(Swans - August 1, 2011) In his weekly address on June 4, 2011, in the wake of dismal economic news -- a crawling growth rate, low job creation, contracting consumption, rising inflation, weaker housing sector, high pessimism from small businesses -- President Obama said, "we're facing some tough headwinds," which were caused by various factors: "Lately, it's high gas prices, the earthquake in Japan and unease about the European fiscal situation," he said, adding that there will be "bumps on the road" on the way to full economic recovery. But, always optimistic, always confident, our cheerleader in chief concluded: "We're a people who don't give up, who do big things, who shape our own destiny...and I'm absolutely confident that if we hold on to that spirit, our best days are still ahead of us." Fed chairman Ben Bernanke had mentioned the same factors on April 27, 2011, during his first ever press conference. Then, on June 22, he mimicked Obama (without the cheerleading part), and told journalists: "We don't have a precise read on why this slower pace of growth is persisting. One way to think about it is that maybe some of the headwinds that have been concerning us like, you know, weakness in the financial sector, problems in the housing sector, balance sheet and deleveraging issues, some of these headwinds may be stronger and more persistent than we thought." In other words, the head of the central bank, who was first nominated by Bush Jr. and renewed in his function by Obama, admitted quite candidly that he was clueless -- which, thinking of it, is a rather scary confession/proposition. These people have yet to realize that we are facing whirlwinds, not headwinds, and the only question is whether these will be of the minor or major sorts. Instead, the authorities are still hoping for some kind of tailwind, prodded by fiscal and monetary policies, in order to bring the economy back to the ex-ante situation.
Whether out of intellectual blindness or laziness, neoliberal dogma or self-interest (both political and financial), the decision makers on both sides of the Atlantic failed to understand the nature and extent of the crisis, and either willfully or ignorantly accumulated error after error in their responses to the historical crack that has hit the capitalist system. In addressing the economic and financial crises they took the wrong steps all along, which goes a long way to put in plain words the reasons these crises will get worse in the not so distant future. First, they deliberately chose to keep the banking system whole -- that is, to save the scalp of the investors (share and bondholders) -- and, second, they treated the economic recession affecting Main Street like any past recession, injecting a relatively modest amount of liquidity into the economy coupled with a sempiternal round of tax cuts with the wishful thinking that it would grease the wheels of the economic engine.
Let's focus first on the ongoing financial crisis. The economic crisis will be examined in the second part of this analysis.
Between 2008 and 2011, over $13 trillion of public money have been injected into the financial sector. It began in March 2008 when the Federal Reserve Bank of New York headed by Timothy Geithner (currently the US secretary of the treasury) and the Federal Reserve (the US central bank known as the FED and headed by Ben Bernanke) decided to bail out the investment bank Bear Stearns (though with deep losses to the shareholders), thus giving a wink to the financial sector that it would eventually be saved with public money if needed. According to a speech by Andrew G. Haldane, the Bank of England's executive director of financial stability, delivered at the Institute of Regulation & Risk in Hong Kong on March 30, 2010, "In 2008, 145 banks globally had assets above $100 billion, most of them universal banks combining multiple business activities. Together, these institutions account for 85% of the assets of the world's top 1,000 banks ranked by Tier 1 capital." These megabanks, known as Too-Big-to-Fail banks, received the bulk of public-funded bailout. Said Haldane: "The same 145 institutions account for over 90% of the support offered by governments during the course of the crisis." (1)
Bernanke et al. argued, and sold to an indifferent public and bought-out or fearful politicians, that the financial crisis was a "crisis of liquidity." It was not, and the contention should have raised many red flags here and there. How come, two years earlier, the markets were flooded with liquidities that investors did not know how to exploit? How did the situation turn from too much to too little? The response for objective observers is rather simple. There was no excess of liquidity, except on paper -- balance sheets that were not worth the paper (or digital files) on which they were written. In due and aggravated respect to Ben Bernanke, et al., the crisis of liquidity was in fact a crisis of solvency. The 145 megabanks were not short of cash, which they supposedly had had in abandon. They were insolvent -- in other words, broke.
Bernanke, Geithner, Henry Paulson (then US secretary of the treasury), all central bankers, and presumably presidents and prime ministers were fully aware of the situation. This is an irrefutable assertion due to a classified cable from the US embassy in London dated Monday, March 17, 2008, 18:27, just about the time Bear Stearns was falling apart and being taken over by J.P. Morgan with a $30 billion loan from the NY FED. Rare are the people aware of this cable. Recall the outgoing executive editor of The New York Times, Bill Keller, proclaiming in December 2010 that the "right not to publish" was as essential as the "right to publish" for press freedom. Sure enough, that particular cable never reached the public, except for the few followers of WikiLeaks. The cable was released in December 2010. (2) It read, in part:
Since last summer, the nature of the crisis in financial markets has changed. The problem is now not liquidity in the system but rather a question of systemic solvency, Bank of England (BOE) Governor Mervyn King said at a lunch meeting with Treasury Deputy Secretary Robert Kimmitt and Ambassador Tuttle. King said there are two imperatives. First to find ways for banks to avoid the stigma of selling unwanted paper at distressed prices or going to a central bank for assistance. Second to ensure there's a coordinated effort to possibly recapitalize the global banking system.
[...]
A coordinated effort among central banks and finance ministers may be needed to develop a plan to recapitalize the banking system.
The cable was dispatched to the state and treasury departments and to the US European office in Brussels. Notice that the crisis of solvency began in the summer of 2007, seven or eight months before the dated cable, at a time when the toxic subprime garbage could no longer be priced. It's hard to imagine that Mervyn King, who had to be in constant contact with his US and European peers, never talked to them about this actuality. Yet, the narrative remained unchanged: It's not a crisis of solvency, it's a crisis of liquidity. We know the result: States flooded the banks with public money, making the investors whole and piling up debts. We are living with the consequences of that blatant intellectual and ideological forgery.
Some commentators at the time, who were not in a position of responsibility and hence could not influence the decision making, had a different take on the financial mayhem. In the U.S., the free-market purists -- the "Atlas Shruggians," if you will -- vociferated that the failed banks ought to be let go into bankruptcy, ignoring the fact that these megabanks "account for 85% of the assets of the world's top 1,000 banks ranked by Tier 1 capital" (cf., Andrew G. Haldane). To let them go into bankruptcy would certainly have wiped out the investors, but it also would have debilitated the depositors and led to a total collapse of the Main Street economy.
However, there was another alternative -- neither let the banks fail nor make the investors whole, the latter having been the road taken (with few exceptions) -- that was advocated by other commentators, including this one, who were not in a position of responsibility either: the governmental seizure of these megabanks; that is the nationalization of these behemoths. Analysts and economists such as Paul Jorion and Frédéric Lordon in France (3) or Joseph Stiglitz, Paul Volcker, and Robert Kuttner in the U.S. come to mind. Sheila Bair, who headed the Federal Deposit Insurance Corporation (FDIC) for five years until her retirement on July 8, 2011, was a strong proponent of that approach. Under her leadership, the FDIC successfully managed over 370 bank failures in the past three and one-half years -- the biggest one was Washington Mutual, which was the sixth-largest US banking institution with over $300 billion in assets when it collapsed in September 2008, and was seized by the Office of Thrift Supervision and put into receivership with the FDIC. Unfortunately, Mrs. Bair commanded little clout in the higher echelons of the Bush and Obama administrations.
Mrs. Bair, a life-long Republican rooted in Bull Moose progressivism, considered that bailing out Bear Stearns was a huge mistake; that investors were not entitled to being made whole since they took risks for greater financial rewards and therefore should take losses when their investments (bets, gambles) went the wrong way; and that depositors needed to be protected before anything or anybody else. Her sound thinking was ignored by the decision makers. (4)
It is worth repeating that Mrs. Bair is a life-long Republican. She cannot be accused of being a socialist, a radical, or a revolutionary. Her clear-minded, pragmatic approach is simple and quite comprehensible: An investment bank fails, let the investors take a hike. A commercial bank fails, seize the bank(s), protect the depositors, clean the balance sheet from its bad assets, letting the shareholders and bondholders take a hair cut or have their investments be wiped out as the case may be, and then bring back the bank(s) into private hands. One additional step, eloquently put forward by Andrew G. Haldane in his Hong Kong speech (mentioned supra -- see note #1), would have been to break these megabanks into entities with only $100 billion in assets, and to bring back the wall between commercial and investment banking (cf., Glass-Steagall).
Haldane, Bair, Lordon, Jorion, and many others (included this author) were dismissed and ignored. The investors were made whole on the public trough. Life went on. But how long is the leash ought to be contemplated.
Our public decision makers and their gatekeepers in the media claim that the financial sector is off the cliff and back into profitability. Financial compensations (salaries, bonuses, stock options) are booming again. The apocalypse that the End Times, millenarian conspiracists worship (and the powers-that-be exploited) has been avoided. It's time to move forward, time to get the economy growing again. But the apocalypse or Armageddon is not what we are facing. The world and nature will indeed move on. What we are facing -- the human species -- are years or perhaps decades of pain. First, the Too-Big-to-Fail banking system, a leech that brings absolutely nothing to the well being of people (but for the tiny happy few), remains in deep voodoo, ever so close to the cliff again. Second, the decision to save investors has further bankrupted states and nations, thus impoverishing the commons.
In April 2011, the International Monetary Fund (IMF) released its semiannual "Global Financial Stability Report," subtitled ironically, "Durable Financial Stability: Getting There from Here" (a 182-page PDF document, 7.5 MB). On pages 13-18 one can read (emphasis mine):
...global banks face a wall of maturing debt, with $3.6 trillion due to mature over the next two years. Bank debt rollover requirements are most acute for Irish and German banks, from 40 percent to one-half of all debt outstanding is due over the next two years.
[...]
Banks in Austria, the United Kingdom, and the United States have high loan losses, but are aided by relative profitability. German banks, conversely, have low revenues and this has fed through into low capital levels for Landesbanken and cooperative banks. These low levels of capital make some German banks, as well as weak Italian, Portuguese, and Spanish savings banks, vulnerable to further shocks.
[...]
This all means that banks in Europe still need to raise a significant amount of capital to regain funding market access. In current market conditions, it is unlikely that they will be able to raise all of this in markets. Institutions could build capital by reducing dividend payout ratios and retaining a greater proportion of earnings. Banks could also gradually downsize balance sheets to reduce capital and funding needs. But it is likely that some of the capital will need to come from public sources.
[...]
Further policy action is needed to restructure and, where necessary, resolve this weak tail of undercapitalized banks.
Which public sources can be tapped? After bailing out the megabanks it's now the turn of states -- Greece, Ireland, Portugal, and counting. Spain, Italy, and Belgium are under increased pressure... As Stefan Homburg, the director of the Institute of Public Finance at Leibniz University in Hanover, said in a Spiegel interview...
... when push comes to shove, it is creditors, and creditors alone, who have to write off their loans. Only then do they have an incentive to carefully choose who they lend money to. A market economy with no personal liability cannot function. The government bailout initiatives create misdirected incentives that continuously exacerbate the problems on the financial markets.
[...]
If the bankruptcy of little Greece were actually to trigger a global financial crisis, new bailout programs couldn't solve the problem: They would actually exacerbate it. If no more states or banks are allowed to go bankrupt because this might precipitate a financial crisis, then we're finished. Then the problem continuously escalates and leads to a much greater crisis.
[...]
First, states bailed out their banks, now states themselves are being bailed out. But there is no next level to fall back on beyond this bailout. The bailout packages have merely exacerbated the crisis
To sum up: Trillions of dollars of good money thrown after bad. The banking sector remains on the verge of insolvency; an increasing number of states have become fully insolvent. Still, the notion of seizing the banks remains off limit in the corridors of power. It's like the wolf howling to the moon: It is not the "economy, stupid!" or "finances, stupid!". It is "politics, stupid!" as Frédéric Lordon lucidely exposes.
In a recent press conference, Nicolas Sarkozy, the president of France, lamented the fact that banks and corporations that had needed to be bailed out by public funds in 2008-2009 were back to paying lavish bonuses and salaries to their managerial teams, as well as higher dividends to the shareholders, after a year of increased profits, but did not share any of these profits with their employees. He said he was shocked by such a behavior, which in his mind makes no sense. To ask the workforce to sacrifice is one thing. To refuse to share the bounties when profits are back is an all-together other thing. He could not fathom such nonsense. President Obama, for his part, has addressed the TV audiences, wondering how come the wealthy few, who have made gazillions of money in recent decades, are not willing to pay higher taxes when the country is in dire need. Can't these few be enlightened and take the health of the nation at heart? Can't they voluntarily make the right decision and help save the future?
Indeed, these people are clueless -- and malevolent.
Continue to Part II, The Economic Crisis
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Gilles d'Aymery on Swans -- with bio. He is Swans' publisher and co-editor. (back)
Notes
1. Andrew Haldane's speech -- "The $100 billion question," BIS Review 40/2010 -- can be read on the Web site of the Bank of International Settlements, at www.bis.org/review/r100406d.pdf (PDF). Haldane makes a powerful case for breaking the megabanks to a size that can be managed. (back)
2. The cable -- "08LONDON797" -- can be accesses and read in full at www.wikileaks.ch/cable/2008/03/08LONDON797.html. (back)
3. Both Lordon and Jorion have consistently been correct in their analyses of the financial and economic crises, and have been advocating sound solutions. But neither one is in a position of power. For people who can read French, I highly recommend their writing. The Blog of Frédéric Lordon, "La pompe à phynance," can be accessed on Le Monde Diplomatique, at blog.mondediplo.net/-La-pompe-a-phynance-. Paul Jorion's Blog is at: pauljorion.com/blog. (back)
4. Sheila Bair, with Mary Schapiro and Elizabeth Warren, was featured on a 2010 cover of Time under the deadline, "The New Sheriffs of Wall Street." Mrs. Bair was chronicled in an excellent "Letter from Washington" by Ryan Lizza in The New Yorker, July 6, 2009, entitled "The Contrarian." More recently, after her retirement, she was interviewed by Joe Nocera for The New York Times magazine: "Sheila Bair's Bank Shot," July 10, 2011.
Elizabeth Warren, who just was passed over by President Obama for the head of the Consumer Financial Protection Bureau, which she pretty much created -- she could not be confirmed due to the opposition of the Republicans in the US Senate -- is an extraordinary competent and fair-minded professional. In an interview with Harry Kreisler (CounterPunch, April 30 - May 2, 2010) she elaborates on her life and philosophy. She was also chronicled by James Surowiecki in The New Yorker, June 13, 2011: "the Warren Court." She has been a strong voice in favor of consumer protection for many years. See her Summer 2007 article, "Unsafe at Any Rate," on Democracy.
I do not think that Mary Shapiro is made of the same cloth as Mrs. Bair and Mrs. Warren. However, Brooksley Born, a past chairwoman of the Commodity Futures Trading Commission who was marginalized by the Clinton administration, certainly fits the bill. She too kept raising red flags as early as the 1990s. (back)