by Gilles d'Aymery
(Swans - April 6, 2009) Last week, US Treasury Secretary Timothy Geithner unveiled the administration's latest plan to deal with the financial tsunami, the Public-Private Investment Partnership (PPIP). The stock market soared. Meanwhile, President Obama flew to London to attend the two-day G-20 summit, which, at its conclusion, issued an optimistic communiqué that emphasized the commitment of the respective governments to stabilize the global economy, get back on the road to growth, and create jobs. The market responded with mitigated zeal. The pundits claimed that at long last the bottom had been reached and the worst of times was finally behind us. Time to invest again, they trumpeted. Never mind that the real economy lost over 600,000 jobs in March and that it keeps deteriorating at a fast pace. Hope springs eternal. However, in light of the sheer magnitude of numbers involved in this worldwide financial crisis, the chances that the PPIP plan and the decisions taken by the G-20 will succeed are unfortunately close to nil. The numbers speak for themselves.
The G-20 decided to inject $5 trillion in the world economy in the foreseeable future, pump another $1.1 trillion into the International Monetary Fund (IMF), of which $750 billion will be used as lines of credit for poor nations and $250 billion for loan guarantees to stimulate global trade. In addition, the IMF's Special Drawing Rights will be boosted by $250 billion and the World Bank and regional development banks will receive $100 billion. They also decided that the Financial Stability Forum will be reformed and turned into a global financial supervisory authority charged with devising new international financial regulations. There is, however, no formal obligation to introduce a new general economic stimulus program; this is left to each nation's decision.
For its part the PPIP plan entails an injection of $500 billion to $1 trillion of public funds in partnership with institutional investors (hedge, equity funds, etc.) to buy toxic assets and recapitalize banks. The government will provide low interest loans to the investors in the order of 90 percent of the assets to be purchased, and the investors will put up the difference -- 10 percent. In case of losses the government will swallow the losses up to 90 percent. The investors are only risking their own funds (10 percent). Nobel prize-winning economists Joseph Stiglitz and Paul Krugman have been highly critical of this plan. Stiglitz, a professor of economics at Columbia and former chairman of the Council of Economic Advisers, has called it a "robbery" of public money, which it is as once again public money is transferred to wealthy investors. Stiglitz wrote in a worth-reading Op-Ed in The New York Times, "Obama's Ersatz Capitalism" (March 31, 2009), that what "has been described by some in the financial markets as a win-win-win proposal" is actually a win-win-lose proposal: the banks win, investors win - and taxpayers lose." He goes on to clearly illustrate how the public is going to be fleeced.
The G-20 plan, whose purport is to bring back "stability, growth, jobs," is characterized by best-selling author and senior correspondent of Der Spiegel in Washington, D.C. Gabor Steingart as possibly a turning point, "but a turning point downwards." "In combating this crisis," he writes in a scathing critique, "The West's Fatal Overdose" (April 3, 2009), "the international community is in fact laying the foundation for the next crisis, which will be larger. It would probably have been more honest if the summit participants had written 'debt, unemployment, inflation' on the wall." He adds:
At the summit in London, delegates talked about everything -- except this issue. As a result, no attention was given to the fact that the crisis is being fought with the same instrument that caused it in the first place. The acreage for cheap dollars will now be extended once again. Only this time, the state is also acting as the dealer, so that it can personally take care of how the trillions are distributed.
Steingart's very pertinent analysis, which the American press has not broached, is right on the mark. For him the issue is the US printing presses that have been running with abandon for years and are now in overdrive. The risk of hyperinflation, as I have repeatedly stated, is far greater than the immediate deflationary trends, but Steingart misses the larger issue, that of the sheer magnitude of the numbers the world is facing. This is an issue that Krugman, Stiglitz, and many other economists -- as well as the media -- keep ignoring. The numbers!
Bloomberg News' latest estimate of the cost of direct spending, loans, and aid guarantees to fight the financial crisis has reached $12.8 trillion -- just in the U.S. Yet, it has not stabilized the markets and turned the economy around. One has to wonder whether another infusion of $7-plus trillion (PPIP and G-20 new infusions) will do the trick. There are good reasons to seriously doubt it. Before getting into these reasons let's bring some perspective in relation to the magnitude of the problem.
According to the CIA World Factbook, the GDP of the entire world (gross world product) in 2008 was estimated to be $70.65 trillion (purchasing power parity) or $78.36 trillion (official exchange rate). The GDP of the United States was $14.58 trillion (purchasing power parity) or $14.33 trillion (official exchange rate).
With these numbers in mind, let's look at another set of numbers. Stephen Pizzo, a journalist and author of Inside Job: The Looting of America's Savings and Loans, has analyzed the data regarding the amount of derivatives floating around the world provided by the Bank for International Settlements (BIS). The BIS, based in Basel, Switzerland, was established in 1930. According to its Web site, "it is the world's oldest international financial organization" that "fosters international monetary and financial cooperation and serves as a bank for central banks."
As of June 2008, the amount of derivatives totaled $1.14 quadrillion -- that is, over 1,000 trillions of dollars! -- divided, according to Pizzo, as follows:
1) Listed credit derivatives stood at USD 548 trillion.
2) The Over-The-Counter (OTC) derivatives stood in notional or face value at USD 596 trillion.
(See "Follow The Numbers," Opednews.com, March 2, 2009.)
In the USA, according to the US OCC's [Office of the Comptroller of the Currency] Quarterly Report on Bank Trading and Derivatives Activities (PDF - 229 kb), the top 25 commercial banks and trust companies had as of September 30, 2008, total assets of $10.550 trillion and carried on their books $175.842 trillion in (notional amount of) derivative contracts. (see pp. 22-24) Note the amount of exposures of, in particular, JP Morgan Chase, Bank of America, and Citibank. And also note that's only what is kept on their balance sheet. There are a lot of derivative debts that have been kept off balance sheet! In other words these too-big-to-fail banks are by all accounting rules insolvent. How much of this stuff is "toxic," worth pennies on the dollar? Hard to tell.
You may wonder how in the world, in a global economy worth about $71 trillion, such a phenomenal amount of derivatives could have been created? First, there are a lot of different derivatives out there (here is a non-exhaustive list), some of which have very exotic appellations, like the "Reverse Floater," the "catastrophe bond," the "Hamster Option," the "Kitchen sink bond," and the "naked dog basket" (see Stephen Pizzo's explanation of these "financial instruments"). But there is more, much more. Our Masters of the Universe were quite creative indeed. They created new derivatives out of thin air, pure and simple. Have you heard of synthetic collateralized debt obligations (CDOs)?
Frank Partnoy, a former Wall Street trader in the 1990s, author of the 1997 FIASCO: Blood In The Water On Wall Street, and currently a professor at the University of San Diego law school, explained in the Afterword of his recently republished book:
Wall Street saw they could use credit default swaps to create an infinite amount of crap. They quickly engineered new repackaging transactions, using credit default swaps to clone risky subprime-mortgage-backed investments that, when pooled, generated more sky-high ratings. These new deals were known as "synthetic" CDOs, because they had been created artificially, through derivatives side bets. Instead of basing payoffs on subprime mortgage loans that actually existed in the real world, the banks created an Alice in Wonderland world and based payoffs on the multiple virtual realities that were down the rabbit hole.
It was high-stake gambling made by our "innovative" Masters of the Universe. Now the piper has knocked on the door and no one, absolutely no one knows how to get out of this debacle, the PPIP, the G-20 plan, and the $12.8 trillion already gone down the drain notwithstanding. So long as we do not realize the financial monster that we are facing (and have created) and do not address it head on, there is little or no chance the real economy can recover in the foreseeable future.
The continuation of our current policies -- to save the banks, the investors, and the creditors at any cost borne out by the rest of us, wage earners and debtors -- is leading us to national bankruptcy. (And don't forget the insane expenses we incur due to the military-industrial-congressional complex and the two inane wars that we should never have launched in the first place.) This economic system cannot be re-inflated through more debts -- huge amounts of debts -- put on a society that is already indebted to the hilt. What needs be done is forcing the creditors and the investors to take a drastic "haircut" by writing off these derivative debts. Then the big banks that are too big to fail must be broken off into smaller entities, with, and only with, the deposits being safeguarded by the government -- and redistributed among regional, local, and community banks. Finally, any new taxpayer expenditures must be directed to the real economy, to Main Street (not Wall Street), and, for heaven's sake, a moratorium on all home foreclosures must be put in place for the people who live in them (not the speculative "flippers").
Then it will be time to exit the age of oligarchic cronyism and design a new societal system that will put people first.
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