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Monday, March 09, 2009


Like Somali Pirates, Wall Street Holds U.S. to Ransom

   by Ann Pettifor

Somali Pirates were condemned when they hijacked tankers, took sailors hostage and demanded million-dollar ransoms. But their demands were a drop in the bucket compared to the ransoms demanded by Wall Street.
And the Somalis were kinder to their hostages than Wall Street is to millions of unemployed Americans. For while the Somalian pirates returned hostages unharmed, bankers, fraudsters and failed insurers continue to harm the US administration and hold millions of Americans hostage. The latter are being stripped effectively, of pensions, savings, livelihoods and jobs.
The Pentagon ordered the US Navy to apprehend Somalian pirates. However there has been no such 'Counter Piracy Execute Order' from the White House or US Treasury and aimed at Wall St. buccaneers. On the contrary. The US Treasury, like the British government, is capitulating to the pirates of the finance sector with a haste and a timidity that is unseemly, and if I may say so, unmanly.
Britain's government announced yesterday that while it was obliged to take a 65% stake in a 'broke' bank - Lloyds - it was refraining from exercising its full rights. The government would not, for example, use its stake in the bank to give taxpayers full control. Nor would they call for the resignation of CEOs and board members responsible for breaking the bank. Lord Mandelson the Business Minister said this was neither "necessary or desirable".
The US Treasury has set the pattern. While filling the vaults of Wall Street banks with taxpayer-backed funds, Secretary Geithner has refrained from asking for letters of resignation from the board members and CEOs that broke the banks. These banks have used their control over the nation's deposits and savings and over interest rates to hold the whole economy to ransom.
The US administration, like the British government, is pumping taxpayer-backed 'liquidity' into these banks without giving taxpayers full control over the banks.
The liquidity has gone through the front door. An indecent proportion has been funnelled straight out the back door to pay bonuses to failed executives. The rest of the loot has been grabbed and hoarded by the banks and is not being lent out to companies and households at affordable rates.
In other words, the pirates have been paid a handsome ransom and left in charge of the hijacked ship that is the nation's finances.
All this daylight robbery and confusion takes place because policy-makers - at the US Treasury, the Federal Reserve and the British government - do not understand what is going on.
Let us spell it out for them. Banks are going bust because their customers cannot repay debts, or afford to borrow. Customers cannot repay debts because a) these debts exceed their income and/or assets and b) because the interest rates or borrowing costs on these debts are too high, and unpayable. If you don't believe me, ask Warren Buffett. He tells shareholders that "highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels.
Though Berkshire's credit is pristine - one of only seven AAA corporations in the country - (its) cost of borrowing is now far higher than competitors with shaky balance sheets but government backing."
Millions of individuals and many thousands of companies are now unable to borrow. Burdened with huge debts by de-regulated lenders and financiers, many are being bankrupted by record high borrowing costs on their debts.
This is the real crisis in the economy. And the Federal Reserve declines to address this crisis of high real rates of interest.
Because they are facing insolvency, companies are firing workers. This is pushing up unemployment to levels comparable to those at the height of the Great Depression. Unemployed workers can't pay debts. It's simple.
Our graph below gives the real unemployment figures. Last week the Labor Bureau suggested that only 5 million people have lost their jobs in the last twelve months, and that only 12.5 million people are unemployed. We think that is optimistic.
The Bureau does not include in the official release, 'discouraged' employees or those working part-time because they simply can't get full time jobs. Dig deeper, and the percentage unemployed today is almost double that announced on Friday: 15%. We predict if policies are inadequate and interest rates stay high, that it will be as high as 20% by the end of this year. That will bring unemployment - under President Obama's watch - close to the level it hit, 25%, at the height of the Great Depression in 1933.

These millions of unemployed are American hostages tied up in a global economic failure not of their making.
They are desperate for the Federal Reserve to act as decisively as the Pentagon, and take on the banking pirates.
This cannot be done by pumping more taxpayer-backed money into the banks. Why? Because the crisis has moved on. It's no longer a crisis of liquidity, but of solvency. Banks cannot be made solvent by taxpayers. They can only be made solvent if and when companies and individuals can afford to borrow, and to repay debts.
By throwing money at the banks, and by refusing to take full charge of how they are run; by refusing to lower borrowing costs, US Treasury officials and the Fed Reserve are dodging the big issue: corporate and household insolvency.
Cutting borrowing costs would start to address the solvency issue. Putting a floor under insolvent companies and insolvent homeowners - would save the banks. At the same time it would release the hostages that are the unemployed, the elderly, the savers and the entrepreneurs.
The Federal Reserve can begin to lower borrowing costs by measures known as Quantitative Easing (QE). These were adopted by the Bank of Japan in March, 2001, and by the Bank of England last week. QE does not mean 'printing money' - this is a widespread misunderstanding. (For more on QE, click here.) QE will help to lower interest rates and therefore borrowing costs. Governor Ben Bernanke is still ignoring the experience of Japan and the way in which QE was used to lower rates and loosen the grip of insolvency on the economy.
He must adopt QE measures urgently. The Obama presidency has only just been launched on a wave of excitement and anticipation. If it is not to end with a hostage crisis of mass unemployment, rising crime, hungry children and riots outside banks, then the Federal Reserve and the US Treasury must take control.


WeLoveVentnor said...

Hi Glenn,

Interesting article topic for today on your blog. There's a little bit more to the big picture that you analyze in your piece. If more taxpayers knew about it, they'd be angry to find just how wasteful all the bank bailout extravaganza, adding to the general debt of the nation, has truly been.

Both Steve Forbes and former Assistant Treasury Secretary Paul Craig Roberts have written opinion pieces for the Wall Street Journal in recent days. They point out that FDR adopted two regulations which were very wise in stabilizing financial markets back in the 1930's. Those were the "uptick" rule and the asset valuation rule.

The uptick rule prohibits investors from engaging in short sales of a stock if it hasn't enjoyed an uptick in the previous day. There are also rules which prohibit "naked" short sales, wherein a seller doesn't have a covering option to buy the stock he's short-selling. The uptick rule was abandoned or repealed in the waning year or two of the Bush administration. It became common knowledge on The Street that the naked short sale rules were not being enforced by SEC, and traders took advantage of that neglect.

Similarly, in the past year or so under Bush, there was a change in which mark-to-market rules were made applicable not only to more highly liquid assets (which can be easily valued by a glance at the stock tickers) but also to long-term far less liquid investments.

The upshot has been that short-sellers have gone on a highly profitable binge of naked short-sales of the financial sector. One guy on the 2008 Forbes 400 list of Richest People shot up from a position of $500 million net worth to $50 billion net worth, in the space of just a couple years, thanks to all his short-selling activity, directed at banks, in a fund he manages. That downward pressure on stock prices impedes the ability of banks to raise capital through stock offerings.

The mark-to-market rules also put the banks in a bind, once the subprime mortgage loan problems started to surface and then snowball. The "securitization" process of chopping up all that debt into packages of paper sold to investors makes it very hard to figure out what a fair price might be for any of the bundled paper. When there is no real "market" for such assets, how do you mark the asset to a market value? These paper instruments have not been traded on stock exhanges for the most part. They're in a "shadow world" or a parallel universe of private hedge funds and the like. AIG wrote a lot of insurance against their default in an unregulated sphere with no "reserves" for payout in case default occurred. A lot of panicky assumptions have been made that they're worthless, when in fact a lot of the loans are not in default. However, the banks have felt a huge squeeze because they're assigning major "losses" of value (in order to "mark" to an unknown "market" value), and then when they mark these "losses on paper only" they don't meet their legal obligations to carry "reserve assets" as banks. Banks must carry a certain fractional reserve against the loans they extend.

It's emphatically NOT A CASH CRUNCH that the banks are in. They are rolling in actual cash.

An absolutely NO COST TO TAXPAYER solution could have been imposed by any President and his Administration (Bush or Obama) if they had any financial sense. All they had to do was revive the Uptick Rule, start enforcing the still-existing (but ignored) prohibition on naked short-sales of stocks, and do away with the Mark-to-Market Rule.

The first scattering of roughly $350 Billion from TARP is not being lent to Main Street because the banks are hoarding it to meet their own reserve obligations against loans outstanding. (It's also far from being spent "all on executive bonuses" like politicians are fond of saying, as they stir the pot to misdirect public anger solely at bankers.)

The fact of the matter is that banks are sitting on a whole lot of cash. But "sitting" is the operative word. They're buying up other banks because those kinds of asset exchanges still keep them in a comfort zone of holding necessary reserves against outstanding loans.

Meanwhile, the new Administration and Congress are doing a lot of "sitting" of a different kind -- on their hands, failing to re-instate Roosevelt era rules that made sense. FDR may have prolonged the Depression with some of his boondoggle spending pursuits, and he opened Pandora's Box to what has become our modern world of $53 Trillion unfunded liabilities for entitlement programs, but he and the Congress of that era weren't wrong about everything.

It is utterly amazing to anyone with some finance background that quick regulatory solutions are not being pursued.

Reinstating the uptick rule would keep jackals at bay from adding to market volatility. Enforcing the "no naked" rules would help anchor trading in the real world bounded by a finite number of how many shares of a stock are actually outstanding on a company. Allowing banks to carry many illiquid assets like 30 year long term loans at cost, and only mark them down if they actually became impaired (borrowers in actual default) would go a long way.

Best regards,
Paula DeLuca

Anonymous said...

Very informative and intersting