�I think the [US financial] system
is basically sound, I truly do.� --George W. Bush, July 15, 2008
�Since 1951, the budget of the Department of Defense each year exceeds the
net profits of all U.S. corporations. So, in finance capital terms, that means
that the management of that budget controls the largest single block of finance
capital resources.� --Seymour
�The first panacea for a mismanaged nation is inflation of the currency; the
second is war. Both bring a temporary prosperity; both bring a permanent ruin.
But both are the refuge of political and economic opportunists.� --Ernest Hemingway (1899-1961),
been many policy missteps over the last 20 some years, and this has amounted to
a mismanagement of the U.S. economy. The result has been an unhealthy
mixture of greed, shortsightedness and market manipulation. And now, all the
chickens are coming home to roost and the crisis is deepening. This does not
mean that the private side of the U.S. economy is not resilient and strong. It
only means that government policies have often been misguided and have damaged
the private economy and hurt the people economically.
Essentially, at the government level, each new economic
crisis seems to have been �solved� by creating the conditions for the next one.
This is particularly true in regards to
regulation policy, monetary policy, and fiscal policy. Each
time a policy choice had to be made, it seems that short-term benefits were
often privileged at the expense of long-term costs.
First, let us consider regulation policy for the crucial financial sector. Over the last 20 years, U. S. deregulation
of the financial sector has been based on developing what I would call predatory
financial capitalism, that is to
say the systematic encouragement of excessive risk taking
(moral hazard) and of corporate greed in
general, the development of the
pyramidal $2.5 trillion hedge fund industry, the practice
of highly-leveraged buyouts (LBOs) of healthy companies with their own high-yield debt,
also known as �bootstrap� investments, and the practice of program trading. Moreover, this was a system that was
not only risky but also fraught with shady activities.
To accomplish this deregulation or non-regulation of the financial sector and to
encourage the over-indebtedness of the U.S.
economy, a whole series of safeguards that had been wisely established to
prevent a repeat of the financial and economic disasters of the 1930s were
dismantled and cast aside. The last one in line was the reckless abolition by
the U.S. Securities and Exchange Commission
(SEC) of the speculative prevention rule called the downtick-uptick rule (which prohibited short-selling when
stock prices were falling), in July 2006. Such safeguards had been put in place
in order to avoid systemic financial instability, to make financial
institutions more responsible to users and to avoid costly government bailouts
when large financial institutions fail. Today, we are back to the 1930s with
large financial institutions reaping huge profits and paying obscene salaries
to their CEOs in good times and with government bailing them out with public
money when things turn sour.
During the Reagan-Bush era of the 1980s, deregulation
encouraged unsound real estate lending by Savings and Loans financial institutions
(S&Ls) and this led to the 1986-1995 Savings and Loan associations crisis, when about $160 billion was lost,
most of it through a $124.6 billion bailout by the U.S. government.
The 1980s also saw the flourishing of vulture or predatory capitalism when
financial operators were allowed to raid profitable companies and saddle them
with the debt incurred to take them over. In 1989, for example, the corporate
raider firm of Kohlberg Kravis Roberts (KKR)
closed in on a $31.1 billion dollar hostile takeover of RJR Nabisco. It
was, at that time, the largest hostile leverage buyout in history. The event
was chronicled in the book (and later the movie), Barbarians at the Gate: The Fall of RJR
Nabisco. To this
day, nothing has been done to stop this practice that rewards irresponsible
gambling and punishes prudent behavior. For the time being, however, it can be
said that the practice of leveraged finance and of high-yield debt was somewhat stalled last August (2007) when
the subprime crisis began to unfold.
At the center of current financial problems is the failure
to adapt standard financial regulation to new financial institutions, such as broker-investment banks, off-shore based hedge funds and large derivatives markets that remain, for the most part, outside of
the traditional authority of regulators. However, when things go wrong, as they
did with Bear Stearns last March, their
demise threatens to destabilize the entire financial system and handy
government bailouts are quickly called in.
Second, let us consider monetary policy.
Over the last few years, U.S. monetary policy has resulted
in a massive wealth transfer from savers, retirees and money holders in general
to banks, mortgage lenders and debtors in general as the purchasing power of
the dollar has plummeted. Last September, after the Bernanke Fed decided to
drop interest rates as the U.S. dollar was already in the downtrend, I wrote, �foreign
(dollar) investors have been �taxed� by the American Fed�s policy of benign
neglect regarding the dollar.�
Since then, the Bernanke Fed has gone much further. It has
pushed the Federal funds rate to the 2 percent level from the 5.25 percent
level it was in mid-September 2007. In so doing, by pushing real interest rates
deep into negative territory and by depreciating the U.S. dollar, the Fed has
heavily taxed retirees and savers in its rush to shore up American financial
institutions. Indeed, it can be said that the semi-private Fed has been
floating American financial problems in a sea of new money by running the
The act of printing excessive amounts of bills is the worst enemy of sound money. It is a way to destroy fiat currencies. It
is the main source of inflation and,
sometimes, of hyperinflation. In the end, we know that it robs
people of their savings and lowers their standards of living.
Paradoxically, while the Fed is lending heavily to financial
institutions in trouble by discounting their bad subprime loan paper through
its so-called new special lending facilities (at
2% annual interest rate), banks become more selective in extending credit to
borrowers, forcing companies and consumers alike to cut down on their investment
and consumption projects.
The economy is thus placed in a sort of �liquidity trap� where
everybody wishes to remain short term and liquid. There is a lot of money
around, as the monetary base, or �High-powered
money,� is increasing rapidly, certainly enough to feed inflation, depreciate
the U.S. dollar and push long term bonds down (long term interest rates are on
their way up), but banking credit as such remains
scarce and may be getting more scarce as banks attempts to recapitalize
What the Bernanke Fed is doing nowadays is a continuation,
although at a much higher level, of what the Greenspan Fed did in the late 1990�s.
At that time, then Fed Chairman Alan Greenspan reacted
to the collapse of an investment firm specializing in hedged funds, Long-Term Capital Management, by pumping large amounts of liquidity into capital markets and by
lowering interest rates.
This approach was called a �Greenspan put,� because it had
the effect of guaranteeing the profitability of many risky financial operations
that otherwise would have failed. That policy paved the way for the dot-com stock market bubble of 1999-2000.
In the same spirit, some refer to the Fed�s bailouts of
troubled investment banks as a sort of Bernanke put, because of the Fed�s
aggressive policy of reducing interest rates to fight market falls or to bail
out financial companies in trouble.
Because of the current economic slowdown, the inflationary
consequences of such a policy is not apparent yet, but it could be the
foundations of future inflation down the road. Let us keep in mind that historically-low
interest rates, lax lending standards, and inadequate regulation were behind
the U.S. housing bubble. The seeds are
now sown for the next bubble.
Third, let us look quickly at fiscal policy.
The Bush-Cheney administration�s fiscal policy has been
characterized by budget deficit upon budget deficit, whatever the state of the
economy. In its entire eight years in office, in fact, it has never balanced
the budget. On the contrary, it has even spent the budget surplus that it inherited
from the Clinton administration. And it has announced that it plans to leave
the coming administration with a record 2009 deficit of half a
trillion dollars. Indeed, the previous Bush-Cheney administration�s record was
its 2004 $413 billion deficit.
Although such deficits at about 3.3 percent of the gross
national product (GDP) are lower than the 6.0 percent of GDP we saw in the
early 1980�s, they are cumulative, and they have occurred at a time when U.S.
foreign indebtedness is much higher and the U.S. dollar much weaker. It can be
said that they have contributed to weakening the United States and making it
more vulnerable to economic and financial shocks.
In economics, bad decisions and bad policies do not always
result in immediate negative consequences. It takes time for them to work their
way through the economy and produce their corrosive effects. Many of the
current economic and financial problems of today are the result of bad policies
of the past.
Rodrigue Tremblay lives in Montreal and can be reached at email@example.com. He is the author of the book ��The New American Empire.� His new book,
�The Code for Global Ethics,� will be published in 2008. Visit his blog site at thenewamericanempire.com/blog.