What Caused our Economic Meltdown?
Jere L Hough
I have been in the process of composing articles like this one for many years. This analysis is one of hindsight, and it is 20-20. But I have been writing of the now unfolding economic collapse for decades, and especially since GWB was elected in 2000. What is happening in our world was fully predictable to even ordinary citizens (such as myself) who had time or the will to access the hard facts and look at them truthfully.
This article has my full endorsement, as far as it goes. However, it doesn’t go nearly far enough to get at the roots of the causes of our economic collapse and all the impending chaos that it will trigger like a chain of falling dominoes. The roots of the problem are so deep that almost no one can find them. They are so ingrained in our current cultural and economic paradigms that they appear ludicrous to the unlearned and PhD alike – even Economics PhDs. Please read the article first, and then see my postscript for the deeper root causes and the true solutions. – Jere L Hough
Once and For All…
Dr. James Glenn
“There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises
Like most Americans I’ve been watching the dramatic, and often titillating, finger pointing exchanges between Wall Street,Congress, the media, and the candidates with a combination of glee, dismay, disgust, and jaw dropping incredulity. Mostly incredulity, because few of these people, pundits, politicians, or patricians has gotten the story right about our recent financial apocalypse. Let me set the record straight, once and for all.
The right likes to blame the mess on “Big Government” (surprise), and ‘The Community Reinvestment Act” passed in 1977 which outlawed “redlining” by consumer banks (cherry picking loan customers), and dictated that they must “serve” all of their market when it came to home loans, not just the most lucrative segments. In other words, they had to provide home loans to marginal customers if they could pass the underwriting guidelines. They also heap blame, not entirely meritless, on Fannie Mae, and Freddie Mac, government sponsored entities (GSEs) which were responsible for providing sub prime loans to many of the now bankrupt subprime mortgage market. The critical point missed by these people is that it was investment banks on Wall Street and Wall Street Bankers and a corrupt irresponsible Fed responsible for the meltdown, not consumer banks, sub prime borrowers, or Fannie and Freddie. Limbaugh, Hannity, and their ilk love to demonize the left with sound bites for simpletons, this latest financial debacle being but another perfect example of their taking extremely complex issues like this latest meltdown and its causes, and disgorging simplistic, vacuous, incoherent, and incorrect ruminations to their rabid listeners.
The right has part of this story right however. It was Ronald Reagan’s “big government” of the 80s, which ran up the first trillions in our now 11 trillion dollar debt, which set the ball rolling on our current meltdown. Reagans “deregulation” and “privatization” mantra, aided and abetted by that banking shill, Alan Greenspan, who he appointed as chief fed head, that “deregulated” the S&Ls, which lead to the property bubble of the late 80s, a housing collapse, and the recession of 90-91. This cost the taxpayer approximately 500 billion. Sound familiar? Greenspan just last week, under glaring Congressional testimony, admitted that his long held beliefs regarding deregulation, and banks, and Wall Street being able to “police” themselves, had “proven to be “incorrect.” His “model” of the world was erroneous he says. Thank you Sir Alan for the scintillating confession. A day late and two trillion dollars short. Thus the grubby grasping at “deregulation” by those self serving miscreants in the 80s, as a panacea for everything from the common cold, to world war, set the stage for what was to follow.
On the heels of “deregulation” of the S&Ls came “securitization” in the 90s, which banks and brokerages dreamed up to shift investment risk from themselves to “investors”. Securitization you see allowed banks to “bundle” asset classes for resale. One of the most lucrative of these “asset classes” was mortgages, which could now be taken off the banks balance sheets and sold to investors. This effectively absolved the banks of any responsibility in performing their traditional job, i.e., underwriting good loans by correctly assessing credit risk. Banks balance sheets were freed up, and their reserves replenished so they could “turn” their inventory (mortgages) virtually as fast as they could be written. They no longer kept the mortgage so who cared about credit risk? They just wanted their 1-2% origination fee that came with each loan. Profits soared. Add deregulation, and securitization, to a somnambulant, laizzez faire Fed, the evisceration under Bush of the regulatory and rating agencies, and a rapacious Wall Street, and we had the makings of a tremendously explosive financial meltdown cocktail.
The real coup de gras came in the 90s with the creation of exotic and mostly unregulated financial instruments called “derivatives” which allowed Wall Street to take an asset, like a mortgage, and “leverage” it many, many times over (30-60:1), ostensibly for “risk management” but just as often for pure speculation. Warren Buffet recently called these derivatives “weapons of financial mass destruction” and many, myself included, have been warning about the unregulated, opaque, and greed infested waters in which they trade as a financial disaster waiting to happen for many years.
What cemented our current disaster was the repeal of the Glass-Steagall Act in 1999, passed in 1933 to prevent the cronyism, corruption, and greed of the 20s, brought to you by the same cast of characters as today, from ever happening again. Glass-Sreagall for over 65 years had stood as an effective bulwark against the baser instincts of bankers, brokers, and politicians, essentially preventing banks from buying brokerages, and both of those from buying insurance companies. It strictly forbade co mingling of funds, clients, and personnel between banks, brokerages, and insurance companies because this is what had led to the meltdown in the 20s, and the Great Depression. With the passage of Graham-Leach-Blyly in 1999, the sponsor of whom recently called us all “a nation of whiners”, and said the recession was “imaginary, and all in our heads”, the last remaining semblance of any economic restraint in financial services disappeared with a flourish of the pen. Investment banks could now own consumer banks, insurance companies, mortgage companies, appraisal companies etc. Imagine the possibilities! For cronyism, conflicts of interest, rampant speculation, and unbridled malfeasance! We got it all, not necessarily in that order, and in less than ten years, the same bankers, brokers, and politicians had us dangling from a knife edge, staring into the financial abyss, staring down the barrel of another Great Depression. Amazing isn’t it? How people, and history never change?
Credit default swaps, originating from insurance companies like AIG in the late 90s, and investment banks on Wall Street like Lehman Brothers, were the real icing on the cake however. These instruments were issued to insure against bond defaults. Sounds simple right? Pay us a premium of X, and we’ll insure your bond issue for Y. If the issue went bad, the originators had recourse against AIG to collect on the losses from the issue. These CDSs (Credit Default Swaps) were used extensively at the height of the housing bubble by nervous mortgage originators worried about the solvency of the underlying mortgage pools they were creating (I wonder why), packaging, and reselling to pension funds, insurance companies, bond funds and individual investors worldwide. The collateralized mortgage obligations (CMOs), GNMAs, FNMAs all represented securitized mortgages. Many of these mortgages were of the sub prime variety.
Problem was, the people insuring these mortgage pools were not using realistic pricing models to evaluate the real intrinsic risk in the new asset (mortgage pool). Surprise, surprise. Their models were using totally unrealistic default rates of 3-4% (marked to myth) because it was more profitable (required fewer reserves) when in actuality, nearly anyone with a cerebral cortex knew the default rates on these CDSs would be much, much, higher. More like 25-30%. And of course, it turns out that the rating agencies were in bed with the purveyors of this trash, giving these bonds highly inflated, and undeserved ratings.
When the housing bubble burst and the asset underlying these derivatives and credit default swaps went south, all hell broke loose of course. The inevitable happened as it always does. The leverage of 30-60:1 started working against the hedge funds, brokers, and banks that had been buying these derivatives. Leverage of 60:1 (possible with the eradication of Gas-Steagall and a complicit Fed) against you is not pretty, as we’ve seen in the last 3 months. The value of these instruments plummeted, forcing these players to raise cash. This required selling all other asset classes from gold to stocks, creating a cascade in the financial markets, an “unwinding” of leverage the likes of which no one has ever seen.
Owners of mortgage backed securities, likewise, demanded restitution from those that had “insured” them against default, AIG and Lehman in this example. AIG was on the hook for anywhere from 40-unknown billions due to their massive issuance of CDSs in the last ten years. It had been a massive revenue generator, but was now about to bury the company. In addition, if AIG did not honor its commitments to pay, many of which were to our major creditors, Japan, China, Korea, and the EU, they would not only never lend us another dime, but a “domino effect” could ensue in which AIGs counter parties went belly up, causing their counter parties to go belly up, creating a symbiotic implosion heard around the world. Oh, and by the way, ending capitalism as we know it. Maybe not such a bad thing. So here we were.
Deregulation=S&L debacle (80s) + Securitization (90s)= financial bubbles in bonds/stocks=bust/tech wreck of 2000 = Derivatives + Credit Default Swaps (2000s)= Housing Bubble Extraordinaire= Bust + Depression. Clear?
Or, if you prefer:
Deregulation – Securitization – Glas-Steagal Repeal–Derivatives – Credit Default Swaps–Financial Armageddon
This is the daisy chain that leads us to today. This financial “unwinding” as CNBC likes to put it, prompted Paulson, who ran Goldman Sachs for years, and is now head of our Treasury unbelievably, to ironically, run red faced, and panting, to that “Big Government” the right loves to demonize so much for a 750 billion “bailout” just a few short weeks ago. Talk about Socialism! A government owned banking and insurance sector??? Why the rush to pump the taxpayer you rightly ask? Kind of reminiscent of Bushes’ “war resolution” just before midterm elections, or ramming the Patriot Act through Congress, isn’t it?
Paulson has intimate ties to AIG through his days at Goldman, which would also be bailed out by the by, and AIG begged him (or paid him) to get them off the hook. Without a handout, they’d go under and the western world as we know it would cease to exist they pleaded. I’m sure this was the scenario. Their dutiful errand boy then runs to Congress and using extortion and threats (falling financial markets and possible martial law) to force Congress to pony up. A little more sophisticated than a protection racket run by the mob, but not by much. So the thugs get their money, select investment banks (Goldman) and banks (Bank of America and 7 others) get bailouts, while others like Lehman Brothers are allowed to go under. Why Lehman you ask?
Because Lehman was a major competitor to Goldman of course, and this was the perfect opportunity to let them be swallowed up by the cess pit of banking history, and free up more business for Goldman and Morgan, the two go to boys for the Federal Reserve. That is, Morgan and Goldman are the two major purveyors of government bonds, and it is they whom “open market operations” of the Fed are choreographed. Couldn’t have the major purveyors of the bankrupt governments worthless paper going out of business, could we? That wouldn’t instill much “con”fidence in what has come to the biggest con game of all, selling government paper.
So friends, as McCain would say, there you have it. PLEASE get your facts straight before showing off your ignorance. It was unbridled, unregulated, and fraudulent use of derivatives and credit default swaps, by Wall Street, and a corrupt Federal Reserve, which led to this fiasco. Not “big government”, not mortgages made to poor people (they never could have been made if the Fed had been doing its job), not Fannie and Freddie, and certainly not the Community Reinvestment Act. This tripe, drivel and vacuous nonsense peddled by the likes of Hannity would be laughable, if our economy were not at stake. These are the same charlatans calling anyone who disagrees with the bald faced lying, corruption, irresponsibility, and disgraceful and unlawful shenanigans of the last eight years, Marxists and Communists. It would be laughable if it weren’t so tiresome, ugly, and untrue. Some people just have no self respect, or shame, it seems.
Good night friends.
Dr. James Glenn
October 31, 2008
End Glenn Article – Begin The Rest of the Story” by Jere L Hough.
I applaud this article, especially the point that this is not a left/right, liberal/conservative or Democrat/Republican issue. Nor is it an exercise in placing the blame just to make the “other guy” look bad. The only valid reason for fixing blame is in order to come up with the right solution. It also does little good and much possible harm to blame persons for systemic problems, unless the systemic flaws are also addressed.
Dr. Glenn is accurate on every point he covers. He just doesn’t cover nearly enough.
He sums it up in a very helpful way:
“Deregulation=S&L debacle (80s) + Securitization (90s)= financial bubbles in bonds/stocks=bust/tech wreck of 2000 = Derivatives + Credit Default Swaps (2000s)= Housing Bubble Extraordinaire= Bust + Depression. Clear?
Or, if you prefer:
Deregulation – Securitization – Glas-Steagal Repeal–Derivatives – Credit Default Swaps–Financial Armageddon”
To his list of causation I could add another dozen or two of antecedents, going back to the wars, panics, booms and busts, and The Great Depression of the 20th Century, and all the way back to the US Constitution itself, and the Supreme Court decisions from that time to today.
I will leave out the details and get to the last layer of the onion.
MONEY – The Founding Fathers of our nation did not understand or properly define the nature of money, where it should come from, how it should come into being, how its value should be regulated, and by whom it should be created and regulated. At least they could reach no consensus on money. Jefferson, Franklin, Madison, and Paine had some advanced ideas on the subject, especially Franklin. This inability to reach a consensus that was written into our constitution has led to an imbalance of political and economic power that was not foreseen by the FFs, or they would have provided checks and balances to issues of economic and monetary power and policy, as they tried doing with other powers and functions of federal government.
The largest and most essential of these neglected constitutional issues are whether or not money should be publicly or privately created and controlled and how “money” is defined.
Definition: Money is a medium of exchange. It can be any medium, as long as it is nearly universally accepted within a given economy, and it accepted in payment of government taxes and fees. Money can be metal coins, paper, commodities, checks, accounting entries (debits & credits) on paper or electronically, debit or credit card transactions, and so on. The purpose of money is to enable transactions of land, resources, products, labor and services (real wealth).
The US Constitution does give clear authority to congress to coin (create) money and set its value. (Article 1, Section 8)
The creation of money in any and all its forms should be a sovereign right and responsibility. In a democracy or republic the “citizen” is the ultimate sovereign, and only cedes certain sovereign rights to government in a “social contract” – matters of maintaining civil order, defense, safety of person, home, business, trade and commerce, education, public health, sanitation, water, utilities and infrastructure such as roads, bridges, schools and media centers. All other sovereign rights not “ceded” to governments are to be retained by “the people”. This includes the right to use one’s labor and creativity to work as he chooses and to profit from his labors or their fruits, the end products.
In order to profit from the fruits of one’s labors one must sell or market them. So trade, commerce and markets are essential rights, as is the right to barter, exchange, or use a common medium of exchange to assist in realizing the fruits of one’s labor. That means having access to money to use to grease the wheels of trade. So the creation of money should be a sovereign right that can be delegated upward to be useful to more people and wider markets. Money should be under public supervision. Money should not be privately created and loaned into circulation as it is today, under our unconstitutional Federal Reserve System.
Money creation should be a public enterprise, according to formula including population and trade per capita, and other considerations.
The point is that the usurious system of money-creation and regulation we have today is broken, and banker and corporate elites with heavily vested interests want to keep us from fixing it, or even discovering the true causes of its failure. Banking and money creation as it is structured today is nothing but a grand Ponzi Scheme – the granddaddy of them all – huge enough to funnel the world’s wealth up the pyramid to those at the very top – while giving those in the middle the illusion of prosperity until the growth at the bottom stops, as it always must.
Unless the power to create interest-free money is reclaimed by the public (our government) there is no hope of avoiding an escalating and widening Apocalypse. The derivates and credit default swaps are just the looters and plunderer’s “new game strategies” for grabbing all they can before it all unwinds, or collapses – same thing.
Collapse will mean world financial and political reorganization, with new global money and new economic systems. ( [i] ) In many or most places it will mean martial (military) law, curfews, banning of private or public discussions and meetings, gasoline or food rationing, and possibly the economically or militarily forced enslavement of populations – for their own protection, of course. Their lands and resources may be “appropriated” in a number of ways, lease, purchase, or outright theft – annexation. It won’t be a pretty scenario.
The solution is to create viable alternative public money systems. On the US National level the window has probably closed for the ideal solution – placing the Fed and FRS under public control – even with the election of “pro-change” Barack Obama as US President and a more liberal democratic congressional majority. But there are other levels of government that could implement their own currencies, credits, or bookkeeping systems that could allow local commerce to continue.
It is my view that the US Constitution preserves the rights of people to a fair and just medium of exchange (money) with which to advance commerce and trade in private and public transactions. Furthermore, the background discussions, papers and letters of the framers show they would have been in agreement with this just principle of fair, debt-free money.
In today’s world and with our current technology, only the cost of maintaining an office with a half-dozen staff, fail-safe accounting system and printing press should suffice to keep track of most commerce of a decent-sized town. Merchants and customers could pay a small transaction fee far less than today’s ATM charges to keep the system going.
It remains to be seen how such local, county or state money or debit systems will be viewed by national and global government and monetary authorities. However, it is probably a survival paradigm to experiment with alternative systems of monetary exchange. It will certainly be better than barter.
(i) This will probably mean returning to some kind of money at least partially backed by gold, silver or other precious metals, gems or commodities. Or it could be pure fiat, backed by nothing but the “full faith and credit” of that issuing government or corporate authority. It really matters little to a society what the so-called “backing” is. What matters is who issues it, public or private – and whether or not those who “create it” charge interest, and use a “fractional reserve” basis for loaning (creating) money. The best and most stable money is debt-free money that can be spent into circulation by communities, towns, cities, states or nations for the public welfare. Private money creation by making fractional reserve loans is immoral, unethical and should be illegal. It is a “Ponzi Scheme”, pure and simple, only on a scale for too large for most people to ever comprehend or imagine possible.
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