Sunday, May 10, 2009

Betting on a Global Crapshoot

Betting on a Global Crapshoot

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You have to hand it to Wall Street. It wreaks havoc on the global economy, and the rest of us - as taxpayers - prop it up so that it can do it all over again.

We give the Wall Street banks trillions of dollars in bailout money, and they still fail to do their job, which is to loosen credit and provide the liquidity that businesses and consumers need. A major hedge fund - Cerberus Capital - plays chicken with President Obama in his effort to save Chrysler. Bankers spend millions lobbying to stop Congress from providing help to homeowners facing foreclosure. And, having failed to stop a Credit Card Bill of Rights in the House of Representatives, the banksters now aim to kill it in the Senate.

Because Bank of America, CitiBank, AIG, Goldman Sachs and the others are "too big to fail," Treasury Secretary Tim Geithner continues to redistribute astronomical sums of money from taxpayers to these giants of finance capitalism. And, predictably, they use our money to remain too big to fail as they extend their power in the most predictable ways. Thanks to us, the taxpayers, bankers still "own" the US Senate, as Sen. Dick Durbin (D-Illinois) put it. Thanks to us, the insurance companies and health maintenance organizations still have the clout to keep single-payer health care "off the table." And thanks to us, the huge financial supermarkets like CitiBank can still block a reenactment of anything like the New Deal's Glass-Steagall Act, which kept the high-rollers in investment banks from gambling with "the people's savings" in commercial banks. For those who forgot, Wall Street pushed the repeal of Glass-Steagall in 1999.

Why so many Americans put up with - and pay for - Wall Street's continued power, I will never understand, for all the easy ideological answers. I only know that Wall Street's power remains a fact of life, and not just for the United States. Kept alive by taxpayer dollars and government printing presses, the finance capitalists on Wall Street fully expect to continue shaping the global economy in their own image, exporting to the world the same high-risk derivatives that created the present crisis.

Derivatives come in many flavors, from currency futures that minimize the risks of international trade to the credit default swaps on which the failed insurance giant AIG owed billions of dollars that it could not pay. Some derivatives, such as crop futures, go back at least as far as the ancient Greeks. Others depend on modern computers, instantaneous global communications, and revolutionary breakthroughs in mathematics, such as the work on determining the value of derivatives that brought Robert Merton and Myron Black the Nobel Prize for Economics in 1997. Some derivatives pose no serious threat except to those who bet on them. Others can be, in Warren Buffet's prophetic words, "financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."' Buffet said this in 2002, and we are now living through precisely the dangers he predicted.

The problem should be obvious. From farming the land to building a better mousetrap, all economic activity entails some degree of betting - on when it will rain, how the market will respond, or other factors beyond control. The truly dangerous derivatives, though ostensibly designed to manage risks, involve betting on a complex series of other bets. A local bank bets that a homeowner will pay off her mortgage. An investor bets that a package of mortgages will pay appreciably more than he has to pay. Other investors bet on an index of packaged mortgage prices. And so the uncertainty grows, to the point that even the most brilliant investors with the fanciest mathematical models have no way of knowing how much risk they are taking. And neither have the governments who would regulate them.

Before the current crisis, this global crapshoot had grown into a multitrillion-dollar industry, depending on which derivatives are included and how they are valued. The financial engineering of these derivatives is one of the major fields in which the United States holds a comparative advantage internationally, and Wall Street and its defenders eagerly promote how much of a contribution these products could make to America's balance of payments. Purely in economic terms, this potential would prove alluring to policy-makers, no matter who sits in the Oval Office. But key members of President Obama's economic team, such as Tim Geithner and former Treasury Secretary Larry Summers, seem especially unlikely to suggest reforms and regulations that would seriously tie Wall Street's hands in exporting American-style finance capitalism.

To their credit, many on Wall Street and their friends in government have accepted the inevitability of increased regulation of the entire financial services industry, including the "shadow banking system" of investment banks and insurance companies. But the defenders of financial engineering insist on remaining free to create ever more complex derivatives, with all the incalculable risks they pose to the global economy. Will Obama and the Democratic-led Congress leave Wall Street with the freedom to rule and ruin? Or will wiser heads prevail? The debate has only just begun.


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