. . . a bailout of GSE (Fannie and Freddie) bondholders would be perhaps the greatest taxpayer rip-off in American
history. It is bad economics and you can be sure it is terrible politics.� --Matt
Kibbe, President of Freedom Works
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), (September 1932)
[After the Bear Stearns bailout] �As
more firms lost access to funding, the vicious circle of forced selling,
increased volatility, . . . and margin calls that was already well advanced at
the time would likely have intensified. The broader economy could hardly have
remained immune from such severe financial disruptions.� --Ben Bernanke,
Fed Chairman (March 2008)
2007, at the very beginning of the subprime financial crisis in the
U.S., and referring to the alchemy-like practice of creating artificial
financial instruments, such as mortgage-backed securities (MBSs), here is what
I wrote: �Like
all �Ponzi schemes�, such pyramidings of debts with no liquid assets behind them
are bound to implode sooner or later.�
I also wrote about the Fed�s intervention in such cases,
that �it alleviates the �liquidity crisis,� for sure, but this does nothing
to cure the underlying �solvency crisis� of institutions holding large
chunks of non-performing mortgage-based assets. Sooner or later, such
low-valued derivatives will have to be written off, and this will necessarily
lead to an erosion of these institutions� capital base. Bankruptcies of the
most leveraged and imprudent institutions are to be expected.�
In fact, such bankruptcies of over-leveraged financial
institutions become unavoidable. For a while, forced mergers between banks,
initiated by the Fed or the Treasury, can soften the blow. But after a while,
outright bankruptcies cannot be avoided and balance sheets have to be balanced.
What is the cause of this financial mess?
Last month, I provided a short answer:
�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.�
Today I say that this major crisis has to be placed at the
very feet of the Washington establishment. This is a politico-financial
establishment that has pushed to the limits its ideology of deregulation of
financial markets and stretched the working of unregulated corporate market capitalism to the breaking point. Now, the system is
imploding under our very eyes and financial institutions are falling like
dominos. As I wrote last August, and repeated in April of this year, the U.S. financial
problem is not one of liquidity, (there is plenty of liquidity provided by the
Fed when banks and brokers can borrow at will newly printed dollars from the
Fed�s discount window) but one of solvency, weak balance sheets, risky assets
and debt liquidation. That�s a horse of a different color.
Over the last 25 years, beginning with the Reagan
administration and culminating with the current Bush-Cheney administration, the
Washington establishment dismantled piece by piece the system of protection
that had been built since the 1930s economic depression and removed
nearly all government regulations that could stand in the way of greed and
gouging on the part of unscrupulous market operators.
And that�s where the rubber hits the road. Short of
bankruptcies is the nationalization of the over-leveraged banks by the
government. And the Bush-Cheney administration took a big step in that
direction when it came to the rescue of the two largest mortgage financing
institutions, Fannie Mae (Federal National
Mortgage Association: FNM) and Freddie Mac, (Federal Home Loan Mortgage Corporation: FRE)
which were close to being insolvent. This step was initiated after foreign central
banks (in China, Japan, Europe, the Middle East and Russia) threatened to stop
buying U.S. bonds and debentures issued by the two shaky financial
But the Bush-Cheney administration, while providing public
money to keep the two lenders in operation, stopped short of nationalizing
them. Indeed, the U.S. government committed to invest as much as $200 billion
in preferred stock and extend credit through 2009, to keep the two mortgage
lenders solvent and operating.
But instead of taking them over by placing them into
administrative receivership, in order to change
their business model, as they should have done since the government is now
guaranteeing their outstanding debts, (more than $5 trillion US) the U.S.
government chose rather to keep the appearance that these were still two
privately run banks and only appointed a legal conservator for Fannie Mae and Freddie Mac. Even when they
bail out what can be called two government sponsored enterprises
(GSEs), their market ideology prevents them from doing the right thing.
After years of irresponsible public deregulation and private
mismanagement and irresponsible, pyramiding risk taking, the American financial
system is now in serious trouble, and it may draw the U.S. economy further down
with it in the months and years to come.
In the coming weeks, however, as other American financial
institutions teeter on the brink of bankruptcy, the U.S. government will have
to consider creating a Bank Resolution Trust under the model of the 1989 Resolution Trust Corp. which took
over the savings and loan banks that were then in financial difficulties. For
example, as recently as February 16 of this year, the British government did
not hesitate to nationalize the Northern Rock bank and rescued
this large British bank with about �55 billion ($107 billion) in public loans
and guarantees. Sooner or later, the American government will have to do the
same, in order to stabilize the financial system, because the financial
problems in the U.S. are systemic and much more serious than elsewhere.
By the same token, maybe the U.S. government should correct
an anomaly of the 20th century, that is the semi-private status of its central
bank. Indeed, the American Federal Reserve is a semi-public
and semi-private central bank organization that is as much responsible to large
private banks as it is to the U.S. government and the population. This creates
an unhealthy conflict of interests that is not fair to the American public.
Indeed, the American practice of privatizing profits and socializing losses
would be considered unacceptable in most other democracies.
What we are witnessing these days in the U.S. is a massive
wealth transfer from taxpayers, savers and retirees to banks, their creditors
and their managers. On the one hand, the Fed has pushed real interest rates
deep into negative territory to help troubled banks, and, on the other hand,
the American taxpayers have foot the bill for bailing out very large financial
I wonder what the two presidential camps, the Obama and the
McCain camps, have to say about that? They both want to increase the federal
deficit and add significantly to the already high national debt.
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.