses, not attempts to make outmigration less necessary. And yet the UN Intergovernmental Panel on Climate Change [IPCC] which is probably the most respected scientific body in the world, has already warned us that in Africa, the yields of rain-fed agriculture are likely to be reduced by 50 percent, deserts will gain ground, species destruction has already reached such proportions that we are in the midst of the sixth geological extinction of the planet’s four and a half billion-year history. The fifth extinction was the one that put paid to the dinosaurs.
I could go on drawing out relationships between the poverty, financial and ecological crises but I’m sure you need no more. The question is what we can do about all this and by “we” , I mean people everywhere who understand that the triple crisis is real and urgent.
Knowing that I will doubtless offend a great many people here, let me say straight away that there is an exit strategy, a genuine solution exists, but it is not in my view the one that many well-meaning environmentalists have long advocated. I’m sorry, but the time has passed for telling people to change their behaviour and their lightbulbs; that if enough people do this, then together “we” can save the planet. I’m sorry, but “we” can’t. Obviously I’m not suggesting that people shouldn’t change their behaviour and their lightbulbs—but even if the entire population of Europe does so—a most unlikely scenario—it’s not going to be enough. I agree as well with proposals for localisation and scaling down, but we have also got to scale up.
We need large-scale solutions, sophisticated, industrial solutions and huge involvement of governments in order to cut greenhouse gas emissions drastically enough to save our future. In other words, we must have the courage to challenge not just our political leadership but the entire neo-liberal, unregulated, privatised, capitalist economic system in place in order to provoke and promote a quantitative and qualitative leap in the scale of environmental action. Dare I say it here? Sometimes big can be beautiful and right now is one of those times.
Since I believe that individual and local solutions are necessary but tragically insufficient to address the seriousness and the urgency of the ecological crisis, I will use the rest of my time to discuss the twin problems of how to deal with governments and with the capitalist corporate production and financial system. The dilemma I wrestle with is this: Can we save the planet while international capitalism remains the dominant system, with its focus on profit, share-holder value, predatory resource capture and with no-holds-barred finance capital making more and more decisions? Can we rescue our natural home when confronted with a powerful caste that does not know the meaning of “enough” and is allergic to the kind of fundamental change a New Ecological Economic Order requires? Can we move forward when governments basically work for the interests of that class?
On bad days I reply No: We can’t save the planet. It’s impossible to reverse the climate crisis under capitalism. But that is a despairing answer and if true, it means there is virtually no hope. No hope, because I do not see how even the most convinced, most determined people could replace, much less overthrow capitalism fast enough to carry out the necessary systemic change before a runaway climate effect takes hold—always assuming it hasn’t done so already. First of all, there are not that many convinced and determined people prepared to act against the dominant economic system and there is nothing that resembles in the smallest degree an avant-garde revolutionary party that might lead them even if they existed. There is no one-size-fits-all replacement solution for capitalism. Considering the historical record and role of such parties and such solutions, I consider this an unmistakably good thing.
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But there are other obstacles to once-for-all revolutionary change. Nobody knows, figuratively speaking, who the Tsar is that we would have to overthrow today and nobody has a clue where to find the Winter Palace we would have to storm. We know the Winter Palace isn’t on Wall Street which was up and running again a few days after 11 September and is now taking full advantage of the bailouts. The US is only one of many world capitalist centres. Even if we were to win in one place, the nomadic money-moguls would simply mount their camels and head for another. The worlds of 1917 and of 2007 are utterly different, so we must try to move beyond this revolutionary impasse, this dead-end and find a new synthesis.
The question we face is not so much what to do — I think that is reasonably clear and I’m about to spell it out--but whether we will have the intelligence and the strength to seize the great opportunity with which we are now presented. Perhaps the words “great opportunity” strike you as wildly optimistic considering the long and dire preamble you’ve just listened to. However, I am now going to argue that not only are individual solutions insufficient but that the remedies offered by Kyoto, Bali, Bonn or whatever timid future agreements may be negotiated are tragically inadequate, Once more--I cannot stress this enough--the scale is crucial. And the great opportunity is to be found in the financial crisis itself. Properly targeted and used, it could open the door to the quantitative and qualitative leap we must make.
Some progressive people will reject the solution I propose, but I would then ask them what alternative they offer. The ecological crisis is of a different nature from the financial and poverty crises in the sense that once climate change is underway, as it is now, it is irreversible and we haven’t time for theoretically perfect solutions. With politics you can sometimes turn back and start over, but not where nature is concerned. So you can accuse me if you like of suggesting a way to give capitalism a new lease on life and I will plead guilty.
Let’s take first the slightly easier question “How can we deal with governments?” at least in the more or less democratic countries. China is another matter. People are generally way ahead of their governments in recognising the emergency. The political issue is not simply to "throw the rascals out" because they would be replaced by other rascals just as bad, just as beholden to the corporations, their lobbies and the financial markets. The trick is to convince politicians that ecological transformation and environmental practices can pay off politically.
This means that citizens, activists and experts, whether they like it or not, have got to work with local, regional and national politicians and governments; help them to find like-minded partners and formulate ambitious projects they can undertake on the broadest possible scale. Citizens, activists and experts must furthermore help these politicians and governments to become shining ecological examples with the electorate by publicising their efforts and their successes. Could the Schumacher Society become a kind of nexus for an ongoing forum of best-standards/best practice, bringing together political decision makers at every level with citizens groups and experts to discuss and carry out the best public-sector initiatives? Politicians must be convinced that these policies will not just work but also be highly popular with their constituencies.
Now let’s take the more difficult question of confronting the economic system as a whole. In his book Collapse, Jared Diamond examines several historical cases of social extinction due to over-exploitation of the environment. He identifies several common characteristics. One of these is the isolation of the elites, giving them the capacity to keep on consuming way above ecologically sustainable limits long after the crisis has already struck the poorer, more vulnerable members of society. That is where we are now globally, not just in isolated places like Easter Island or Greenland.
So how can we realistically combat the ecological footprints of our dinosaur elites, recognising that we don’t have the option of shouting “Off with their heads” in some imagined, world-wide revolution. Nor can we force them to change both themselves and the system that serves them so well, whereas we know that we must change that system because it is raping the planet and its inherent logic is to keep on doing so.
I can see only one way out: the coming together of people, business and government in a new incarnation of the Keynesian war economy strategy. I was born in the United States in 1934 and I remember well when the US switched massively to a war economy, converting all the rubber plants in my native city [Akron, Ohio] to production not for private cars and trucks but for the military. There was huge citizen involvement and support. Thousands of factories, research labs, housing projects, military bases, day care centres, and schools were built or expanded during the war. Public transport was improved and worked overtime to move millions of men and women to Army bases or new defence jobs.
Yes, there were still worker-management conflicts and yes, big corporations rather than small business got most of the government contracts but on the whole the workers were well paid, African-Americans and women began making a few modest gains and the whole war effort finally pulled the United States out of the Depression—it was Keynesianism on a huge scale. There was also an elite group of businessmen called “Dollar-a-Year Men” on loan from their companies to the government, who were charged with making sure that military production and quality targets were met. They had enormous prestige—my godfather was one and I was doubtless insufferable bragging to my little school friends about him.
Why am I going back over this ancient history? Because I think we have a similar opportunity today. The US and the world economy are heading downhill fast and the fallout for ordinary people in terms of jobs, housing, consumption and future welfare is going to be grave. If this diagnosis is right, then some new economic tools will have to be used to combat recession and stagnation, simply because the old ones have already been pushed to their limits and have little or nothing left to give.
The way Central Banks and Treasuries usually try to solve financial recession or depression is through standard remedies like interest rate cuts, currency devaluations or incurring new debt—but the United States has reached the end of its leash on that score. Interest rates are already extremely low—although not in Europe, where the European Central Bank and its hidebound president are ideologically committed to the same sorts of monetary policies that prolonged the Great Depression in the 1930s. The dollar is already weak, which makes US exports cheaper, but it can’t be devalued much further without risk. Deficit spending is already beyond belief. With the bailout of Fannie Mae and Freddie Mac, the Federal Reserve in effect took on their bad debt and added hugely to the liabilities of the United States Treasury. It risks doing so again. Households too are over-indebted and are losing more equity every day as the value of their dwellings deteriorates.
Since the traditional tools are worn out, the only new tool I can think of to pull the world out economic ruin and social chaos is a new Keynesianism, not military this time, but environmental; a push for massive investment in energy conversion, eco-friendly industry, new materials, efficient public transport; the green construction industry and so on.
Stringent standards for new buildings must become the norm; older ones can be “retro-fitted” on easy financial terms; families and commercial property-owners can receive financial incentives for installing green roofs and solar panels and sell excess energy to the grid. Research and development can be oriented towards alternative energies and strong, ultra-light materials for airplanes and vehicles. Technically speaking, we already know how to do such things, although some clean solutions are still more costly than dirty ones. Mass-produced, they would become less so.
All these new, eco-friendly industries, products and processes would have huge export value and could quickly become the world standard. I am trying to describe a scenario that can be sold to the elites because I don’t think they will embrace genuine environmental values and conversion if there’s nothing in it for them. But this approach is not merely a cynical attempt to get the elites to move in their own interests. There are also plenty of advantages in such an economy for working people. A huge ecological conversion is a job for a high-tech, high-skills, high-productivity, high-employment society. It would be supported, I believe, by the entire population because it would mean not just a better, cleaner, healthier, more climate-friendly environment, but also full employment, better wages, and new skills, as well as a humanitarian purpose and an ethical justification—just like World War II.
How could one finance such a huge effort? It would have to involve targeted government spending in the traditional Keynesian sense and governments are bound to complain that they haven’t the means to carry out such a policy.
The financial crisis provides the ideal opportunity both to finance the conversion and to get the runaway global financial system under control.
At present, taxes almost always stop at national borders. The secret is to take taxes up to the European level and to the international one through currency and other financial transaction taxes. People who oppose such schemes pretend they are not feasible because one would need to obtain the consent of every national jurisdiction in the world, but that is not correct. In fact, currency and other transaction taxes would require nothing more than political determination, the cooperation of the Central Bank and a few lines of software. For the currency transaction tax first proposed by James Tobin in the 1970s and now considerably refined, the tax base is the currency itself, not the place it’s traded. Thus the European Central Bank could easily collect the taxes on any transactions involving euros, the Bank of England the same for the pound, the Fed for the dollar and so on. Since currency trades now amount to $3.2 trillion dollars every day, a tax of one basis point, that is, a levy of one per thousand could raise a tidy sum for ecological conversion and poverty reduction. Britain already imposes a tax on stock market transactions but other European countries do not and should imitate Britain.
Carbon taxes are another much mooted and equally feasible idea. So is a unitary profits tax on transnational corporations, which would require knowing the total sales of the company, the total taxes paid, the sales realised in each jurisdiction and the tax paid in each jurisdiction. If, for example, a TNC reported that in country X, a particularly low-tax jurisdiction, it made 5 percent of its sales yet paid 50 percent of its taxes, the authorities would find it a bit fishy. I’m presenting an extremely crude summary here but believe me, there are experts—bankers, corporate lawyers, fiscal experts and accountants--who know exactly how to do such things. Perhaps to encourage more local consumption, one could also think about taxing the miles travelled by the food we eat and the clothes we wear.
We would not forget the poor countries of the South which are the major terrain of the poverty crisis. Debt cancellation for poor countries that the G-8 has been promising for a decade must finally happen but against the requirement that these countries also contribute to the planetary environmental effort through re-forestation, soil conservation, species protection and the like. They would also be required to involve their own people in democratic decision-making and the funds would be carefully monitored by independent auditors.
Tax havens that allow affluent individuals and corporations to avoid paying their fair share of the conversion should be shut down: it would be cheaper to pay the inhabitants of the Cayman Islands, Liechtenstein and the rest a living wage for twenty years. Plenty of cash would remain for eco-investments, job-creation and poverty relief.
In exchange for their bailouts, the banks and investment houses have to accept regulation—not just regulations to insure transparency and eliminate the incentives for stupid behaviour but also more stringent ones forcing them to participate in the ecological offensive. They should be obliged to devote X percent of their loan portfolios to eco-projects at below market interest rates—which they could make up by charging much higher rates on loans to dirty or otherwise anti-ecological projects. Low or no-cost financing for home conversion projects should be another compulsory priority for banks. This could give a huge spurt to the construction industry.
Nobody is asking for the moon here. Banks would still make loans, finance investments and earn a fair return for their services. Taxes on currency transactions at one basis point are not going to ruin anyone. Unitary profits taxes on large corporations would simply return us to the era when the companies paid their taxes because they couldn’t avoid them. The point is that a Keynesian taxation and redistribution system would be invested, nationally and internationally, both ecologically and socially, in education, health care, clean, green energy, efficient water distribution, communications technology, public transport, and various other things the world needs and that we already know how to do. These measures would, in turn go a very long way to creating opportunities for far more people to participate in the new green economy through jobs, life-long education, more social protection and reduced inequality. Getting the present financial crisis-producing, free-flowing, unregulated financial system under public and citizen control is the prerequisite for solving both the environmental and the poverty crises.
In other words, it’s a Public Relations dream. Whichever political parties understand this can win on such a programme without anyone having to bring down the entire capitalist system as a prior condition for saving the planet.
A Keynesian ecological programme would furthermore bring many constituencies together in a common cause. As matters now stand, politically speaking, no single interest group can solve the problem that concerns it most. By this I mean that, by themselves, ecologists can't save the environment; farmers alone can’t save family farms; trade unions alone can’t save well-paid jobs in industry and so on. Broad alliances are the only way to go, the only strategy that pays. The Global Justice Movement, as international social activists call it, has begun to have some success in working democratically and making alliances with partners who come from different constituencies but are basically on the same wavelength.
Now we must go beyond this stage and attempt something more difficult: to forge alliances also with people we don't necessarily agree with on quite major questions—for example, with business. This can only be accomplished by recognising that disagreements, even conflicts, can be fruitful and positive so long as the areas where it is possible to agree are sought out, identified and built upon. We must find where the circles of our concerns overlap. At least one of those overlaps ought to be saving our common home. I don't see any other way of generating citizen enthusiasm, involvement and the qualitative and quantitative leap in scale that is now required.
I haven’t time to elaborate on all the technical details concerning the content and the financing of necessary environmental investments. What I can do is guarantee you that the conversion to a green economy is technically feasible. The schemes for new taxes have been thought through; the industrial prototypes already exist; the machinery is ready to hum into action the moment people can make their politicians accept the challenge. Getting the financial system under control and taxing international capital at quite ridiculously low rates in order to redistribute it institutionally and internationally would be enormously popular. We could seriously attack climate change and eliminate the worst of world poverty within a decade. We are talking politics, not technical aspects here and trying to figure out a way to tame the raging beast, the crisis-producing, free-flowing, unregulated financial system and putting it under public and citizen control.
Capitalism is not sane in the sense that most people understand sanity. We humans normally think about our future, that of our children and the future of our countries and the world. The market, on the contrary, operates in the eternal present which, by definition, cannot even entertain the notion of the future and therefore excludes safeguards against future, looming destruction unless these safeguards are imposed upon it by law.
We need law, for sure, and political forces with the backbone to propose and to vote the law into existence, but we also need to think about human motivation. Remember the prestigious Dollar-a-Year Men of the 1940s and imagine what might happen if we could transpose them into the world of 21st century capitalism. A significant number of contemporary captains of capitalism, all of them with bloated, unimaginable salaries, might be brought to believe that money is all very well, but is there nothing more? Why not found an extremely exclusive Order of the Earth Defenders, or the Environmental Knights or the Carbon Conquerors who alone, in recognition of their special contributions to the national and international environmental conversion effort. They would have the right to display a highly visible emblem on a banner in front of their homes; a fanion on their cars, a green and gold rosette in their buttonholes like the French Legion d’Honneur or a Congressional Medal of Ecological Honour. They would belong to the small assembly of the anointed; those who provide the means and have the honour of saving the earth. Becoming a member ought to appeal to their competitive spirit.
In conclusion, let me say that myth has always been the driving force of every great human achievement, from Greek democracy to the Renaissance to the Enlightenment and the American and French Revolutions. So must it be in the coming age of Ecological Stewardship. To save the planet, we must change, quickly and profoundly, the way the majority thinks and feels and acts, and we must start with the social forces we have right here and right now, and no others. It’s no use wishing they were different ones or stronger, or wiser. We must play the hand history deals us.
For such a change, we will need six “Ms”, starting with Money, Management and Media. But even more important than these three “Ms”, we must try to create a new sense of Mission and Motivation and Myth at the noblest level. “Myth” in this sense has nothing to do with story-telling or lies. It is the grand narrative that empowers us to believe that we can accomplish what we must accomplish. It speaks to the deepest motivations of human consciousness and inspires the desire for honour and for a life’s work which transcends death. The elites already have Money, Management, Media. On our side, we have Mission, Motivation and Myth. If we can bring together all these, the future will take care of itself.
And wouldn’t that be nicer than having another war?
Thank you.
tirsdag den 7. oktober 2008
French Premier Francois Fillon: We're on "the edge of the abyss”
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”.
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”.
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-
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