Tuesday, September 9, 2008

The 65 mpg Ford the U.S. Can't Have

The 65 mpg Ford the U.S. Can't Have

Ford's Fiesta ECOnetic gets an astonishing 65 mpg, but the carmaker can't afford to sell it in the U.S.

If ever there was a car made for the times, this would seem to be it: a sporty subcompact that seats five, offers a navigation system, and gets a whopping 65 miles to the gallon. Oh yes, and the car is made by Ford Motor (F), known widely for lumbering gas hogs.

Ford's 2009 Fiesta ECOnetic goes on sale in November. But here's the catch: Despite the car's potential to transform Ford's image and help it compete with Toyota Motor (TM) and Honda Motor (HMC) in its home market, the company will sell the little fuel sipper only in Europe. "We know it's an awesome vehicle," says Ford America President Mark Fields. "But there are business reasons why we can't sell it in the U.S." The main one: The Fiesta ECOnetic runs on diesel.

Automakers such as Volkswagen (VLKAY) and Mercedes-Benz (DAI) have predicted for years that a technology called "clean diesel" would overcome many Americans' antipathy to a fuel still often thought of as the smelly stuff that powers tractor trailers. Diesel vehicles now hitting the market with pollution-fighting technology are as clean or cleaner than gasoline and at least 30% more fuel-efficient.

Yet while half of all cars sold in Europe last year ran on diesel, the U.S. market remains relatively unfriendly to the fuel. Taxes aimed at commercial trucks mean diesel costs anywhere from 40 cents to $1 more per gallon than gasoline. Add to this the success of the Toyota Prius, and you can see why only 3% of cars in the U.S. use diesel. "Americans see hybrids as the darling," says Global Insight auto analyst Philip Gott, "and diesel as old-tech."

None of this is stopping European and Japanese automakers, which are betting they can jump-start the U.S. market with new diesel models. Mercedes-Benz by next year will have three cars it markets as "BlueTec." Even Nissan (NSANY) and Honda, which long opposed building diesel cars in Europe, plan to introduce them in the U.S. in 2010. But Ford, whose Fiesta ECOnetic compares favorably with European diesels, can't make a business case for bringing the car to the U.S.


First of all, the engines are built in Britain, so labor costs are high. Plus the pound remains stronger than the greenback. At prevailing exchange rates, the Fiesta ECOnetic would sell for about $25,700 in the U.S. By contrast, the Prius typically goes for about $24,000. A $1,300 tax deduction available to buyers of new diesel cars could bring the price of the Fiesta to around $24,400. But Ford doesn't believe it could charge enough to make money on an imported ECOnetic.

Ford plans to make a gas-powered version of the Fiesta in Mexico for the U.S. So why not manufacture diesel engines there, too? Building a plant would cost at least $350 million at a time when Ford has been burning through more than $1 billion a month in cash reserves. Besides, the automaker would have to produce at least 350,000 engines a year to make such a venture profitable. "We just don't think North and South America would buy that many diesel cars," says Fields.

The question, of course, is whether the U.S. ever will embrace diesel fuel and allow automakers to achieve sufficient scale to make money on such vehicles. California certified VW and Mercedes diesel cars earlier this year, after a four-year ban. James N. Hall, of auto researcher 293 Analysts, says that bellwether state and the Northeast remain "hostile to diesel." But the risk to Ford is that the fuel takes off, and the carmaker finds itself playing catch-up—despite having a serious diesel contender in its arsenal.

Comrades Bush, Paulson and Bernanke Welcome You to the USSRA (United Socialist State Republic of America)

Comrades Bush, Paulson and Bernanke Welcome You to the USSRA
(United Socialist State Republic of America)

By Nouriel Roubini

Go To Original

The now inevitable nationalization of Fannie and Freddie is the most radical regime change in global economic and financial affairs in decades. For the last twenty years after the collapse of the USSR, the fall of the Iron Curtain and the economic reforms in China and other emerging market economies the world economy has moved away from state ownership of the economy and towards privatization of previously stated owned enterprises. This trends was aggressively supported the United States that preached right and left the benefits of free markets and free private enterprise.

Today instead the US has performed the greatest nationalization in the history of humanity. By nationalizing Fannie and Freddie the US has increased its public assets by almost $6 trillion and has increased its public debt/liabilities by another $6 trillion. The US has also turned itself into the largest government-owned hedge fund in the world: by injecting a likely $200 billion of capital into Fannie and Freddie and taking on almost $6 trillion of liabilities of such GSEs the US has also undertaken the biggest and most levered LBO (“leveraged buy-out”) in human history that has a debt to equity ratio of 30 ($6,000 billion of debt against $200 billion of equity).

So now Comrades Bush, Paulson and Bernanke (as originally nicknamed by Willem Buiter) have now turned the USA into the USSRA (the United Socialist State Republic of America). Socialism is indeed alive and well in America; but this is socialism for the rich, the well connected and Wall Street. A socialism where profits are privatized and losses are socialized with the US tax-payer being charged the bill of $300 billion.

This biggest bailout and nationalization in human history comes from the most fanatically and ideologically zealot free-market laissez-faire administration in US history. These are the folks who for years spewed the rhetoric of free markets and cutting down government intervention in economic affairs. But they were so fanatically ideological about free markets that they did not realize that financial and other markets without proper rules, supervision and regulation are like a jungle where greed – untempered by fear of loss or of punishment – leads to credit bubbles and asset bubbles and manias and eventual bust and panics.

The ideologue “regulators” who literally held a chain saw at a public event to smash “unnecessary regulations” are now communists nationalizing private firms and socializing their losses: the bailout of the Bear Stearns creditors, the bailout of Fannie and Freddie, the use of the Fed balance sheet (hundreds of billions of safe US Treasuries swapped for junk toxic illiquid private securities), the use of the other GSEs (the Federal Home Loan Bank system) to provide hundreds of billions of dollars of “liquidity” to distressed, illiquid and insolvent mortgage lenders, the use of the SEC to manipulate the stock market (restrictions on short sales), the use of the US Treasury to manipulate the mortgage market (Treasury will now for the first time outright buy agency MBS to manipulate and prop up this market), the creation of a whole host of new bailout facilities (TAF, TSLF, PDCF) to prop and rescue banks and, for the first time since the Great Depression,to bail out non-bank financial institutions, and a whole range of other executive and legislative actions (including the recent bill to provide a public guarantee to mortgage for banks willing to reduce their face value).

This is the biggest and most socialist government intervention in economic affairs since the formation of the Soviet Union and Communist China. So foreign investors are now welcome to the USSRA (the United Socialist State Republic of America) where they can earn fat spreads relative to Treasuries on agency debt and never face any credit risks (not even the subordinated debt holders who made a fortune yesterday as those claims were also made whole).

Like scores of evangelists and hypocrites and moralists who spew and praise family values and pretend to be holier than thou and are then regularly caught cheating or cross dressing or found to be perverts these Bush hypocrites who spewed for years the glory of unfettered wild west laissez faire jungle capitalism (and never believed in any sensible and appropriate regulation and supervision of financial markets) allowed the biggest debt bubble ever to fester without any control, have caused the biggest financial crisis since the Great Depression and are now forced to perform the biggest government intervention and nationalizations in the recent history of humanity, all for the benefit of the rich and the well connected. So Comrades Bush and Paulson and Bernanke will rightly pass to the history books as a troika of Bolsheviks who turned the USA into the USSRA. Fanatic zealots of any religion are always pests that cause havoc and destruction with their inflexible fanaticism; but they usually don’t run the biggest economy in the world. But these laissez faire voodoo-economics zealots in charge of the USA have now caused the biggest financial crisis since the Great Depression and the nastiest economic crisis in decades. So let them be shamed in public for their hypocrisy and zealotry that has caused so much financial and economic damage.

Pending Home Resales Decline More Than Forecast

Pending Home Resales Decline More Than Forecast

By Timothy R. Homan and Bob Willis

Go To Original

Fewer Americans signed contracts to purchase previously owned homes in July as harder-to-get financing kept would-be buyers from taking advantage of lower prices.

The index of pending home resales fell 3.2 percent after rising 5.8 percent in June, the National Association of Realtors said today in Washington. A separate report showed inventories at U.S. wholesalers piled up twice as fast as forecast in July as their sales slid.

Today's housing figures help explain why the government took over Fannie Mae and Freddie Mac two days ago. Policy makers are aiming to stem the increase in mortgage rates triggered in part by the turmoil that engulfed the two companies, which make up almost half the $12 trillion U.S. mortgage market. Rates have dropped since Treasury Secretary Henry Paulson's intervention.

‘‘The market is still showing a lot of fragility,'' said Jeffrey Roach, chief economist at Horizon Investments in Charlotte, North Carolina, who forecast the pending sales gauge would drop 3 percent. ‘‘The credit crunch is causing some of these borrowing costs to remain higher and that's part of the reason people are hesitant to jump in.''

Stocks dropped and Treasuries rose. The Standard & Poor's 500 Stock Index lost 0.8 percent to 1,257.41 at 10:32 a.m. in New York. Benchmark 10-year Treasury notes yielded 3.66 percent, down from 3.69 percent late yesterday.

Inventories Jump

The Commerce Department said that wholesale inventories rose 1.4 percent, led by higher stockpiles of automobiles, machinery and petroleum, after an increase of 0.9 percent in June. Sales dropped 0.3 percent, the most since February.

Economists had projected the home-sales index would fall 1.5 percent, according to the median of 39 forecasts in a Bloomberg News survey.

Thirty-year fixed-rate mortgages averaged 6.29 percent in July, up from an average of 5.81 percent in the first half of the year, according to Bankrate Inc. Rates fell to 5.88 percent yesterday.

As home-loan losses mount, banks are reducing lending. Wachovia Corp. in June stopped offering option adjustable-rate mortgages, which let borrowers skip part of their payment and add the balance to principal. Chief Executive Officer Robert Steel said today the Charlotte, North Carolina, bank next year will cut $1.5 billion of expenses as it's ‘‘tapping the brakes'' on risk.

Pending resales were down 6.8 percent from July 2007, reflecting declines in every region except the West, today's housing report showed.

Compared with June, resales dropped the most in the West, where they were down 10.6 percent. They fell 7.5 percent in the Northeast and were unchanged in the South. Pending sales increased 2.8 percent in the Midwest.

Leading Indicator

Pending resales are considered a leading indicator because they track contract signings. Closings, which typically occur a month or two later, are tallied in a separate report from the Realtors.

‘‘The housing correction poses the biggest risk to our economy,'' Paulson reiterated on Sept. 7 when he announced the takeovers of Fannie and Freddie. The Treasury will also start purchasing mortgage-backed securities issued by the two companies to ‘‘support the availability of mortgage financing for millions of Americans,'' he said.

Figures on August existing home sales are due from the NAR Sept. 24. Purchases in July rose 3.1 percent to a 5 million annual pace, with at least one-third of the purchases coming from foreclosed properties.

Supply Glut

At the July sales rate, it would take 11.2 months to sell all the houses on the market, about twice the supply that reflects a balanced market, according to the agents' group.

Other measures also show how bank seizures may push down home prices and suppress sales. Foreclosures increased to the fastest pace in almost three decades during the second quarter, the Mortgage Bankers Association in Washington said in a report last week.

Home prices in 20 U.S. metropolitan areas fell in June by 15.9 percent from a year earlier, the most on record, the S&P/Case-Shiller home-price index showed on Aug. 26.

Homebuilders are struggling to maintain profits as they compete with a glut of unsold properties on the market. Toll Brothers Inc., the largest U.S. luxury homebuilder, reported its fourth straight quarterly loss last week.

‘‘Weak consumer confidence has kept many potential buyers from taking advantage of the current buyers' market,'' Chief Executive Robert Toll said on a conference call with analysts Sept. 4. ‘‘Once the supply of foreclosed inventory is exhausted, we believe that favorable demographics will kick in and the housing market in general will begin to recover.''

US Waves Goodbye to Prosperity and Democracy

US Waves Goodbye to Prosperity and Democracy

By David Hirst

Go To Original

THE events of the weekend begin the greatest intervention in the US economy by the Federal Government since the Great Depression, with the Bear Stearns rescue but a splutter on this road we must now travel.

If you were wondering what all the flag-waving at the Republican convention has been about, it is now clear. Americans are waving goodbye to the prosperity the nation has enjoyed since the Great Depression and a final goodbye to democracy. But while preparation for the most important decision made in the nation's post-depression financial history towered above the conventions, I don't think the fate of Freddie and Fannie and the remaining government-sponsored enterprises (GSEs) was mentioned during either convention.

And the politicians. President Bush has long authorised the Treasury to open its purse strings and, naturally, Treasury Secretary Henry Paulson said he did not expect the line of endless taxpayer credit to be used. This is like signing an authority to go to war and saying we don't expect to go to war. Once the authority is given, it will happen. It was always laughable to expect otherwise. Paulson "briefed" John McCain and Barack Obama on the "plan". The fact is that while America, and the world, wait to see who will govern, Mr Paulson has decided to take matters out of the politicians' hands.

They willingly agreed. The ultimate political power, to spend taxpayers' money, has been tossed away. Obviously the economy is too important to be left to the politicians. Instead it is to be put into "conservatorship". It has come to this.

We don't know exactly what "this" is, but all will be revealed before the Asian markets open today. Like all things Paulson has done lately, it is aired in rarefied circles during the week, decided on by Friday, announced on Saturday, the details hammered out on Sunday and a final deal revealed for the Asian markets, which will judge the matter on the Monday morning.

But the politicians can't entirely escape. While the future of US institutions "too big to fail" dominated all on Friday night, the Federal Deposits Insurance Commission quietly announced yet another bank was too small to save. The Silver State Bank of Nevada is actually a good-sized bank. I wonder if any attention will be attracted to John McCain, whose son Andrew retired from a directorship of the bank a few weeks ago.

Back to the deluge. As this column, citing Brad Setser of RGE Monitor, among others, has been at pains to point out, foreign, particularly Asian, central banks are key investors in Fannie and Freddie paper and they have been losing confidence in the GSEs. The take on that by Barron's was that "Fed data offer circumstantial evidence of, if not of a run, then of a steady walking away from Fannie and Freddie securities".

The consequences of this are so dire, we are assured, that Paulson had to act. The moral hazard no longer underpins US or global banking. Instead one is reminded of Doolittle when asked by Pickering: "Have you no morals man?" "Na, nah. Can't afford 'em, Governor."

The refrain is that we must urgently use this power to protect the taxpayer. But the taxpayer didn't dig this hole; it was the banks.

Today we are seeing panic at the top while Joe Sixpack is behaving with the sort of calm we should be seeing at the top.

David Hirst is a journalist, documentary maker, financial consultant and investor. His column, Planet Wall Street, is syndicated by News Bites, a Melbourne-based sharemarket and business news publisher.

Why The Fannie-Freddie Bailout Will Fail

Why The Fannie-Freddie Bailout Will Fail

By Martin D. Weiss, Ph.D.

Go To Original

With yesterday's announcement of the most massive federal bailout of all time, it's now official: Fannie Mae and Freddie Mac, the two largest mortgage lenders on Earth, are bankrupt.

Some Washington bigwigs and bureaucrats will inevitably try to spin it. They'll avoid the "b" word with vengeance. They'll push the "c" word (conservatorship) with passion. And in the newspeak of 21st century bailouts, they'll tell you "it all depends on what the definition of solvency is."

The truth: Without their accounting smoke and mirrors, Fannie and Freddie have no capital. The government is seizing control of their operations. Their chief executives are getting fired. Common shareholders will be virtually wiped out. Preferred shareholders will get pennies. If that's not wholesale bankruptcy, what is?

Some Wall Street pundits and pros will also try to twist the facts to their own liking. They'll treat the bailout like long-awaited manna from heaven. They'll declare that the "credit crisis is now behind us." They may even jump in to buy select financial stocks. And then they'll try to persuade you to do the same.

The reality: This was the same pitch we heard in August of last year when the world's central banks made a coordinated attempt to rescue credit markets with massive injections of fresh cash. It was also the same pitch we heard in March when the Fed bailed out Bear Stearns. But each time, the crisis got progressively worse. Each time, investors lost fortunes.

Together, both Washington and Wall Street are trying to persuade you that, "no matter what, the government will save us from financial disaster." But the real lessons already learned from these events are another matter entirely:

Lesson #1. Each successive round of the credit crisis is far deeper and broader than the previous.

  • In 2007, the big news was big losses; in 2008, it's big bankruptcies.
  • In March, the failure of Bear Stearns shattered $395 billion in assets. Now, just six months later, the failure of Fannie Mae and Freddie Mac is impacting $1.7 trillion in combined assets, or over four times more. And considering the $5.3 trillion in mortgages that Fannie-Freddie own or guarantee, the impact is actually thirteen times greater than the Bear Stearns failure.

Lesson #2. Despite unprecedented countermeasures, Washington has been unable to stem the tide.

Yes, the Fed can inject hundreds of billions into the banking system. But if banks don't lend, the money goes nowhere.

Sure, the Treasury can inject up to $200 billion of capital into Fannie and Freddie. But if their mortgage portfolio is full of holes, all that new capital goes down the drain.

And of course, the U.S. government has vast resources. But if the $49 trillion mountain of U.S. debts and the $180 trillion pile-up of U.S. derivatives are beginning to crumble, all those resources don't amount to more than a band-aid and a prayer.

Lesson #3. Shareholders are the first victims.

Bear Stearns shareholders got wiped out. Fannie and Freddie Mac shareholders are getting wiped out. Ditto for shareholders in any of Detroit's Big Three that go belly-up, any bank taken over by the FDIC or any insurer taken over by state insurance commissioners.

The Next Lesson:
The Primary Mission of the Fannie-Freddie
Bailout Will Ultimately End in Failure

Most people assume that when the government steps in, that's it. The story dies and investors shift their attention to other concerns. In smaller bailouts, perhaps. But not in this Mother of All Bailouts.

The taxpayer cost for just these two companies — up to $200 billion — is more than the total cost of bailing out thousands of S&Ls in the 1970s. But it's still just a fraction of the liability the government is now assuming.


First, because the number of home foreclosures and mortgage delinquencies has now surged to a shocking four million — and a substantial portion of the massive losses stemming from this calamity have yet to appear on Fannie's and Freddie's books.

Second, because the U.S. recession is still in an early stage, with surging unemployment just beginning to cause still another surge in foreclosures and mortgage delinquencies.

Third, even before Fannie and Freddie begin to feel the full brunt of the mortgage and recession calamity, their capital had already been grossly overstated.

Indeed, right at this moment, while Wall Street analysts are trying to evaluate the details of a bailout plan that's supposed to save them, regulators and their advisers are poring over the Freddie-Fannie accounting mess they're supposed to inherit. According to Gretchen Morgenson and Charles Duhigg's column in yesterday's New York Times, "Mortgage Giant Overstated the Size of Its Capital Base" ...

  • Freddie Mac's portfolio contains many securities backed by subprime and Alt-A loans. But the company has not written down the value of many of those loans to reflect current market prices.

  • For years, both Freddie and Fannie have effectively recognized losses whenever payments on a loan are 90 days past due. But in recent months, the companies saidthey would wait until payments were TWO YEARS late. As a result, tens of thousands of other loans have also not been marked down in value.

  • Both companies have grossly inflated their capital by relying on accumulated tax credits that can supposedly be used to offset future profits. Fannie says it gets a $36 billion capital boost from tax credits, while Freddie claims a $28 billion benefit. But unless these companies can generate profits, which now seems highly unlikely, all of the tax credits are useless. Not one penny of these so-called "assets" could ever be sold. And every single penny will now vanish as the company goes into receivership.

In short, the federal government is buying a pig in a poke — a bottomless pit that will suck up many times more capital than they're revealing. My forecast:

Just to keep Fannie and Freddie solvent will take so much capital, there will be no funds available to pursue the primary mission of this bailout — to pump money into the mortgage market and save it from collapse. That mission will ultimately end in failure.

The Most Important Lesson of All:
As the U.S. Treasury Assumes
Responsibility for $5.3 Trillion in Mortgages,
It Places Its Own Borrowing Ability at Risk

The immediate reason the government decided not to wait any longer to bail out Freddie and Fannie was very simple: All over the world, investors were beginning to reject their bonds, refusing to lend them any more money. So the price of Fannie and Freddie bonds plunged, and the yields on those bonds went through the roof.

As a result, to borrow money, Fannie-Freddie had to pay higher and higher interest rates, far above the rates paid by the U.S. Treasury Department. And they had to pass those higher rates on to any homeowner taking out a new home loan, driving 30-year fixed-rate mortgages sharply higher as well.

Now, with the U.S. Treasury itself stepping in to directly guarantee Fannie-Freddie debts, Washington and Wall Street are hoping this rapidly deteriorating scenario will be reversed.

They hope investors will flock back to Fannie and Freddie bonds.

They hope investors will resume lending them money at a rate that's much closer to the Treasury rates.

And they hope Fannie and Freddie will again be able to feed that low-cost money into the mortgage market just like they used to.

In other words, they hope the U.S. Treasury will lift up the credit of Fannie and Freddie.

There's just one not-so-small hitch in this rosy scenario: Fannie's and Freddie's mortgage obligations are just as big as the total amount of Treasury debt outstanding.So rather than the Treasury lifting up Fannie and Freddie, what about a scenario in which Fannie and Freddie drag down the U.S. Treasury?

To understand the magnitude of this dilemma, just look at the numbers ...

  • Mortgages owned or guaranteed by Fannie and Freddie: $5.3 trillion.

  • Treasury securities outstanding as of March 31, according to the Fed's Flow of Funds (report page 87, pdf page 95): Also $5.3 trillion.

If Fannie's and Freddie's obligations were equivalent to 10% or even 20% of the U.S. Treasury debts, the idea that they could fit under the Treasury's "full faith and credit" umbrella might make sense. But that's not the situation we have here — Fannie's and Freddie's obligations are the equivalent of 100% of the Treasury's debts.

And it's actually worse than that:

  • Foreign investors, the most likely to dump their holdings if they lose confidence in the United States, hold an estimated 20% of the Fannie- and Freddie-backed mortgages outstanding. But ...

  • Foreign investors own 52.7% of the Treasury securities outstanding (excluding those held by the Fed).

So based on the above stats, Treasury securities are actually more vulnerable to foreign selling than Fannie and Freddie bonds.

What happens if the international mistrust and fear afflicting Fannie and Freddie bonds infects U.S. Treasury bonds? Foreign investors would start dumping Treasury securities en masse. They'd drive Treasury rates sharply higher. And they'd wind up forcing Fannie and Freddie to pay much higher rates for their borrowings after all.

How will you know? Just watch the all-critical spread (difference) between the yield on Fannie-Freddie bonds, considered lower quality, and the yield on equivalent government bonds, considered high quality. Then consider these two possibilities:

  • If that spread narrows mostly because Fannie and Freddie interest rates are coming down toward the level of the Treasury rates, fine. That means the immediate goal of the bailout is being achieved. BUT ...

  • If the spread narrows mostly because Treasury rates are going up toward the level of Fannie's and Freddie's rates, that's not so fine. It not only means a failure to achieve the immediate goals, but it will also imply that the entire Fannie-Freddie bailout is backfiring on the Treasury.

A Fictional Scenario
That's Coming True

In my book, Investing Without Fear: Protect Your Wealth in All Markets and Transform Crash Losses Into Crash Profits, I anticipated this very scenario. In a fictional scenario about the not-too-distant future, I warned what might happen if the U.S. Treasury tried to bail out the bonds of a giant corporation, just as it's doing for Freddie and Fannie right now.

In my scenario, a few days after the bailout is announced, the Treasury secretary calls the president of the United States on the phone to bring him up to date with the impact in the financial markets. Here's the dialog that follows, quoted from my book verbatim [with any additions in brackets]:

"It's no good. The benefit of our plan to the stock market is a spit in the ocean. On the other hand, to the government bond market, it's a potential hydrogen bomb. The quality spreads are narrowing — and in the wrong direction."

The president didn't know much about quality spreads. "What are the causes and what are the consequences of changes in quality spreads?" he asked.

"I am referring to the difference in yield between a Treasury bond and a corporate bond. A big corporation [like Fannie or Freddie] always has to pay more than the U.S. Treasury to borrow money. Typically, the difference has been about one full percentage point.

"Then, several months ago, when the full threat of corporate bankruptcies was first apparent, the yield on medium-grade corporate bonds went up by 2 1/4 percent, but the yield on the governments went up only 1/4 percent. In other words, the spread increased by two full percentage points. It was a red-hot flashing signal of trouble. It revealed that confidence in all corporations — no matter how creditworthy — had collapsed. But that was before our rescue package was announced."

"And now?"

"Now the opposite is happening. Corporate bond yields [like Fannie's and Freddie's] are back down sharply, but government bond yields are actually up sharply. The spread between them has narrowed to practically nothing — a very bad sign." The Treasury secretary felt satisfied that he had put forth a very clear and straightforward explanation.

"Well, isn't that what we had said we wanted — to bring up the corporate bond market, to get it back up toward the level of government bonds?"

The secretary shook his head, trying to hold his voice steady so that his feelings of frustration with the president's lack of knowledge of bond markets would not be picked up over the phone. In the past, he tried several times to explain to the president how interest rates and prices moving in opposite directions always meant the same thing, but that spreads, although moving in the same direction, could mean a variety of different things.

How does one make such things simple for a president to understand without sounding condescending? The secretary certainly didn't know how. He spent the next half hour going over the events in the marketplace until finally, after considerable effort, the president developed an image of bond markets that looked similar to the chart below.

Bond Rescue

"Now I see," the president said finally. "We wanted to bring the corporate bonds up to the level of the government bonds. What's happening is precisely the opposite. The 'governments,' as you call them, are falling down to the level of the 'corporates.' In short, we are not lifting them up; they are dragging us down."

"Yes, Mr. President. We bent over, we bent all the way over, to pull them out of the quicksand. Instead, they pulled us down with them, and now we're sinking in the quicksand too."

The president thought for a moment before he spoke. "The question is, Why? Don't they believe we're serious? Why haven't we restored confidence? At the meeting, it was said that we can create cash, that the law gives us the authority to funnel this cash wherever we please."

"The answer is that we can create cash. But we cannot create credit."

"What's the difference?" the president queried.

"There's a very big difference. To create more cash, all we have to do is speed up the printing presses at the mint — or, actually, pump it in electronically. And when we dish it out, no one is going to turn us down. But to create credit, we have to convince investors and bankers to make loans — and in this environment of falling confidence, I can assure you that this isn't easy. If it were so easy, we could have saved Bethlehem Steel or Enron or Kmart or Global Crossing or WorldCom or any of the other giants that have failed. But we didn't, and for good reason."

The president was getting impatient. "So what's the point?"

"The point is that you can create cash; you can't create confidence."

"It would seem to me that the more money we give 'em, the more confidence they'd have."

"No, no! It's exactly the opposite. The more we spend the government's money recklessly, the less confidence they have and the more they fear our government bonds will go down in value."

"Oh? But why can't we just buy more corporate bonds? That should convince them we mean business!"

"No, it just convinces them we're throwing more good money after bad — their good money after bad."

"But what about the new law?"

"The law gives us the on-paper authority to buy private securities. It does not give us the actual power to create real economic wealth."

"Why didn't we recognize this when we discussed the rescue plan?"

"We did. But you overrode us, and we consented. We hoped that the marketplace might swallow it. We seriously underestimated the sophistication of U.S. and foreign investors — very seriously underestimated."

Still the president sounded perplexed. "You're saying the market is sensitive. You're saying the market is smart. I see that now. But ..."

The secretary's irritability was becoming more apparent. "Let's say I'm a foreign investor and I own U.S. Treasury bonds. This implies that I trust the U.S. government; that I loaned you my money for the purpose of running your government. Now you take my money and pass it on to a third party, a private company. So I say to you, 'What did you go and do that for? If I wanted to loan the money to that company, I would have done so myself — directly — in the first place. But I didn't. I didn't do it because I don't trust the company. I trusted you. But now I can't trust you anymore either. Now you're just one of them.' So the investor stops buying our bonds or, worse, dumps the government bonds he's holding, and then we are in trouble. Then we can't sell our government bonds anymore to pay off the old ones coming due. Then we, the United States government, default."

The president hesitated for a few seconds before responding, but it seemed like hours as the tension built.

"Then what?"

The secretary could not believe his ears. The president of the United States had treated the government's default with levity, utter levity. He could no longer control his boiling frustration — and fear. "Do you want to allow the entire market for U.S. government securities to shut down? Do you want to be the one who has to lay off hundreds of thousands of government employees because you can't raise the money to meet the government payroll? Do you want to be the last president of the United States? Do you want to risk a new republic with a new constitution? Do you want to destroy, in one fell swoop ..."

The secretary's voice broke with emotion. Silence reigned.

"[Hank], I appreciate the sincerity of your emotions, but you misunderstood me. What I said, in fact, was 'then WHAT,' indicating to you my surprise and disbelief that our country could ever reach the point you've described so dramatically just now."

Back to the Present

In my book's future scenario quoted above, the government ultimately decided to abandon its plan to rescue large private corporations like Fannie or Freddie. It was the only way it could save its own credit and its own ability to continue borrowing from domestic and foreign investors.

In the real world of the present, however, the government is going forward with its bailout plan — and the plan is even more ambitious than the one contemplated in my book.

But for the same reasons I've outline above, the Treasury will ultimately have to effectively abandon Fannie and Freddie: It will set a cap on the resources it will commit. It will not write a blank check. In the final analysis, it must save its own neck first.

The same applies to you. Follow our instructions to get your money to safety. And even use this crisis as a unique opportunity to build your wealth. To learn exactly how, join us online one week from today, Monday, September 15.

For all the details and for your free registration, click here.

Good luck and God bless!


This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Economic Democracy Is Turning Into a Financial Oligarchy

Economic Democracy Is Turning Into a Financial Oligarchy

An interview with Michael Hudson, former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JP Morgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation).

By Mike Whitney

Go To Original

On Friday afternoon the government announced plans to place the two mortgage giants, Fannie Mae and Freddie Mac, under “conservatorship.” Shareholders will be virtually wiped out (their stock already had plunged by over 90 per cent) but the US Treasury will step in to protect the companies’ debt. To some extent it also will protect their preferred shares, which Morgan-Chase have marked down only by half.

This seems to be the most sweeping government intervention into the financial markets in American history. If these two companies are nationalized, it will add $5.3 trillion dollars to the nation's balance sheet. So my first question is, why is the Treasury bailing out bondholders and other investors in their mortgage IOUs? What is the public interest in all this?

Hudson: The Treasury emphasized that it was under a Sunday afternoon deadline to finalize the takeover details before the Asian markets opened for trading. This concern reflects the balance-of-payments and hence military dimension to the bailout. The central banks of China, Japan and Korea are major holders of these securities, precisely because of the large size of Fannie Mae and Freddie Mac – their $5.3 trillion in mortgage-backed debt that you mention, and the $11 trillion overall U.S. mortgage market.

When you look at the balance sheet of U.S. assets available for foreign central banks to buy with the $2.5 to $3.5 trillion of surplus dollars they hold, real estate is the only asset category large enough to absorb the balance-of-payments outflows that U.S. military spending, foreign trade and investment-capital flight are throwing off. When the U.S. military spends money abroad to fight the New Cold War, these dollars are recycled increasingly into U.S. mortgage-backed securities, because there is no other market large enough to absorb the sums involved. Remember, we do not permit foreigners – especially Asians – to buy high-tech, “national security” or key infrastructure. The government would prefer to see them buy harmless real estate trophies such as Rockefeller Center, or minority shares in banks with negative equity such as Citibank shares sold to the Saudis and Bahrainis.

But there is a limit on how nakedly the U.S. Government can exploit foreign central banks. It does need to keep dollar recycling going, in order to prevent a sharp dollar depreciation. The Treasury therefore has given informal assurances to foreign governments that they will guarantee at least the dollar value of the money their central banks are recycling. (These governments still will lose as the dollar plunges against hard currencies – just about every currency except the dollar these days.) A failure to provide investment guarantees to foreigners would thwart the continuation of U.S. overseas military spending! And once foreigners are bailed out, the Treasury has to bail out domestic American investors as well, simply for political reasons.

Fannie and Freddie have been loading up on risky mortgages for ages, under-stating the risks largely to increase their stock price so that their CEOs can pay themselves tens of millions of dollars in salary and stock options. Now they are essentially insolvent, as the principal itself is in question. There was widespread criticism of this year after year after year. Why was nothing done?

Hudson: Fannie and Freddie were notorious for their heavy Washington lobbying. They bought the support of Congressmen and Senators who managed to get onto the financial oversight committees so that they would be in a position to collect campaign financing from Wall Street that wanted to make sure that no real regulation would take place.

On the broadest level, Treasury Secretary Paulson has said that these companies are being taken over in order to reflate the real estate market. Fannie and Freddie were almost single-handedly supporting the junk mortgage market that was making Wall Street rich.

The CEOs claimed to pay themselves for “innovation.” In today’s Orwellian vocabulary financial “innovation” means the creation of special rent-extracting privilege. The privilege was being able to get the proverbial “free ride” (that is, economic rent) by borrowing at low-interest government rates to buy and repackage mortgages to sell at a high-interest markup. Their “innovation” lies in the ambiguity that enabled them to pose as public-sector borrowers when they wanted to borrow at low rates, and private-sector arbitrageurs when they wanted to get a rake-off from higher margins.

The government’s auditors are now finding out that their other innovation was to cook the accounting books, Enron-style. As mortgage arrears and defaults mounted up, Fannie and Freddie did not mark down their mortgage holdings to realistic prices. They said they would do this in a year or so – by 2009, after the Bush Administration’s deregulators have left office. The idea was to blame it all on Obama when they finally failed.

But at the deepest level of all, the “innovation” that created a rent-extracting loophole was the deception that making more and more bad-mortgage loans could continue for a prolonged period of time. The reality is that no exponential rise in debt ever has been able to be paid for more than a few years, because no economy ever has been able to produce a surplus fast enough to keep pace with the “magic of compound interest.” That phrase is itself a synonym for the exponential growth of debt.

The Road to Debt Peonage

In an earlier interview you said: “The economy has reached its debt limit and is entering its insolvency phase. We are not in a cycle but the end of an era. The old world of debt pyramiding to a fraudulent degree cannot be restored.” Would you expand on this in view of today’s developments?

Hudson: How long more and more money can be pumped into the real estate market, while disposable personal income is not growing by enough to pay these debts? How can people pay mortgages in excess of the rental value of their property? Where is the “market demand” to come from? Speculators already withdrew from the real estate market by late 2006 – and in that year they represented about a sixth of all purchases.

The best that this weekend’s bailout can do is to postpone the losses on bad mortgage debts. But this is a far cry from actually restoring the ability of debtors to pay. Mr. Paulson talks about more lending to support real estate prices. But this will prevent housing from falling to levels that people can afford without running deeper and deeper into mortgage debt. Housing prices are still way, way above the traditional definition of equilibrium – prices whose carrying charges are just about equal to what it would cost to rent over time.

The Treasury’s aim is to revive Fannie and Freddie as lenders – and hence as vehicles for the U.S. economy to borrow from the foreign central banks and large institutional investors that I mentioned above. More lending is supposed to support real estate prices from falling quite so far as they otherwise would – and in fact, the aim is to keep the debt pyramid growing. The only way to do this is to lend mortgage debtors enough to pay the interest and amortization charges on the existing volume of debt they have been loaded down with. And since most people aren’t really earning any more – and in fact are finding their budgets squeezed – the only basis for borrowing more is to inflate the price of real estate that is being pledged as collateral for mortgage refinancing.

It is pure hypocrisy for Wall Street’s Hank Paulson to claim that all this is being done to “help home owners.” They are vehicles off whom to make money, not the beneficiaries. They are at the bottom of an increasingly carnivorous and extractive financial food chain.

Nearly all real estate experts are in agreement that for the next year or two, many of today’s homeowners will find themselves locked into where they are now living. Their situation is much like medieval serfs were tied to their land. They can’t sell, because the market price won’t cover the mortgage they owe, and they don’t have the savings to pay the difference.

Matters are aggravated by the fact that interest rates are scheduled to reset at higher non-teaser rates for the rest of this next year and 2010, increasing the financial burden. You may remember that Alan Greenspan recommended that homebuyers take out adjustable-rate mortgages (ARMs) because the average American moves every three years. By the time the mortgage interest rate jumped, he explained, they could sell to a new buyer in this game of musical chairs – presumably with more and more chairs being added all the times, and plusher ones to boot.

But homeowners can’t move today, so they find themselves stuck with rising interest charges on top of their rising fuel and heating and electricity charges, transportation charges, food costs, health insurance and even property taxes as these begin to catch up with the rise in Bubble Prices.

The government has carefully avoided nationalizing the companies and thereby taking them onto its own balance sheet. It has created a “conservatorship” (a word that my spellchecker does not recognize). So the bailout of Fannie and Freddie looks like the Republicans are trying to play the financial just-pretend game simply until they leave office in February, after which time they can blame the failure of the “miracle of compound debt interest” on the incoming Democratic Congress.

So it’s politics as usual: play for the short run. In the long run – even next year – the real estate market will continue to drift down.

The economic news keeps getting grimmer and grimmer, but you’d never know it by listening to the politicians at the Republican Convention. The only time the economy was brought up at all was in the context of praise for free markets and globalization. The housing crash and credit market meltdown were not mentioned. Could you tell us what you think the rising unemployment numbers, falling consumer demand, skyrocketing foreclosures and ongoing troubles in the credit markets mean for America’s future? Is this just a blip on the radar or are we in the middle of a major retrenchment that will result in falling living standards and a deep, protracted recession?

Hudson: The Republicans prefer to distract attention from how the Bush regime has failed over the past eight years. If attention can be focused on Iraq and terrorism, on personalities and style, serious discussion of such matters may be crowded out. That’s what the news media are for.

When politicians do talk about the economy, the basic strategy is to fight the November election over who has the nicest dream for what people would like to believe. Amazing as it seems, a large number of Americans actually expect to have a good chance of becoming millionaires. They’re simply not looking at the debt side of the balance sheet.

The most striking economic dynamic today is polarization between those who live off the returns to wealth (finance and property extracting interest and rent, plus capital gains as asset prices are inflated) and those who live off what they can earn, struggling to pay the taxes and debts they are taking on. The national income and product accounts – GNP and national income – don’t say anything about the polarization of property, and doesn’t include capital gains, which are how most wealth is being achieved these days, not by actual direct investment to increase the means of production as lobbyists for trickle-down economic theory claim.

Here’s how things look today: The richest 1 per cent of the population receive 57.5 per cent of all the income generated by wealth – that is, payment for privilege, most of it inherited. These returns – interest, rent and capital gains – are not primarily a return for enterprise. They are pure inertia, weighing down markets. They do not “free” markets, except by providing a free lunch to the wealthiest families. The richest 20 per cent of the population receives some 86 per cent of all this income – that is, what actually is increasing household balance sheets.

What people still view as an economic democracy is turning into a financial oligarchy. Politicians are looking for campaign support mainly from this oligarchy because that is where the money is. So they talk about a happy-face economy to appeal to American optimism, while being quite pragmatic in knowing who to serve if they want to get ahead and not be blackballed.

During the 1990s the bottom 90 per cent of the population tried to catch up by going into debt to buy homes and other property. What they didn’t see was that an insatiable growth in debt is needed to keep a real estate and finance bubble expanding. All this credit imposes financial charges, which have been largely responsible for polarizing wealth ownership so sharply in recent decades.

These debt charges have grown so heavy that debtors are able to pay only by borrowing the interest that is falling due. They have been able to borrow for the past few years by pledging real estate or other collateral whose prices are being inflated by Federal Reserve policy. The Treasury also contributes by giving tax favoritism, un-taxing property and finance. This forces labor and tangible industrial capital to pick up the fiscal slack, even as they are being forced to carry a heavier debt burden.

Homeowners do not gain by this higher market “equilibrium” price for housing. Higher prices simply mean more debt overhead. Rising price/rent and price/earnings ratios for debt-financed properties, stocks and bonds oblige wage earners to go deeper and deeper into debt, devoting more and more years of their working life to pay for housing and to buy income-yielding stocks and bonds for their retirement.

Debt expansion to buy property seems self-justifying as long as asset prices are rising. This asset-price inflation is euphemized as “wealth creation” by focusing on real estate, stock and bond prices – even as disposable personal income and living and working conditions are eroded.

So to come back to your broad question, I don’t see consumer demand rising much, except by foreign tourists coming over and spending their money as the dollar falls. Here in New York, foreign buyers are supporting the real estate market. The Wall Street downturn already has forced the city to postpone its promised property tax cuts and its subway expansion. My wife and I just got our condo tax bill this week. There was an explanatory note telling us that the only tax cuts will be for commercial property owners. Residential property tax rates rise.

It gets worse. Without better transportation, wage earners will be squeezed across the country. Higher gas prices, electricity, health care and food are crowding out spending on output and forcing people into even more debt. That’s why arrears and defaults are rising. Even rents are rising, despite falling real estate prices. This is because houses under foreclosure can’t be rented out, so millions of houses may be taken off the market.

What exactly do you mean by “modern debt peonage”?

Hudson: This is what happens when wage earners are obliged to turn over all their income above basic subsistence needs to the FIRE sector – mainly for debt service but also to pay for compulsory insurance and, most recently, the tax burden that finance and property have shifted off themselves.

The distinguishing feature about peonage is its lack of choice. It is the antithesis of free markets. As I mentioned above, many families today find themselves locked into homes that have negative equity. Their mortgage debt exceeds the market price. These homes can’t be sold – unless the family can pay the difference to the banker who has made the bad mortgage loan. The gap may exceed all the income the family earns in an entire year – just as it was making on paper a price gain larger than its annual take-home pay.

But what did all this matter, in retrospect, if the house was for living, not for buying and selling? This dimension of use value was left out of account by focusing on paper wealth.

In a nutshell, debt peonage is the other side of the coin in a rentier economy. The negative equity we are seeing today is a key component of debt peonage. It forces debt peons to spend their lives trying to work their way out of debt. The more desperate they get, the more risks they take, and the deeper they end up. In Kansas City, one of my students wrote his class paper on how the immediate cause of many mortgage defaults is gambling debt. Missouri has a lot of fundamentalist Christians who think of God as watching carefully over them. Being good people, they want to give God a chance to reward them for living an honest life. So they go to the gambling boats that are moored along the river. But the odds are against them, and it looks like Einstein was wrong when he said that God doesn’t play dice. Gambling – and much financial speculation – is all about probability, and the odds are as much against gamblers as they are against debtors. Being laws of nature, the laws of probability are like the privilege of land ownership: a gambling license provides the house with an opportunity to rake economic rent off the top.

Debt deflation and the tax shift off finance and property onto labor

In the short run it looks like slow growth and deflation will be bigger problems than inflation. Commodities, including gold and oil, are tumbling almost daily, while bank assets are being steadily downgraded, foreclosures are soaring and the stock market is reeling. The financial crisis that began in the real estate market has triggered a boycott of structured products and is now rippling through the broader economy.

The Federal Reserve has already dropped interest rates by 3.5 per cent and has used up half its balance sheet ($450 billion) to shore up the faltering banking system. But the situation keeps getting worse. The banks have curtailed their lending, and consumer spending is off in nearly every area. It looks like the Fed is out of ammo. Is it time to consider fiscal alternatives to the present downturn, such as cutting payroll taxes to give families more money to increase demand, or initiating massive infrastructure projects?

Hudson: By “deflation” I assume you mean debt deflation – draining purchasing power as a result of rising debt service and compulsory insurance, plus the wage squeeze that the government praises for “raising productivity” to “create wealth” for the CEOs who pay themselves what they have cut back from labor’s paycheck. There will be less consumer spending – but even so, consumer prices may not come down if the dollar resumes its fall, especially if monopoly pricing continues to be permitted.

Your solution is indeed what is needed, and Mr. Obama has promised to raise the wage and salary limit subject to FICA withholding. I think that an even better idea would be to go back to the original 1913 income tax and exempt wages that merely cover subsistence. I would restore a cut-off point at $102,000 in today’s dollars, matching the terms of America’s 1913 income tax. People earning less would not have to file an income-tax return at all.

This truly conservative idea would free income to be spent on improving living standards. Instead, high income brackets and property are being un-taxed today, and their tax savings are being spent mainly in making loans that are used to bid up the price of wealth and luxury goods.

This is what the classical economists warned against, yet the tax shift off property onto labor is being done hypocritically in their name. To get the kind of free markets they advocated, taxes should fall on the FIRE sector (finance, insurance and real estate) and monopolies, not wages or bona fide industrial profits stemming from tangible capital investment and employment.

This June you wrote a groundbreaking paper for a recent Post-Keynesian conference at the University of Missouri in Kansas City, where you’re an economics professor. Its title was “How the Real Estate Bubble drives Home buyers into Debt Peonage.” You earlier wrote a now famous May 2006 Harpers cover story on debt peonage. Your Kansas City paper produces charts showing how tax favoritism for real estate and other clients for the banking and financial sector stimulates asset-inflation, leading to massive equity bubbles like the one we are currently experiencing in the housing market. Would you give us a brief summary of your thesis?

Hudson: My paper explained how the money the tax collector gives up is “freed” to be paid to banks as interest. This is the motto of real estate investors: “Rent is for paying interest.” The FIRE sector has adopted a populist rhetoric to persuade homeowners to believe that lowering the property tax will end up giving them more money. It seems at first blush that this would happen. But in practice, new buyers – and speculators – come into the market and pledge the tax cuts to bid up housing prices all the more. The winner in this new anti-tax marketplace is the buyer who pledges to pay the tax cut to the banks as interest on a mortgage loan to buy the property.

As my paper describes:

“Tax favoritism for real estate, corporate raiders and ultimately for bankers has freed income to be pledged to carry more and more debt, which has been used to fuel asset-price inflation that raises the price of home ownership, corporate stocks and bonds – but not to increase production and output. ... Shaping the marketplace to favor finance and property over industry and labor does not create a ‘free market.’ It favors the debt-leveraged buying and selling of real estate, stocks and bonds, distorting markets in ways that de-industrialize the economy. [And] shifting taxes off property and finance is more a distortion than a virtue, unless debt leveraging is deemed virtuous.

"This is the tragedy of our economy today. Credit creation, saving and investment are not being mobilized to increase new direct investment or raise living standards, but to bid up prices for real estate and other assets already in place and for financial securities (stocks and bonds) already issued. This loads down the economy with debt without putting in place the means to pay it off, except by further and even more rapid asset-price inflation.

This is largely the result of relinquishing planning and the structuring of markets to large banks and other financial institutions, political lobbyists have rewritten most of today’s tax laws and sponsored general public deregulation of the checks and balances that were being put in place by the late 19th century. At that time, just over a hundred years ago, it seemed that wealth – and banking – were being industrialized, while landed wealth and monopolies would become more socialized and their rents fully taxed. Instead of real estate prices rising, the rental ‘free lunch’ would provide the basic source of public finance. Technology and productivity would increase industrial capital formation and raise labor’s living standards. These policies would free markets from rent extraction and also from taxes as the fiscal burden was shifted back onto property.

But this is not what has occurred. The financial system has used its power to extract fiscal favors for real estate and to press for deregulation of monopolies as the major source of its interest and collateral for its loans.”

What do you think the positive effects would be of taxing property rather than income and industrial profit?

Hudson: It would have two major positive effects. First, it would free labor and industry from the tax burden. And by the same token, it would require the economic rent currently used to pay interest and depreciation to be paid instead as a property rent tax. This would free an equivalent sum from having to be raised in the form of income and sales tax. That was the classical idea of free markets. As matters stand today, the tax subsidy for real estate and finance leaves more net rental income to be capitalized into bank loans. This is a travesty of the “free markets” that lobbyists for the banks and the wealthy in general claim to advocate.

Replacing income and sales taxes by a land-rent “free lunch” tax would make real estate prices more affordable, because the interest now “free” to be paid to banks to support a high debt overhead would instead be collected and used to lower the tax burden on labor and industry. This would reduce the cost of production and living, I estimate by about 16 percent of national income.

Homeowners and renters would pay the same amount as they now do, but the public sector would recapture the expense of building transportation and other basic infrastructure out of the higher rental value this spending creates. The tax system would be based on user fees for property, falling on owners in a way that collects the rising value of their property resulting from the rent of location, enhanced by public transportation and other infrastructure, and from the general level of prosperity, for which landlords are not responsible but merely are the passive beneficiaries under current practice.

A Neo-Progressive fiscal policy would aim at recapturing the land’s site value created by public infrastructure spending, schooling and the general level of prosperity. The debt pyramid would be much smaller, and savings could take the form of equity investment once again. Slower growth of debt, housing and office prices, and lower taxes on income and sales would make the economy more competitive internationally.

I’d like to expand on what you have said in your article and you can correct me if I’ve got it wrong. You say that today’s tax code poses an obstacle to progressive political change, and puts more and more power in the hands of bankers and speculators who profit from “boom and bust” cycles. In other words, reworking the tax system has to be the cornerstone of any progressive platform? Is this the bigger point you are trying to make?

Hudson: It’s certainly the tax point I want to make. But I think that my most important point is the analysis of how the mathematics of compound interest intrudes increasingly into the economy. The fiscal link is that as finance strips more and more wealth, Wall Street converts its economic power into political power. Its main aim is to free itself from taxation – by shifting the burden onto labor.

One way to achieve this tax shift has been to re-define taxes as a “user fee.” This is what the Greenspan Commission did in 1983 when it imposed heavy regressive taxation on labor via FICA wage withholding for Social Security and Medicare instead of funding these programs out of the general budget, to be paid for largely by the higher brackets. The Social Security Trust Fund generated a heavy tax surplus, which was used to cut tax rates on the upper wealth brackets.

The tax code’s “small print” made commercial real estate free of having to pay income tax by pretending that landlords were losing money on their property as buildings depreciated – as if the land’s rising site value did not more than compensate. Most important, interest was treated as a tax-deductible expense. This encouraged debt leveraging rather than equity investment, creating an enormous market for bankers creating credit and collecting interest on it.

You say in your article that there’s “a symbiosis between finance, insurance and real estate” which is at the core of the Bubble Economy. And that this creates a “a feedback between bank credit and asset prices. The quickest and easiest path to wealth is not to earn profits by investing in industry, but to go into debt to ride the wave of asset-price inflation. The result is a shift of wealth seeking away from industry to financial maneuvering on credit to ride the wave of asset-price inflation.”

Is this financialization trend irreversible, or is there a way we can revitalize America’s industrial base? Should we consider nationalizing the failing auto industry and putting people to work while we build vehicles for the future?

Hudson: Nationalization may not be the answer as long as financial interests have replaced the government as society’s new central planners. I fear that nationalization under today’s political conditions would mean “socializing the losses,” having the government bear them and then sell off the companies at the usual give-away price to new buyers on credit, all to the benefit of Wall Street.

If there is any sector to be nationalized, it should be the FIRE sector – finance, insurance and industry – along with taking basic infrastructure back into the public domain by de-privatizing it. The Progressive Era’s plan that made America so rich and dominant a nation was for the government to supply basic services such as railroads, phone systems, the post office and roads or canals at cost or at a subsidy. This lowered the price structure across the economic spectrum, enabling the United States to undersell and out-produce other economies.

We are now in Year 2 of the so-called credit crisis, what Bloomberg News calls “the worst financial crisis since the Depression.” More and more pundits are pointing at the Fed’s monetary policies as the source of the troubles. Surprisingly, even the New York Times has joined in the finger pointing by admitting that Greenspan played a central role in the housing bubble.

Here’s what The New York Times recently said: “Who’s to blame? In the estimation of many economists, it starts with the Federal Reserve. The central bank lowered interest rates following the calamitous end of the technology bubble in 2000, lowered them more after the terrorist attacks of Sept. 11, 2001, and then kept them low, even as speculators began to trade homes like dot-com stocks. Meanwhile, the Fed sat back and watched as Wall Street’s financial wizards engineered diabolically complicated investments linked to mortgages, generating huge amounts of speculative capital that turned real estate into a conflagration.”

How would you characterize Greenspan's part in the present crisis?

Hudson: He was its cheerleader, with backup from the University of Chicago and a slew of right-wing think tanks. Mr. Greenspan gave all this trickle-down economics a patina of rationale and also a rhetoric pretending that the financial bubble was helping homeowners rather than mortgage lenders and Wall Street. His role was to translate Ayn Rand propaganda into populist euphemism.

The role of a financial cheerleader is to confuse the economic issues, above all by depicting running into debt as “debt leverage” to accelerate “wealth creation.” Looking backward, we now can see that this was really debt creation. When Mr. Greenspan spoke about wealth, he didn’t mean the kind that Adam Smith referred to in The Wealth of Nations – tangible means of production. Mr. Greenspan meant balance-sheet financial claims on this wealth in the form of stocks, bonds and property claims. Adam Smith said that to count these monetary forms of wealth alongside the actual land and capital of Britain would be double counting. For Greenspan, the liabilities side of the economy’s balance sheet – what its producers owed to financial and property owners – became the only kind of wealth he really cared about.

This inside-out perspective was largely responsible for de-industrializing, downsizing and outsourcing the U.S. economy. Mr. Greenspan’s idea of “free markets” was simply to deregulate them – covertly, to be sure, by appointing non-regulators to the government’s key regulatory positions. This resulted in asset stripping, which created some conspicuous billionaires (corporate raiders, re-christened as “shareholder activists” these days) and hence won the praise of Mr. Greenspan for ostensibly playing a positive role in “wealth creation.”

The bottom line is that the economic vocabulary was turned into double-think.

The Political dimension

I have no background in economics, and never had any particular interest in the topic. My frustration with the direction of the country – particularly the Iraq war and the dismantling of civil liberties – led me to search for answers in places that I never otherwise would have looked. Now I am convinced that the war in Iraq and the rapid shift towards a police state here in America are logical corollaries of the economic polarization that has its root in policies that are fundamentally flawed and serve the narrow interests of corporatists, bankers and other vested interests.

Hudson: With regard to your abhorrence of economics, some of my best students at the New School withdrew from the discipline as they found that it wasn’t addressing the problems they were most concerned about. The field has been sterilized by more than a generation of Chicago School intolerance.

The economics profession does not seem to be amenable to reform along the lines that would get you interested in it. It has become mainly a rhetorical gloss to depict financial oligarchy as if it were populist economic democracy. Many people have tried to expand its scope, and have failed. Thorstein Veblen made an attempt a century ago, his analysis – basically, classical political economy – was exiled to the academic sub-basement of sociology. Economists preferred to put on blinders when it came to looking at wealth distribution and the classical distinction between “earned” and unearned” (that is, parasitic) income. Just while sex was becoming un-repressed, wealth distribution became the new politically incorrect topic to discuss.

In the old movies about invaders from outer space such as The Thing, there usually was a near-sighted scientist who said, “Let’s try to reason with it. It’s smarter than we are, because it’s come in a flying saucer with all that great technology.” The monster from outer space then would simply whack the man aside, killing him brutally.

It’s much like the Terminator from the future. “It doesn’t feel compassion. It doesn’t feel pain. You can’t reason with it,” says the movie’s hero. “All it does is kill.”

This is the task the Chicago Boys have taken on in their defense of financialized markets as being “free.” You can’t reason with them. Reason is not their job. They are not there to be fair.

But to achieve its censorial role, today’s economic orthodoxy pretends that markets work in a fair way to provide everyone with opportunity – something like a sperm with a chance to inherit a billion dollars from a Russian kleptocrat or American real estate magnate or Wall Street operator. To promote this worldview, one needs to craft a rhetoric pretending that markets are “free,” not leading to serfdom. One has to pretend that is government regulation of the kleptocrats that is leading to serfdom rather than protecting the population from predatory finance.

Regarding your concern with the police state and, ultimately military aggression that is required to promote “free markets” at gunpoint, Pinochet-style, empire building always has gone hand in hand with impoverishing the population of the imperial center as well as its periphery. For starters, empires and wars don’t pay, at least not in modern times. At best, it is like the war in Iraq – a vehicle for the Bush administration to channel billions of “missing” dollars to its campaign supporters, to recycle back into new Republican campaign funding. The economy at large is taxed as imperialism turns into asset stripping.

A second and more purely political dimension of imperial warfare is to distract the attention of voters away from economic issues, by appealing to their nationalism and chauvinism.

Hobson’s theory of imperialism was that the domestic population lacked the income to consume what it produced, so that producers had to seek out foreign markets. This led to war. But today, the “postindustrial” mode of imperialism is more about recycling wealth to produce capital gains, mainly by globalizing and privatizing the Bubble Economy. The most important markets for “wealth creation” are not for goods and services, but for real estate and financial assets. So we are brought back to your initial questions today, about how Fannie Mae and Freddie Mac will sponsor more sales of mortgage-backed securities.

I think your article offers a straightforward way to avoid disaster and to transform society by changing the tax code so that it strengthens the middle class and levels the playing field between “the haves and the have-nots.” But how can this be achieved without breaking your ideas into snappy sound-bytes and building a broad-based grassroots movement devoted to working class issues and economic justice? Is there a way to make these transformative social changes without starting a third political party; an American Labor Party perhaps?

Hudson: If the incoming Democratic administration proves to be more of the same, pressure will indeed arise to create a new party. More often economic reform has come from the top, but I don’t see it from the Republicans, given their corruption. Within the Democratic Party the question is whether the Wall Street Democratic Leadership Committee (who gave us Gore and Lieberman after the Clintons) will continue to impose its stranglehold.

Any real improvement will need an educational campaign to prepare the ground for making economic reform the centerpiece of major elections. This educational role often has been filled by third parties. In the 1890s, for instance, the main Progressive Era campaigning occurred outside of the Democrats and largely outside of the Republicans as well.

Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JP Morgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002. He can be reached via his website, mh@michael-hudson.com

Mike Whitney lives in Washington state. He can be reached at: fergiewhitney@msn.com

Wall Street's Next Target: Roads and Bridges

Wall Street's Next Target: Roads and Bridges

By David Bollier
Go To Original

In a purported news article at the end of August the New York Times business section gave a big wet kiss to the idea of privatizing the nation's bridges, roads and civil infrastructure. In a nearly 40 column inches, reporter Jenny Anderson casts investors as thwarted social workers ready to do their part in helping to fix America's crumbling infrastructure. Nearly everyone quoted in the story is an investment banker or investor. Politicians are quoted only to bemoan the sad state of roads and bridges, cry about their budget deficits, and wring their hands over the lack of viable solutions.

The obvious solution is private investment. Or at least, that's the only solution that the Times explores (notwithstanding a misleading headline on the online version of the story, "Cities Debate Privatizing Public Infrastructure").

Anderson supplies no critical analysis of why governments and politicians are failing to make needed infrastructure investments, or how government might pursue public-spirited alternatives to private equity. Instead, we hear Norman Mineta, a former U.S. transportation secretary and now an adviser to Credit Suisse, blandly explain, "Budget gaps are starting to increase the viability of public-private partnerships."

The Times story amounts to a hot tip to the investor class: "Vulnerable public assets await your predatory attention. Big ROI is assured!"

Republicans and investors have long railed against "big government" while enjoying government's "liquidity backstopping" (Bear Stearns, Fannie Mae, Freddie Mac) and government borrowing to finance reckless foreign wars. Now that such bleeding of government has led to crumbling infrastructure, Wall Street, in a fine thank you to its benefactor, wants to go in for the kill. Groups like Goldman Sachs, Morgan Stanley and the Carlyle Group have amassed some $250 billion to take public infrastructure private.

Standing ready to help them are politicians who have abandoned their commitment to government except as a tool for military aggression and a way station to lucrative private employment. Such politicians are only too ready to enter into "partnerships" that traduce the public interest. The Anderson article gives such politicians plenty of reason to feel complacent. It offers sales pitches from the executives of investment banks and ideological pap from the libertarian-minded Reason Foundation. The privatization of public roads and bridges is cast as a brilliant, natural innovation. Anderson ignores the compelling economic and public-interest reasons for managing and financing public infrastructure through government.

As it happens, Phineas Baxandall, a senior tax and budget analyst at U.S. PIRG, offered an extensive analysis of these very issues in an essay here on OntheCommons.org a few months ago. His piece was based on a report on the subject that he had previously written for U.S. PIRG. Baxandall makes a number of points that Anderson ignores entirely:

Governments can borrow upfront sums at substantially lower cost than can private companies. A private entity will have higher capital borrowing costs and must divert some revenues to shareholder profits. So even at its most basic financial level, privatization is not advantageous to the public.

Perhaps even more than these fiscal problems, long-term road contracts pose a variety of serious threats to the public interest. These include fragmentation and a loss of public control over transportation policy, and an inability to prescribe future needs in contracts signed decades earlier For example, some privatization contracts explicitly limit the state's ability to improve or expand nearby roads. Private investors fearing that improved free roads would compete with their paying traffic, have obtained non-compete clauses in California and Colorado, and to a lesser extent, in Indiana.

Instead of examining such issues, Anderson merely notes the political backlash that some politicians have suffered. After Indiana Governor Mitch Daniels granted a 75-year lease on a state road for $3.8 billion, drivers began to sport bumper stickers that read, "Keep the toll road, lease Mitch." Without further facts, the article makes it seem as if Indiana drivers are a bunch of ignorant yahoos who stupidly oppose taking Wall Street's money.

Indeed, Anderson makes it seem slightly insane not to privatize infrastructure. She writes: "And then there is the odd romance between Americans and their roads: they do not want anyone other than the government owning them."

This is followed by a self-serving quote from the head of infrastructure investment banking at Credit Suisse, who breathlessly warns, "There's a huge opportunity that the U.S. public sector is in danger of losing. It thinks there is a boatload of capital and when it is politically convenient it will be able to take advantage of it. But the capital is going into infrastructure assets available today around the world and not waiting for projects the U.S. the public sector [sic] may sponsor in the future."

Behind all the genteel business-speak, allow me to offer a plain-speak translation of what the New York Times business section declared today:

"Hurry, hurry, hurry! Step right up and sell off your public infrastructure treasures financed by generations of previous taxpayers! Give them to Wall Street - whom you just bailed out at discount prices - and let them earn fantastic, guaranteed rates of return for decades to come while cutting amenities and ignoring evolving public needs. You poor schlumpy taxpayers can continue to shoulder the high-risk, long-term investments. And if any of those public assets begin to look attractive - say, the Internet, wifi spectrum or federally financed drug research -- why, we'll be sure to swoop down and be the first take them away from you. After all, we have more money and better access to your elected leaders than you do!"

The New York Times is a great institution, but can we please shed the "liberal" moniker that is so often attached to it? A precious commons is threatened by enclosure, and all we hear is cheering.