Monday, October 13, 2008
A $516 trillion derivatives 'time-bomb'
Not for nothing did US billionaire Warren Buffett call them the real 'weapons of mass destruction'Go To Original
The market is worth more than $516 trillion, (£303 trillion), roughly 10 times the value of the entire world's output: it's been called the "ticking time-bomb".
It's a market in which the lead protagonists – typically aggressive, highly educated, and now wealthy young men – have flourished in the derivatives boom. But it's a market that is set to come to a crashing halt – the Great Unwind has begun.
Last week the beginning of the end started for many hedge funds with the combination of diving market values and worried investors pulling out their cash for safer climes.
Some of the world's biggest hedge funds – SAC Capital, Lone Pine and Tiger Global – all revealed they were sitting on double-digit losses this year. September's falls wiped out any profits made in the rest of the year. Polygon, once a darling of the London hedge fund circuit, last week said it was capping the basic salaries of its managers to £100,000 each. Not bad for the average punter but some way off the tens of millions plundered by these hotshots during the good times. But few will be shedding any tears.
The complex and opaque derivatives markets in which these hedge funds played has been dubbed the world's biggest black hole because they operate outside of the grasp of governments, tax inspectors and regulators. They operate in a parallel, shadow world to the rest of the banking system. They are private contracts between two companies or institutions which can't be controlled or properly assessed. In themselves derivative contracts are not dangerous, but if one of them should go wrong – the bad 2 per cent as it's been called – then it is the domino effect which could be so enormous and scary.
Most markets have something behind them. Central banks require reserves – something that backs up the transaction. But derivatives don't have anything – because they are not real money, but paper money. It is also impossible to establish their worth – the $516 trillion number is actually only a notional one. In the mid-Nineties, Nick Leeson lost Barings £1.3bn trading in derivatives, and the bank went bust. In 1998 hedge fund LTCM's $5bn loss nearly brought down the entire system. In fragile times like this, another LTCM could have catastrophic results.
That is why everyone is now so frightened, even the traders, who are desperately trying to unwind their positions but finding it impossible because trading is so volatile and it's difficult to find counterparties. Nor have the hedge funds been in the slightest bit interested in succumbing to normal rules: of the world's thousands of hedge funds only 24 have volunteered to sign up to a code of conduct.
Few understand how this world operates. The US Federal Reserve chairman, Ben Bernanke, tapped up some of Wall Street's best for a primer on their workings when he took the job a few years ago. Britain's financial regulator, the Financial Services Authority, has long talked about the problems the markets could face on the back of derivative complexity. Unfortunately it did little to curb the products' growth.
In America the naysayers have been rather more vocal for longer. Famously, Warren Buffett, the billionaire who made his money the old-fashioned way, called them "weapons of mass destruction". In the late 1990s when confidence was roaring in the midst of the dotcom boom, a small band of politicians, uncomfortable with the ease with which banks would be allowed to play in these burgeoning markets, were painted as Luddites failing to move with the times.
Little-known Democratic senator Byron Dorgan from North Dakota was one of the most vociferous refuseniks, telling his supposedly more savvy New York peers of the dangers. "If you want to gamble, go to Las Vegas. If you want to trade in derivatives, God bless you," he said. He was ignored.
What is a Derivative?
Warren Buffett, the American investment guru, dubbed them "financial weapons of mass destruction", but for the once-great-and-good of Wall Street they were the currency that enabled banks, hedge funds and other speculators to make billions.
Anything that carries a price can spawn a derivatives market. They are financial contracts sold to pass on risk to others. The credit or bond derivatives market is one such example. It is thought that speculation in this area alone is worth more than $56 trillion (£33 trillion), although that probably underestimates the true figure since lax regulation has seen the market explode over the past two years.
At the core of this market is the credit derivative swap, effectively an insurance policy against the default in the interest payment on a corporate bond. One doesn't even need to own the bond itself. It is like Joe Public buying an insurance policy on someone else's house and pocketing the full value if it burns down.
As markets slid into crisis, and banks and corporations began to default on bond payments, many of these policies have proved worthless.
Emilio Botin, the chairman of Santander, the Spanish bank that has enjoyed phenomenal success during the credit crunch, once said: "I never invest in something I don't understand." A wise man, you may think.
Fed Says ECB, Others to Offer Unlimited Dollar Funds
By John Fraher and Simone Meier
The U.S. Federal Reserve led an unprecedented push by central banks to flood financial markets with dollars, backing up government efforts to restore confidence in the banking system.
The ECB, the Bank of England and the Swiss central bank will offer unlimited dollar funds in auctions with maturities of seven days, 28 days and 84 days at a fixed interest rate, the Washington-based Fed said today. The Bank of Japan may introduce ''similar measures.'' The dollar declined and some money-market rates fell.
Policy makers from the Group of Seven nations pledged at the weekend to take ''all necessary steps'' to stem a market panic after the MSCI World stock index plunged 20 percent last week. Central banks last week cut interest rates in tandem for the first time since 2001, the U.S. plans to buy $700 billion in distressed assets from banks and in Europe, the U.K. is leading a push to keep lenders afloat with taxpayers' money.
''By providing unlimited dollar funds they are acting on the back of the G-7 plan to ensure the system is fully liquidized,'' said Lena Komileva, an economist at Tullet Prebon Plc in London. ''We're going to see even more liquidity provided and more aggressive rate cuts are coming.''
The dollar dropped after the announcement, falling as much as 0.9 percent to $1.3671. The cost of borrowing in euros for three months declined to 5.32 percent today from 5.38 percent, according to the European Banking Federation. Stocks rallied worldwide, with the MSCI World Index climbing 2 percent.
The London interbank offered rate, or Libor, that banks charge each other to borrow dollars for three months last week soared to 4.82 percent, the highest level this year.
''Taken together, the latest moves increase the chances that we will begin to see some relaxation of the intense funding stresses,'' a team including Dominic Wilson, senior global economist at Goldman Sachs Group Inc. in New York, wrote in a note today. ''This is because bank solvency risk should decline as the government offers protection.''
Central banks are expanding their toolkits to push down money-market rates. The Fed on Oct. 7 said it will create a special fund to buy U.S. commercial paper and the ECB last week said it would offer financial institutions unlimited euro funds. The Bank of England is scheduled to announce a revamp of its own money-market operations later this week.
The ECB, the BOE and the Swiss National Bank ''can provide U.S. dollar funding in quantities sufficient to meet their demand'' into 2009, the Fed said today. ''Central banks will continue to work together and are prepared to take whatever measures are necessary to provide sufficient liquidity in short- term funding markets.''
All of the previous dollar swap arrangements between the Fed and other central banks were capped.
Today's ''action is unprecedented,'' said Neil Mackinnon, chief economist at ECU Plc in London and a former U.K Treasury official. Andrew Milligan, who helps oversee about $260 billion as head of global strategy at Standard Life said that it's a ''much more important'' move than the coordinated rate cut.
G-7 finance chiefs pledged Oct. 10 to take ''urgent and exceptional action'' after stocks plunged and as a global recession looms. European leaders yesterday agreed to guarantee new bank debt and use taxpayer money to keep distressed lenders afloat. Royal Bank of Scotland Group Plc, HBOS Plc, and Lloyds TSB Group will get an unprecedented 37 billion-pound ($64 billion) bailout from the U.K. government.
The collapse of New York-based Lehman Brothers Holdings Inc. precipitated the latest chapter of the 14-month crisis, causing banks to stop lending to each other out of concern they may not get their money back. The world's largest financial companies have posted more than $635 billion in writedowns and credit losses since the start of last year after the U.S. housing market collapsed.
Today's move is ''another welcome measure,'' said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. ''We'll have to see what comes out of it. We all expect more rate cuts, whether they're coordinated or not is another matter.''
The October Surprise: Global Panic
By Stephen Lendman
Since 9/11, the notion of an October surprise has been around. The idea going something like this. Another real or manufactured terror attack. The dominant media stokes fear. The public is again traumatized. The Bush administration pledges all effective measures to protect national security. Formerly seizes total power. Suspends the Constitution and declares martial law. Mass detentions follow. Beginning with dissenters and elements of the public considered "dangerous."
This may be coming with the 3rd Infantry's 1st Brigade Combat Team back in the US as of October 1. According to the Army Times, as "an on-call federal response force for natural or manmade emergencies and disasters, including terrorist attacks." Augmented by USNORTHCOM.
According to Wayne Madsen's recent article titled "FEMA sources confirm coming martial law," it gets worse. He cites "knowledgeable" FEMA sources saying that "the Bush administration is putting the final touches on a plan (to declare) martial law in the US with various scenarios anticipated as triggers." Economic collapse. Massive social unrest. Bank closures. Street protests. Violence in response, and another stolen election.
Early in the month, a different October surprise arrived. Not the expected one. Not yet at least. The Wall Street Journal put it this way: "The Dow Jones Industrial Average (DJIA) capped the worst week in its 112-year history with its most volatile day ever, as hopes for a major international bank rescue plan were overwhelmed at day's end by another wave of selling."
The DJIA dropped 22% over the past eight trading sessions. Investors were "shell-shocked." Many spent Friday "trying to protect themselves from further declines. The past week's (October 6 - 10) 18% decline "and Friday's 1018.77 point swing from low to high were the biggest since the Dow was created in 1896." The VIX measure of market fear hit 69.95. By far its highest level ever, and some investors think it may touch 100 in the current climate. Until now, the Dow's worst week was in 1933. Trading volume also set a record at 11.16 billion shares.
"Market crash shakes world" headlined the Financial Times (FT). Mass trauma, fear and uncertainty sent tremors everywhere, and no one knows if Friday ended it. Maybe just began it. First markets crater. Then world economies, and finally the inevitable human fallout. Affecting many tens of millions everywhere. Innocent people paying dearly.
Morning headlines say it all. And they're getting grimmer. On October 10, the Wall Street Journal said the "Market's 7-Day Rout Leaves US Reeling. Stocks in a Slow-Motion Crash....After Year of Declines, Investors Lose $8.4 Trillion of Wealth." Most scary is what's ahead and how much more people can or will tolerate.
The Financial Times was just as grim headlining "Global equities plunge....Japan leads Asian market rout...Wall Street in biggest fall since 1987 crash." Once the nation's largest company, General Motors may now face bankruptcy. Its October 10 stock fell to its 1950 valuation and now has a market capitalization of just $2.6 billion. Shockingly expressed in one headline saying "Wheels falling off for General Motors." Add the engine and chassis, too.
Ford Motor's outlook is little better. Its stock price is the lowest in decades, and one analyst warned that "the accelerating deterioration in industry fundamentals will be a serious challenge to liquidity (for both companies and Chrysler) during 2009." JD Power and Associates was even grimmer saying that the global auto market may experience an "outright collapse" in 2009. And we're only talking about autos.
Look at banks and world finance. The source of today's crisis and reason global economies are reeling. Economists like Nouriel Roubini were once scoffed at. No longer. He warned for months that "the risk of a total systemic meltdown is now as high as ever since the credit crunch is gripping European banks as well" and spreading globally. Affecting good ones as well as bad. Trashing the baby with the bath water. Erasing savings for tens of millions everywhere. And for seniors who may not have time to recoup.
The crisis didn't emerge like Topsy. It's been simmering for years, and in July 2006 historian Gabriel Kolko warned about it in an article titled "Bankers Fear World Economic Meltdown." He noted how:
the "whole nature of the global finance system has changed radically in ways that have nothing whatsoever to do with 'virtuous' national economic policies....The investment managers of private equity funds and major banks have displaced national banks....moving well beyond regulatory structures....Traders have taken over from traditional bankers because buying and selling shares, bonds, derivatives and the like now generate the greater profits, and taking more and higher risks is now the rule....They often bet with house money (and) low interest rates....let them do things....that were once deemed foolhardy."
Compounded by the irrational development of global finance, liberalization and loose regulations. Playing fast and loose and betting on the come. The potential gains are enormous and so are the risks of a major financial crisis. A meltdown. Now we've got one that global institutions are "utterly inadequate" to deal with.
Kolko warned then that "the entire global financial structure (was) becoming uncontrollable....financial liberalization produced a monster....contradictions wrack the world's financial system (that's) both crisis-prone (and) immoral. (We) may very well be on the verge of serious crises." Now we've got one and in dire straits.
Because "a kleptocratic class (took) over the economy," according to economist Michael Hudson. A criminal element betting on high returns through computerized gambling "and when bad bets are made, bailouts are the (payoff) for campaign contributions." For having friends in high places as well.
Today's crisis isn't an accident or from happenstance. It was planned, according to economist and critic F. William Engdahl in his recent article titled "Behind the Panic." To "shape the future of global banking" through creative destruction. Panic incited by a well-designed "long-term strategy." To change the "face of European banking." Weaken it with toxic junk. Asset Backed Securities. Force enough of it into liquidation or cheap enough to buy at fire sale valuations. The idea being to "create three colossal global financial giants - Citigroup, JP Morgan Chase, and Goldman Sachs." Add Bank of America and make it a foursome. Then use their "muscle to ravage European banks." Even if they wreck the US and world economies. Resuscitate them so they can "advance their global agenda over the coming years." To dominate world finance and increase US hegemony in the new century.
That's the scheme, and Engdahl calls it "a fight for the survival of the American Century." Built on "the twin pillars of American financial (and military) dominance," but the game is far from over. "Battle lines are drawn." EU nations have their own ideas. Stabilization and recovery plans as well that differ from Washington's and look much sounder. It remains to be seen where things are heading and whether competing nations can work together and do it effectively. They haven't much time.
Washington's Efforts to Shape the Last Century
Engdahl recounted some of them in his important book on war, geopolitics, oil and finance: "A Century of War." He explained how Washington designed "the greatest confidence game" ever. A "special hegemony" to:
-- print limitless amounts of dollars;
-- accumulate huge trade deficits;
-- "inflate (the) currency beyond imagination;"
-- have the government pay bankers interest on its own money; and
-- create an unprecedented public and private debt to enrich the few at the expense of the many.
Up to now it worked. Let America rule the world. Control its energy and finance. Avoid serious challengers and crush potential ones.
From the early years of the last century, US muscle flexing took many forms. From conflicts to geopolitics to controlling world resources to financial warfare. JP Morgan and other Wall Street notables were experts on the latter. Creating panics for greater power. Like today's with similar aims.
In 1969, Richard Nixon had his own scheme with the country in recession. Interest rates were cut. Dollars flowed abroad. The money supply was expanded, and in May 1971 America recorded its first monthly trade deficit. It triggered a panic US dollar sell-off. Gold backed the currency then. Reserves were one-quarter of official liabilities, and (on August 15) Nixon unilaterally imposed a 90-day wage and price freeze. A 10% import surcharge. An 8% currency devaluation, and he closed the gold window. Suspended dollar convertibility into the metal and ended compliance with Bretton Woods' core provision. He pulled the plug on world economies. Shook them and on February 12, 1973 did again. With a further 10% dollar devaluation that created the worst global instability since the 1930s. What lay behind his actions?
To buy time ahead of a bold new monetary "paradigm shift." To revive a strong dollar and US hegemony. By a "colossal assault" on world industrial growth. Through an engineered oil embargo. A 400% increase in oil prices. A flood of petrodollars to be recycled into US investments and purchases. Big Oil and major banks to profit hugely at the cost of economic crisis. The worst since the 1930s. Causing bankruptcies, unemployment and stagflation.
Under Jimmy Carter in 1979, Fed chairman Paul Volker advanced his own radical monetary policy on the pretext of fighting high inflation. It was another Washington scheme to preserve dollar hegemony. Keep it the world's reserve currency, and do it by crushing industrial growth to let political and financial power prop up dollar strength.
It worked by raising interest rates from 10% to 16% and then 20% in weeks. The US and world economies plunged into deep recessions, and the dollar began a strong five year ascent.
In the 1980s under Ronald Reagan, Mexican president Jose Lopez Portillo wanted to use his oil revenue to modernize and industrialize the country. To make it stronger and more independent. That prospect was anathema to Washington and it reacted. With a scheme to demand rigid repayment of Mexican debt at exorbitant rates.
In 1981, it began with an orchestrated run on the peso. Stories were circulated about an impending devaluation and capital flight. Portillo instituted an austerity plan, and his government cracked under pressure. The peso was devalued 30%. Mexican industry was devastated. Industrial production cut. Bankruptcies followed. Millions of Mexicans suffered grievously. The nation became effectively insolvent. It had to accept IMF help. Took on large amounts of debt, and major banks profited hugely by working with the government and IMF. Socializing the debt. Spinning it off to tax payers and privatizing gains through structural adjustment looting. Similarly in other countries. Causing mounting debt. Charging onerous interest rates, and earning greater profits from hundreds of billions of dollars in servicing costs.
Reagan-era deregulation caused the S & L crisis. A lesser version of today's. By letting banks invest in speculative real estate. Engage in massive fraud. And get the right wing Cato Institute to say: "If Congress had set out in 1980 to create an environment that would lure all the crooks and frauds in the country into one industry, few would have been more suitable than" this one. "It was easy (finding) disenchanged S & L owners who were willing to sell out for a reasonable price, and once one had an S & L charter, opportunities abounded."
It ended up bankrupting hundreds of banks. Shrunk the industry from 4500 in 1979 to about 2200 in 1991 and hundreds more afterward. It also cost taxpayers around $200 billion. Pocket change compared to the trillions needed for the current crisis.
In the 1980s, Japan was the country that could say "no." At decade's end, it was the world's economic and banking leader. Because reckless speculation left American banks in deep crisis. Japan operated more prudently. It prospered, and challenged American dominance. Washington feared former communist countries would adopt its model. This was anathema. It might shut out US companies. Show Japan's way was superior so it had to be stopped.
The 1985 Plaza accord was the scheme. To get Japan to exercise monetary and fiscal measures to expand domestic demand and reduce the country's external surplus. At the same time, the Bank of Japan held interest rates at 2.5% from 1987 - 1989. To stimulate US goods purchases. Instead cheap money went into Japanese stocks and real estate. It created two colossal bubbles. A lost decade followed, and the economy is still recovering and under new duress from the current panic.
The 1990s Asian crisis was also manufactured. In summer 1997, it hit. For no apparent reason beyond rumors that the Thai baht was in trouble, and Thailand had too few dollars to back it. "Asian Contagion" was unleashed. Hot money came in earlier. Then exited electronically. From Thailand, Indonesia, South Korea, the Philippines, and other Asian Tiger countries. Through a Washington-engineered scheme because these nations' economic model bested America's and threatened it.
Tiger countries grew by protecting their markets and barring foreign companies from owning land and national firms. They also restricted Western and Japanese imports to grow their own economies and homegrown industries. Again anathema so it had to be stopped.
The countries were hammered. Forced to devalue their currencies and get IMF help. With strings. Accepting debt bondage. Opening their markets. Structural adjustments. Privatizations. Spending cuts. Mass layoffs and constrained wages and benefits. The whole toxic package in return for aid. The regional toll was devastating. An estimated 24 million lost jobs. Its growing middle class destroyed. A black hole of misery for around 20 million people. Forcing them to do anything to survive. Crushing the Asian miracle to let Western brands replace local ones. Bargain hunters get great deals at fire sale prices. The New York Times called it "the world's biggest going-out-of-business sale." The region now hammered again from the current crisis. No secret where it was manufactured. No telling how it will end up. No guessing many millions feel pain and are fearful.
No end to other notable examples. Two especially stand out. The 1990s ones affecting post-Soviet Russia and South Africa. In each case, neoliberal "shock therapy" was devastating. It empowered an oligarch class in Russia. Let them strip mine the nation's wealth and offshore it to tax havens. Impoverished tens of millions of people. Bankrupted 80% of farmers. Caused mass unemployment. Created a permanent underclass. An annual 700,000 a year population decline and much more.
South Africa fared no better. Despite Nelson Mandela's pledge to support black economic empowerment. As president he surrendered to capital. The consequences were horrific. Far worse than under apartheid. Double the unemployment rate and number of people in desperate poverty. Millions of poor blacks without homes. Another million evicted from farms. One-fourth of the population with no running water or electricity. Around 60% with inadequate sanitation. A 13 year life expectancy decline since 1990. Appalling human wreckage much like what happened in Russia and elsewhere. To empower capital at the expense of people. Heading for America and in one week took a quantum leap.
Spreading everywhere. On October 2, enough for The New York Times to say that Latin American leaders have gone from "schadenfreude to fear(ful)." Hugo Chavez skipped the UN General Assembly opening to visit China and said Beijing is more relevant than New York. Venezuela and Bolivia expelled their US ambassadors, and Brazil's Lula da Silva railed against an American regional naval presence and said his nation's warships must be on alert in response. He's also furious at Wall Street and Washington for the current crisis and said: "We did what we were supposed to do to get our house in order. They spent years telling us what to do and they themselves didn't do it."
Argentina's Christina Fernandez de Kirchner was also bitter in stating: "We are witnessing the First World, which at one point had been painted as a mecca we should strive to reach, popping like a bubble." And the Chicago Tribune quoted an Inter-American Dialogue expert saying that "whatever credibility the US had in the region, on economic management, that's clearly gone."
Forty world specialists from 20 countries attended the International Conference of Political Economy in Caracas, Venezuela from October 8 - 11. To analyze and propose South-based, alternative solutions to the financial crisis. Venezuela's Minister for Planning and Development, Haiman El Troudi, highlighted his country's relative strength. Its impressive economic growth (at 6% in first half 2008), and recommended that Venezuelans repatriate their US investments given the current climate. To protect them from unsafe American banks.
He and President Chavez also criticized the IMF and called for it to "dissolve....kill itself." They were harsh on the World Bank as well. Chavez added that "We are decoupling from the wagon of death." El Troudi said we are witnessing the end of neoliberal hegemony. Others agreed that a new model is needed. The old one clearly failed.
The Current Panic and Meltdown
Credit today is frozen. From a debt crisis, not a liquidity one. Markets are reeling as a result. Crashing in free fall from severe financial stress. From the largest ever leveraged asset and credit bubbles. Multiple ones. Imploding. Starting with housing. Causing widespread mortgage defaults and huge financial institution losses. Multi-trillions more asset dollars at risk. Compounded by banks reluctant to lend. Fearing they won't be repaid. Prices are falling. Trust is eroded. Losses mounting from destructive deleveraging. Mortgages, stocks, bonds, commodities, credit, private equity, hedge funds imploding more intensively than since the Great Depression.
Forcing troubled companies to the wall. Each one exposing others. Some too big to fail but they did. Getting investors to run for the exits. Selling good assets to cover bad ones. Freezing up money markets. Making short-term Treasuries the only safe bet. Getting world governments scrambling for solutions. Already in recession and getting worse. Fearing an intensified financial crisis. A systemic collapse.Turning a deepening recession into a global depression. A disaster only urgent, well-designed, and coordinated actions may prevent. But no assurance anything will work this late.
Here's what Nouriel Roubini and others recommend. Mirror opposite of EESA that will do more harm than good:
-- additional rapid rate cuts globally; at least to 1% in America; much lower in the EU, Asia and elsewhere;
-- guarantee all deposits until stability is restored at least;
-- partially nationalize troubled banks; recapitalize them with public funds; in some form that now seems the plan according to The New York Times in its October 11 article headlined: "White House Overhauling Rescue Plan;" capital to be injected into banks by buying non-voting shares; what's known is Henry Paulson's October 10 statement that "We can use the taxpayer's money more effectively....if we develop a standardized program to buy equity in financial institutions;" it remains to be seen what, in fact, happens; Paulson represents Wall Street; not the public, national or world interests;
-- he's not for reestablishing responsible regulation to curb market excesses; what economists like Roubini recommend;
-- freeze all home foreclosures; establish a 1930s type Home Owners' Loan Corporation (HOLC) to refinance homes and prevent foreclosures; let foreclosed homeowners retain their properties and pay affordable rent;
-- ease the debt burden of distressed households; cap credit card and other high consumer loan interest rates at much lower levels; put cash in peoples' hands; lots of it; at least several hundred billion dollars for starters; more if needed; as much as it takes;
-- provide solvent financial institutions with as much liquidity as they need; corporate sector companies as well, including small businesses;
-- save solvent companies; liquidate troubled ones too far gone;
-- fund massive stimulus to revive the economy; for public works, infrastructure, education, alternative energy, unemployment benefits, job training, tax rebates to the needy, and state and local governments strapped for cash; money for what's needed most and that can do the most good;
-- get stronger, more solvent countries to help weaker, more indebted ones; and
-- move on these policies fast; world governments have little time left to save themselves; there's no assurance they can; and these measure don't address our destructive military Keynsianism; permanent war economy and need to redirect those funds for constructive homeland needs; mirror opposite of a reported a new Pentagon document requesting an additional $450 billion over the next five years.
Reeling from One Policy Response to Another
First came EESA. The Emergency Economic Stabilization Act. To reward fraudsters and not address the root of the crisis. Nor help millions of troubled households. Homeowners in foreclosure. Others threatened. The public traumatized by the most calamitous economic events since the 1930s.
Europeans formed their own plans. Different from Washington's. On October 10, G-7 finance ministers met to discuss policy. In early evening, they presented an action plan. Long on promises. Short on specifics. The New York Times reported that: "Many investors had hoped the ministers would (propose) more concrete steps" and quoted Peterson Institute of International Economics deputy director, Adam Posen, saying: "This fell short." But he wasn't giving up entirely or saying what they have in mind or will later decide can't work.
They agreed to:
-- act decisively with all available tools to support financial institutions and prevent their failure;
-- unfreeze credit and money markets; assure banks and other financial institutions "have broad access to liquidity and funding;"
-- ensure banks and financial intermediaries "can raise (sufficient) capital from public (and) private sources;" to rebuild confidence and get them again lending to households and businesses;
-- ensure national deposit insurance protection is sound so people have confidence in the safety of their deposits; and
-- take appropriate action "to restart the secondary markets for mortgages and other securitized assets;" assure accurate valuations and transparency according to "high quality accounting standards."
Besides the US Treasury planning to "buy equity in financial institutions," AP reported on October 12 that the 15 euro-zone countries will "temporarily guarantee future bank debt to encourage lending....for an interim period and on appropriate terms" for up to five years. Recapitalizing banks is part of the plan. The hope is to unfreeze credit and get markets operating normally again.
According to The New York Times on October 12, "each country will announce concrete figures for the measures they expect to take individually." Belgian finance minister Didier Reynders said "There is no question of setting up a European fund." A final proposal will be presented to the full 27-member EU summit later in the week, and individual parliaments will have to vote on it.
Key to understand about whatever emerges in final details or any that follow - world governments will loot their treasuries to save powerful capital interests. Despite bold pronouncements we can expect more of ahead, practically nothing will be done for many tens of millions of people globally in greatest need. At best for them....crumbs.
In the coming days and weeks, we'll see statements become policies and how world markets react. Given the immensity of the crisis, no one's sure if anything can work. Nor is it reassuring to hear George Bush say remain calm. We've got things under control. On October 10, the Dow dropped 300 points while he spoke.
In an October 13 Barron's interview, noted money manager Jeremy Grantham (now age 70) was asked if he thought we'd learn anything from the current crisis. His response: "an enormous amount in a very short time, quite a bit in the medium-term, and absolutely nothing in the long-term."
He's been bearish since last year but added that "the fundamentals are turning out worse than" he expected. "The terrible thing - after all this pain - is that the US equity market is not even cheap." It was so high in 2000 that it hasn't come down to trend, but it's getting close. However, "the really bad news is that great bubbles in history always overcorrect." He believes S & P 500 fair value is around 1025 compared to its 899.22 October 10 close. But "typically bubbles overcorrect by quite a bit, possibly by 20%. This is very discouraging," so he's not rushing to buy but he fears he'll act too soon. He predicts a market low in 2010.
Where he sees things going from here was also posed. He's highly respected as an expert, and yet he emphasized "how little (he) understand(s about) all of the intricate workings of the global financial system. (He) hopes that someone else gets it, because (he) doesn't. And (he) has no idea, really, how this will work out....(It's) so intricate that all (he) can conclude, by instinct (and from history), is that it will be longer, harder and more complicated than we expect." Quite an assessment from a man called "the philosopher king of Wall Street."
The Human Cost of Manufactured Crisis
Ordinary people are hit hardest. Millions will suffer grievously for years as a result of this totally avoidable crisis. Fraudsters who caused it are rewarded. Innocent homeowners, households, and workers are punished. Mercilessly. The result:
-- trillions of dollars lost; likely trillions more ahead;
-- millions of lost homes, homeowners behind in their payments, or threatened with foreclosure in the worst housing crisis since the Great Depression; ultimately may exceed it given current estimates of up to 10 million foreclosures before stability and recovery;
-- likely well over a million 2008 personal bankruptcies and much higher numbers in 2009 compared to 800,000 in 2007 and 573,000 in 2006; figures below the 2000 - 2005 1.5 million average before passage of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act; according to Samuel Gerdano, American Bankruptcy Institute director, consumer over-indebtedness "made worse by the home mortgage crisis" is the problem; it won't likely recede in the near or intermediate-term;
-- rising unemployment; not the spurious 6.1%; including discouraged workers and people working part-time who want (but can't find) full-time jobs, economist John Williams puts the real figure above 12% and rising;
-- consumer over-indebtedness; maxed out on credit but needing more of it to survive; and charged usurious rates to get it;
-- declining wages and benefits in the face of soaring expenses; making it all the harder to cope;
-- food banks and homeless shelters facing increasing demands but forced to turn away people for lack of resources; and
-- things overall are worsening; to the edge of the abyss according to some; even the most optimistic fear what's coming; who can know; no one dares be complacent.
Whatever final policies emerge. In whatever form they take. Unless they address the human dimension, they'll do nothing for people in most need. Growing millions. Desperate and in trouble. Their issue is economic and ethical. The G-7 statement addressed neither. It dealt only with saving Wall Street. Industrial capitalism. A better idea is let them die and replace them with a new order. A workable one. Respecting people, not capital.
Anatomy of the American Financial Crisis: How It is Turning into a Worldwide Crisis
By Prof. Rodrigue Tremblay
"The basis for optimism is sheer terror." Oscar Wilde
[After the March 2008 Bear Stears bailout] "As more firms lost access to funding, the vicious circle of forced selling, increased volatility, and higher haircuts and margin calls that was already well advanced at the time would likely have intensified. The broader economy could hardly have remained immune from such severe financial disruptions."Ben Bernanke, Fed Chairman (March 2008)
“In accounting 101 we learn that high yields equal high risk. We know the CEOs had an incentive to disregard this because they were getting huge bonuses.” David Hartzell, dean of the University of Delaware's business college and a former vice-president of Salomon Brothers
“Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.” Dominique Strauss-Kahn, Head of the IMF (October 11, 2008)
The Bush administration's way of dealing with the ongoing financial crisis has been frantic, but probably less than adequate. In fact, tragic errors may have been made that must be remedied as quickly as possible.
The most damaging error may have been to let the global investment bank Lehman Brothers fail ($691 billion of assets at the end of 2007), on Monday September 15. This fateful date may have to be remembered in the future. This was the largest failure of an investment bank since the collapse of Drexel Burnham Lambert in 1990. In contrast, the Fed and the U.S. Treasury moved quickly in mid-March (2008) to save a similar global investment bank in distress (but half the size of Lehman), Bear Stearns, by quickly lending and guaranteeing $29 billion to the large universal J. P. Morgan Chase bank in order to absorb it. —(N.B.: Let us keep in mind that it was the collapse in June 2007 of two internal Bear Stearns hedge funds that had been heavily invested in mortgage securities that kicked off the full-fledged market panic that unfolded in August 2007, and which today has turned into a full-fledged international financial crisis).
Why was the same treatment not offered to Lehman? Possibly because of a personal lack of empathy between Treasury Secretary Henry M. Paulson Jr. (a former chief executive of rival investment bank Goldman Sacks) and Lehman's CEO Mr. Richard S. Fuld Jr., or possibly because the Bush administration wanted to make an example that all investment banks, no matter how large, could not count on being rescued by the government. The Bush administration did not even bother to appoint a trustee to supervise Lehman’s liquidation in order to make it orderly.
Such a liquidation of a large international bank, known for its worldwide interconnections and unsound banking practices, was nearly a repeat of the mistake made in letting the large Vienna-based Creditanstalt bank fail, on May 13, 1931. This was a bank that had borrowed large amount of money in London and in New York to finance its activities. Its failure created a domino effect among other international banks that had lent to each other in the international credit chain. So much so that the failure of the Creditanstalt forced them to severely tighten their lending to absorb their sudden losses.
Seventy-seven years later, in 2008, the Bush administration's decision to let the Lehman Brothers bank fail has produced a similar ripple effect throughout the international financial system. And, perhaps more important politically, it signaled to the markets that the Bush administration was willing to let a dangerous debt deflation and an ominous credit crunch proceed. This may turn out to have been a most tragic mistake.
Indeed, Lehman's bankruptcy forced the global investment bank to quickly write down its huge portfolio of debt, a fair amount of it in derivative products. But since banks are creditors of each other, especially Lehman which dealt with large institutions, this had the consequence of spreading the American financial disease all over the world, and especially in Europe. Why? Because Lehman's London office was a huge center of sale and distribution for its more or less toxic derivative products all over Europe. Indeed, many European banks had invested in Lehman's securitized paper, and when it failed, they were left with large losses. As a consequence, they had to curtail their domestic lending and that's the reason the credit crunch is now moving to Europe.
The second mistake was to address the “liquidity problem” of American investment and mortgage banks without tackling at the same time their underlying “solvency problem”.
As we wrote right at the very beginning, on August 24, 2007, the financial crisis in the U.S. is not only a classic “liquidity problem”, when banks find themselves short of cash to pay immediate redemptions and withdrawals while their longer term loans are secure, but also and above all a “solvency problem”, because the huge losses that banks had to absorb when they wrote down the value of their toxic assets-backed securitized paper, eroded their capital base to an extent that they became de facto insolvent. Market operators saw that and they sold the banks' shares short and the price of these shares plummeted.
With many banks' solvency now in doubt, inter-bank lending has nearly stopped, and because of a 'flight to safety', the Ted spread [the difference between three-month U.S. Treasury bills yields and yields on three month eurodollar contracts, as represented by the London Inter Bank Offered Rate, called Libor] exploded, and banks cut down their lending. Credit became tight and scarce. Because banks as a whole ordinarily lend between 10 and 12 times their capital base, the most liquid money supply (M1) began to contract in real terms. Even money market funds suffered heavy losses, and a run on them was in full swing when the Treasury stepped in a month ago to offer an emergency $50 billion guarantee.
The U.S. economy may be approaching what can be called a classic “liquidity trap” situation, wherein the Fed is lowering interest rates while lending through its discount window and printing money on a high scale, however the liquid money supply figures, in real terms, are not increasing, but are rather falling. Thus, there is no immediate inflation, but the money supply is contracting as banks reduce their lending and make a rush to T-bills (their yields nearly fell to zero). The short-term result is a net deflationary effect for the overall economy and on the stock market (although the long term bond market sees inflation ahead, and long term rates are rising). —The result is stock market crashes in repetition.
In fact, this is precisely what has happened over the last few weeks, not only in the United States, but also in the U.K and in other European countries. This is a very dangerous development for the real economy, because money data in real terms are a leading indicator of the future course of the economy. Six or nine months down the road, the consequences of the credit crunch will appear in production and employment declines, because the credit crunch has the effect of placing a serious squeeze on most companies. Since the credit contraction really began in June (2008), the early part of 2009 is bound to show severe economic weakness.
On Friday, September 19 (2008), the Bush administration announced its solution to the growing banking crisis. It made public the $700 billion Paulson plan (US Emergency Economic Stabilisation Act, EESA) that primarily focused on creating a government market for some of the bad mortgage-backed securities on the banks' books. —But this was only half of the problem. The other half of the problem was the need to stop the money supply from declining, by restoring bank credit lending and allowing companies to have access to working capital financing. The goal here is to prevent banking problems from morphing into a general contraction of consumption and capital investment plans, thus slowing down production and raising unemployement in the coming months.
For this to happen, however, banks must be allowed to find badly needed new capital. But in a time of crisis, with stock markets declining, it is doubtful that much private capital can be found. The recent association of Warren Buffett with Goldman Sachs may be more of an exception than a rule.
When private capital is not available, the government has no other choice but to inject equity (by buying the banks' preferred shares) into the national banking system, while taking steps to safeguard the public interest by obtaining common share warrants that can be resold profitably later, when the situation stabilizes.
In conclusion, we may ask if it is possible to avoid a repetition of the U.S. Great Depression of the 1930s or the more recent Japan's protracted recession of the 1990s, both the result of a similar severe banking crisis? The answer is yes, if the vicious cycle of asset price decline, banking credit crunch and money supply contraction can be avoided, or, at the very least, stopped and reversed. —In economics, as in medicine, it is never too late to do the right thing.
How to Wreck the Economy
Everything you ever wanted to know about the biggest economic meltdown since the Great Depression but were afraid to ask.
By Arun Gupta. Illustrations By Frank Reynoso
From 1982 to 2000, the U.S. stock market went on the longest bull run ever, as share prices rose to dizzying heights. In the late 1990s, a combination of factors, which included the Federal Reserve lowering interest rates, created a huge price bubble in Internet stocks. A speculative bubble occurs when price far outstrips the fundamental worth of the asset. Bubbles have occurred in everything from real estate, stocks and railroads to tulips, beanie babies and comic books. As with all bubbles, it took more and more money to make a return*. This led to the Internet bubble popping in March 2000.
*For instance, if you purchased 100 shares of Apple at $10 a share and it rose to $20, it cost $1,000 to make $1,000 profit (a 100 percent return), but if the shares were $100 each and rose to $110, it would cost $10,000 to make $1,000 profit (a 10 percent return — and the loss potential would be much greater, too.
Many Americans joined the stock mania literally in the last days and lost considerable wealth, and some, such as Enron employees, lost their life savings. When the stock market bubble erupted, turbulence rippled through the larger economy, causing investment and corporate spending to sink and unemployment to rise. Then came the Sept. 11, 2001, attacks, generating a shock wave of fear and a drop in consumer spending. Burned by the stock market, many people shifted to home purchases as a more secure way to build wealth.
By 2002, with the economy already limping along, former Federal Reserve Chairman Alan Greenspan and the Fed slashed interest rates to historic lows of near 1 percent to avoid a severe economic downturn. Low interest rates make borrowed money cheap for everyone from homebuyers to banks. This ocean of credit was one factor that led to a major shift in the home-lending industry — from originate to own to originate to distribute. Low interest rates also meant that homebuyers could take on larger mortgages, which supported rising prices.
In the originate-to-own model, the mortgage lender — which can be a private mortgage company, bank, thrift or credit union — holds the mortgage for its term, usually 30 years. Every month the bank* originating the mortgage receives a payment made of principal and interest from the homeowner. If the buyer defaults on the mortgage, that is, stops making monthly payments, then the bank can seize and sell a valuable asset: the house. Given strict borrowing standards and the long life of the loan, it’s like the homebuyer is getting married to the bank.
*Shorthand for any mortgage originator.
In the originate-to-distribute model, the banks sell the mortgage to third parties, turning the loans into a commodity like widgets on a conveyor belt. By selling the loan, the bank frees up its capital so it can turn around and finance a new mortgage. Thus, the banks have an incentive to sell (or distribute) mortgages fast so they can recoup the funds to sell more mortgages. By selling the loan, the bank also distributes the risk of default to others.
The banks made money off mortgage fees, perhaps only a few thousand dollars per loan. Because they sold the loan, sometimes in just a few days, they had no concern that the homebuyer might default. Banks began using call centers and high-pressure tactics to mass-produce mortgages because the profit was in volume—how many loans could be approved how fast. This was complemented by fraud throughout the realestate industry, in which appraisers over-valued homes and mortgage brokers approved anyone with a pulse, not verifying assets, job status or income. And the mushrooming housing industry distorted the whole economy. Of all net job growth from 2002 to 2007, up to 40 percent was housing-sector related: mortgage brokers, appraisers, real-estate agents, call-center employees, loan officers, construction and home-improvement store workers, etc.
To make the loans easier to sell, the banks go to Fannie Mae or Freddie Mac and get assurance for conforming (or prime mortgages*). Assurance means one of the agencies certifies that the loans are creditworthy; they also insure part of the loan in case the homeowner defaults. Before their recent nationalization, Fannie and Freddie were government-sponsored entities (GSEs). While anyone could buy shares in the two companies, they were also subject to federal regulation and congressional oversight. This federal role was seen as an implicit guarantee: While there was no explicit guarantee, all parties believed loans backed by Fannie and Freddie were absolutely safe because the government would not let the two agencies fail. This allowed them to borrow huge sums of money at extremely low rates.
*Prime refers to the credit score of the borrower.
Banks then sold their newly acquired assured prime mortgage loans to bundlers, ranging from Fannie and Freddie to private labels, such as investment banks, hedge funds and money banks (ones that hold deposits like savings and checking accounts. Bundlers pooled many mortgages with the intention of selling the payment rights to others, that is, someone else pays to receive your monthly mortgage payments.
The next step was to securitize the bundle (a security is a tradable asset. Much of the financial wizardry of Wall Street involves turning debts into assets. Say you’re Bank of America and you sell 200 mortgages in a day. Lehman Brothers buys the loans after they are assured and bundles them by depositing the mortgages in a bank account — that’s where the monthly payments from the 200 homeowners go. Then, a mortgage-backed security (MBS) is created from this bundle. An MBS is a financial product that pays a yield to the purchaser, such as a hedge fund, pension fund, investment bank, money bank, central bank and especially Fannie and Freddie. The yield, essentially an interest payment, comes from the mortgage payments.
How does it work? The homeowner keeps making monthly mortgage payments to Bank of America, which makes money from the fees from the original mortgage and gets a cut for servicing the mortgage payments, passing them on to Lehman Brothers. Lehman makes money as a bundler of the mortgages and underwriter of the mortgage-backed security. The purchaser of the mortgage-backed security, say, Fannie Mae, then gets paid from the bank account holding the mortgage payments.
At first, this process covered only prime mortgages because Fannie and Freddie could not assure subprime loans. To address low rates of home ownership among low-income populations and communities of color, around 2004 Congress began encouraging Fannie and Freddie to start assuring subprime mortgages on a wide scale. And easy credit fed investors’ appetite for more and more mortgage-backed securities, which provided funding for new mortgages.
One definition of subprime loans is any loan at an interest rate that is at least 3 percentage points more than a prime loan. Many of these loans were adjustable-rate mortgages (ARMs) with teaser rates. The rate was low for the first few years, but then it would reset, causing monthly payments to leap dramatically, sometimes to two or three times the original amount. Subprime borrowers are considered riskier to lend to because of low credit scores. Subprime borrowers are concentrated among people of color and immigrant and low-income communities, partly because racial and class disparities result in less access to banking services such as credit cards, online billing and checking and saving accounts. Bill paying becomes a labor-intensive process, making it much more likely that payments will be late or missed, driving down credit scores. With mortgage brokers and lenders pushing loans on anyone and everyone, those with less financial acumen — disproportionately low-income people, immigrants, the elderly and communities of color — often found themselves with mortgages that became unaffordable.
With the surge in mortgage loans, around 2004, banks started extensively using financial products called collateralized debt obligations (CDOs). The banks would either combine mortgage-backed securities they already owned or bundle large pools of high-interest subprime mortgages. CDOs were sliced tranches — think of them as cuts of meat — that paid a yield according to risk of default: The best cuts, the filet mignon, had the lowest risk and hence paid the lowest yield. The riskiest tranches, the mystery-meat hotdogs that paid the highest yield, would default first if homebuyers stopped making payments. This was seen as a way to distribute risk across the markets. The notion of distributing risk into means all the market players take a little risk, so if something goes bad, everyone suffers but no one dies.
Tranches were given ratings by services like Standard & Poor’s, Moody’s and Fitch. The highest rating, AAA, meant there was virtually no risk of default. The perceived safety of AAA meant a broad variety of financial institutions could buy them. And because tranches were marketed as a tool to fine-tune risk and return, this spurred a big demand. There was a conflict of interest, however, because the rating services earned huge fees from the investment banks. Moody’s earned nearly $850 million from such structured finance products in 2006 alone. The investment bank also bundled lower-rated mortgage backed securities, like BBB -rated ones, and then sliced them to create new tranches rated from AAA to junk. This was like turning the hotdogs into steaks.
Furthermore, the banks would hedge the tranches, another way of distributing risk, by purchasing credit default swaps (CDSs) sold by companies like AIG and MBIA. The swaps were a form of insurance. This was seen as a way to make tranches more secure and hence higher rated. For instance, say you’re Goldman Sachs and you have $10 million in AAA tranches. You go to AIG to insure it, and the company determines that the risk of default is extremely low so the premium is 1 percent. So you pay AIG $100,000 a year and if the tranche defaults, the company pays you $10 million. But CDSs started getting brought and sold all over the world based on perceived risk. The market grew so large that the underlying debt being insured was $45 trillion — nearly the same size as the annual global economy!
Also around 2004, things began to get even trickier when investment banks set up entities known as structured investment vehicles (SIVs). The SIVs would purchase subprime MBSs from their sponsoring banks. But to purchase these MBSs, the structured investment vehicles needed funds of their own. So the SIVs created products called asset-backed commercial paperAsset-backed means it is backed by credit from the sponsoring bank. The SIVs then sold the paper, mainly to money market funds. In this way, the SIVs generated money to purchase the mortgage-backed securities from their bank. The SIVs made money by getting high yields from the subprime MBSs they brought, while paying out low yields to the money markets that purchased the commercial paper (profiting from a spread like this is known as arbitrage). (short-term debt of 1 to 90 days).
Wall Street’s goal was to conjure up ways to make money while not encountering any liability. It was moving everything off-book to the SIVs to get around rules about leveraging. Banks, hedge funds and others leverage by taking their capital reserves — actual cash or assets that can be easily turned into cash — and borrowing many times against it. For instance, Merrill Lynch had a leverage ratio of 45.8 on Sept. 26. That means that if Merrill had $10 billion in the bank, it was playing around with $458 billion. The Federal Reserve is supposed to regulate reserves to limit the growth of credit, but the SIVs were one method to get around this rule. More leverage also meant more risk for the bank, however, because funds could disappear quickly if a few bets went bad. This is all part of what’s called the Shadow Banking System, meaning it gets around existing regulations.
The whole process worked as long as everyone believed housing prices would go up endlessly. This is a form of perceptual economics, one principle of which is that any widely held belief in the market tends to become a self-fulfilling prophecy. In the case of housing, homeowners took on ever-larger mortgages in the belief that prices would keep rising rapidly. Mortgage lenders believed the loans were safe because even if the homeowner defaulted, the mortgage holder would be left with a house that was increasing in price. Confidence in rising prices led the creators and purchasers of mortgage-backed securities to think these investments were virtually risk-free. This also applied to over-leveraging — as long as there was easy credit and quick returns to be made, investors clamored for more mortgage-backed securities. And this applied to the money market funds that brought the paper from structured investment vehicles. As long as the money market funds had confidence in the system, they didn’t cash out the commercial paper when it came due, but rolled it over at the same interest rates. This allowed the SIVs to mint money without posing any liabilities for their sponsoring banks.
This system kept the U.S. economy chugging along for years. For some 35 years, real wages have been stagnant for most Americans, but as house values skyrocketed over the last decade, many homeowners refinanced and cashed out the equity — turning their homes into ATMs. For example, if you owed $200,000 on a mortgage but the house value rose to $300,000, you could potentially turn the $100,000 difference into cash by refinancing. By 2004, Americans were using home equity to finance as much $310 billion a year in personal consumption. This debt-driven consumption was the engine of growth.
U.S. over-consumption was balanced by over-production in many Asian countries. Countries like China, India, Taiwan and South Korea run large trade surpluses with the United States, which speeds their economic development. They invest excess cash in U.S. credit instruments ranging from corporate debt and MBSs to government bonds and bills. It’s what economists call a virtuous cycle: we buy their goods, helping them develop, while they use the profits to buy our credit, allowing us to purchase more of their goods. But it’s also unsustainable. A country cannot over-consume forever.
In the final stage of the housing bubble, fewer first-time buyers could afford traditional mortgages. Rising house prices required ever-larger down payments so subprime mortgages multiplied, as they often required little or no money down. From 2004 to 2006, nearly 20 percent of all mortgage loans were subprime loans. As the vast majority were adjustable-rate mortgages (ARMs), this created a time bomb. The minute interest rates went up, the rates reset, and homeowners with ARMs were saddled with larger monthly payments.
Various factors combined to slow real-estate prices and deflate the bubble. Rising prices led to a building boom and oversupply of houses, everaccelerating prices meant more money brought smaller returns and, once again, the Fed played a role by raising interest rates. It was trying to stave off inflation, but given the proliferation of adjustablerate mortgages, it led to higher mortgage payments, pushing hundreds of thousands of homeowners into foreclosure.
Once the bubble started to leak, the process accelerated, turning the mania into a panic. First, the default spread to the structured debt instruments like collateralized debt obligations and mortgage-backed securities. The system of distributing risk failed. Securitization had spread across the entire financial system — investment and money banks, pension funds, central banks, insurance companies — putting everyone at risk. Because the finance sector had lobbied aggressively for decades to slash regulation, the lack of oversight amplified risk. As mortgage holders defaulted, mortgage-backed securities also began to default. The subprime funding conduit from Wall Street froze up, which led big mortgage lenders like Countrywide, New Century Financial and American Home Mortgage to go belly-up.
As panic set in, money market funds began to stop rolling over the commercial paper — they wanted to cash it out. So SIVs now had to either call on their credit line from their sponsoring banks or sell assets such as the mortgage-backed securities to raise money. Mortgage defaults and forced sales of the MBSs began to push prices down even further. This forced banks to book losses, requiring some to sell more assets to cover the losses, further lowering prices, forcing them to book more losses, creating a vicious cycle. This is known as a liquidation trap. Since no one was sure about the size of the losses, banks began to hoard funds, which caused the credit markets to dry up.
Over the last year, the Federal Reserve and U.S. Treasury have taken increasingly drastic measures — lowering interest rates, pumping cash into the banking sector, allowing investment banks to borrow funds while putting up low-valued securities as collateral. This then proceeded to financing takeovers, such as the Fed providing a $29 billion credit line for JP Morgan to take over Bear Stearns in March. Then it nationalized Fannie Mae and Freddie Mac; this was followed by the federal takeover of AIG, which was done in by its gambling with credit default swaps. In the end, the legendary Wall Street banks disappeared in a fortnight — bankrupt, acquired or converted into bank holding companies like Citigroup.
But the contagion has not been contained. Whether the bailout plan can succeed is highly questionable. Many are skeptical as to whether the bailout will even restore confidence — and credit — to the banking system. As Reuters stated recently, “Doubts remain as to how it [the bailout plan] could immediately thaw the frozen money and credit market.” Even if the bailout revives the banking sector, few economists think it will jumpstart the consumer credit machine. For one, over-leveraged, money-strapped banks will eagerly dump nearworthless securities on taxpayers in exchange for cash to bulk up their reserves. Plus, with working hours and wages declining and unemployment, home foreclosures and inflation surging, banks are in no mood to give consumers more credit, so consumption — and hence the economy — will continue to contract.
How Participatory Budgeting Can Transform PoliticsGo To Original
Money may be killing democracy, but it can also bring it back to life - if we learn new ways to manage it. Progressives often complain that the influence of big money has corrupted politics, leaving us with elite politicians that don't represent most Americans. Once in power, these politicians decide how to spend our taxpayer money, often in unwanted ways. Community groups are forced to fight for budgetary scraps, be they for social services, housing, schools, health facilities, or other services or infrastructure. This is an exhausting and often demoralizing struggle. It encourages competition rather than collaboration, and reliance on politicians rather than democratic community control. For most people, this struggle is not very appealing, so they choose not to participate.
It doesn't have to be this way. Low-income residents and activists in hundreds of cities around the world have designed a different way of managing public money: participatory budgeting. This is a process in which people who are impacted by a budget directly and democratically decide how it is spent. The most famous example is the Brazilian city of Porto Alegre, where residents decide on municipal spending in an annual cycle of assemblies and meetings. Since Porto Alegre pioneered participatory budgeting in 1989, however, it has spread throughout the world. Most of these experiences share a common process: diagnosis, discussion, decision-making, implementation, and monitoring. First, at neighborhood assemblies, residents identify local priority needs, generate ideas to respond to these needs, and elect delegates to represent each community. These delegates then discuss the local priorities and develop concrete projects that address them, together with experts. Next, residents vote for which of these projects to fund. Finally, the government implements the chosen projects, and residents monitor this implementation. For example, if neighborhood residents identify access to medical care as a priority, their delegates might develop a proposal for a new community health clinic. If the residents approve the proposal, the city funds it. The next year, a new health clinic is built.
Roughly 1,200 cities have participatory budgets already. Several countries have passed laws making participatory budgeting mandatory for local governments. The UN and other international organizations have actively promoted it. Even the Church of England is a fan.
Why such broad support? Probably because participatory budgeting offers something for everyone. It gives residents a forum to voice their demands and resources to satisfy many of those demands. They feel more connected to their city and better able to improve their environment, and they learn a lot in the process. Low-income and marginalized residents gain the most, thanks to their high rates of participation (unlike in most consultations) and ?pro-poor' spending criteria that redistribute funds to those with the greatest needs. Social movements and community organizations get to spend less time pressuring policy-makers and more time deciding policies themselves. Regular budget assemblies even help them recruit members and build stronger community networks. For bureaucrats and economists, participatory budgeting is a way to get better information on public needs and minimize corruption. For politicians, it can provide closer links with constituents and increase their popularity.
But participatory budgeting does not always have these effects. When politicians control decision-making and use it to support their own agendas, participatory budgeting can become disempowering. This danger of co-optation is particularly strong in the US. New York, Los Angeles, and other municipalities are increasingly holding consultations on city priorities, but not giving these consultations much power. Politicians and bureaucrats set the agendas, and although residents can share their opinions, they cannot make decisions. This controlled participation may look good for the city, but it rarely changes government spending. In the long run, it shows people that getting involved isn't worth the bother.
Co-optation is not the only challenge. Compared with Brazil, US cities have less urgent needs, more linguistic diversity, and fewer leftists in power. Experiences with participatory budgeting in developed countries, however, suggest strategies for adapting it to the US. Start small, with a pilot project in one neighborhood, agency, or program. Experiment with budgets in any institution that is receptive. Begin by engaging the most marginalized communities, so that they learn to play the game first. Build a bigger funding pot by attracting money from different sources. Use popular education and active facilitation to engage diverse residents and make sure that the loudest voices don't dominate. Link with existing participatory budgets for more legitimacy and fresh ideas.
So far, participatory budgeting has not caught hold in the US, but some cities are heading towards it. Seattle and Burlington, for example, have like-minded participatory grant-making programs, in which boards of residents help decide how city grants are awarded to community groups. Some activists are also working to start participatory budgeting in public housing and schools, based on successful processes in Canada. A US participatory budgeting network recently formed to build on these experiences. If you want to help transform politics by making participation pay, join the network. Or even better, start using participatory budgeting in your own city, school, or organization.
Josh Lerner lives in New York City, where he works on his PhD at the New School for Social Research, serves on the steering committee of Planners Network, and organizes around participatory budgeting in the US and internationally. He blogs at ParticipatoryBudgeting.org and Foresight, and he can be reached at josh_lerner(at)hotmail(dot)com.
The Truth About ACORN's Voter Registration Drive
by Bertha Lewis and Steve Kest
Election Day is less than a month away, and our efforts to make sure that low-income and minority voters have a voice and vote on November 4th are in full swing. Unfortunately, just as we've seen in previous election cycles, the more success we have in empowering these voters, the more attacks we have to fend off from partisan forces making unfounded accusations to disparage our work and help maintain the status quo of an unbalanced electorate. We want to take this opportunity to separate the facts of our successes from the falsehoods of our attackers.
On Monday, October 6, as voter registration deadlines passed in most states, ACORN completed the largest, most successful nonpartisan voter registration drive in history. In partnership with the nonpartisan organization Project Vote, we helped register over 1.3 million low-income, minority, and young voters in a total of 21 states. Highlights of this success include:
We collected over 151,000 registrations in Florida, 153,000 in Pennsylvania, 215,000 in Michigan, and nearly 250,000 in Ohio.
An estimated 60-70 percent of our applicants are people of color.
At least HALF of all are registrations are from young people between 18-29.
We are proud of this unprecedented success, and grateful to everyone who supported us in this massive effort, from our funders and partners to the literally thousands of hardworking individuals across the country who dedicated themselves to the cause and conducted the difficult work of registering 1.3 million Americans, one voter at a time.
And this work is far from over: now begins our effort mobilize these new voters around local and national issues, getting them to the polls and helping to channel their commitment and conviction into an ongoing movement for change in our communities.
As The Nation pointed out recently, ACORN's success in registering millions of low-income and minority voters has made it "something of a right-wing bogeyman." Though ACORN believes that the right to vote is not, and should never be, a partisan issue, attacks from groups threatened by our historic success continue to come, motivated by partisan politics and often perpetuated by the media without full investigation of the facts. As a result, there have been a few recent stories about investigations of former ACORN workers for turning in incomplete, erroneous, or fraudulent voter registration applications. Predictably, partisan forces have tried to use these isolated incidents to incite fear of the "bogeyman" of "widespread voter fraud." But we want to take this opportunity to set the record straight and tell you a few facts to show how these incidents really exemplify everything that ACORN is doing right:
Fact: ACORN has implemented the most sophisticated quality-control system in the voter engagement field, but in almost every state we are required to turn in ALL completed applications, even the ones we know to be problematic.
Fact: ACORN flags incomplete, problem, or suspicious cards when we turn them in, but these warnings are often ignored by election officials. Often these same officials then come back weeks or months later and accuse us of deliberately turning in phony cards.
Fact: Our canvassers are paid by the hour, not by the card, so there is NO incentive for them to falsify cards. ACORN has a zero-tolerance policy for deliberately falsifying registrations, and in the relatively rare cases where our internal quality controls have identified this happening we have fired the workers involved and turned them in to election officials and law-enforcement.
Fact: No charges have ever been brought against ACORN itself. Convictions against individual former ACORN workers have been accomplished with our full cooperation, using the evidence obtained through our quality control and verification processes.
Fact: Voter fraud by individuals is extremely rare, and incredibly difficult. There has never been a single proven case of anyone, anywhere, casting an illegal vote as a result of a phony voter registration. Even if someone wanted to influence the election this way, it would not work.
Fact: Most election officials have recognized ACORN's good work and praised our quality control systems. Even in the cities where election officials have complained about ACORN, the applications in question represent less than 1% of the thousands and thousands of registrations ACORN has collected.
Fact: Our accusers not only fail to provide any evidence, they fail to suggest a motive: there is virtually no chance anyone would be able to vote fraudulently, so there is no reason to deliberately submit phony registrations. ACORN is committed to ensuring that the greatest possible numbers of people are registered and allowed to vote, so there is also NO incentive to "disrupt the system" with phony cards.
Fact: Similar accusations were made, and attacks launched, against ACORN and other voter registration organizations in 2004 and 2006. These attacks were not only groundless, they have since been exposed as part of the U.S. Attorneygate scandal and revealed to be part of a systematic partisan agenda of voter suppression.
These are the facts, and the truth is that a relatively small group of political operatives are trying to orchestrate hysteria about "voter fraud" and manufacture public outrage that they can use to further suppress the votes of millions of low-income and minority Americans.
These tactics are nothing new, and history has shown that they will come to nothing. We'll continue to weather the storm, as we've done for years, and we'll continue to share the truth about our work and express pride about our accomplishments.
Most importantly, we want to assure you that this good work continues, unabated and undeterred. ACORN will not be intimidated, we will not be provoked, and in this important moment in history we will not allow anyone to distract us from these vital efforts to empower our constituencies and our communities to speak for themselves. If the partisan political machines are afraid of low-income and minority voters, they're going to have to do a lot better than coming after ACORN.
After all, there are now at least 1.3 million more of them, and they will not be silenced. They're taking an interest, and taking a stand, and they'll be taking their concerns to the voting booth in November.
And ACORN will be here, to make sure that the voices of these Americans are heard, on Election Day and for every day to come.