“Change,” you say?

Part 2: Financial meltdown

By William C. Shelton

(The opinions and views expressed in the commentaries of The Somerville News belong solely to the authors of those commentaries and do not reflect the views or opinions of The Somerville News, its staff or publishers.)

Responsibility for the financial meltdown is so pervasive that it's hard to identify a blameless economic sector, consumer population, or political institution. Eight years ago, Fannie Mae and Freddie Mac bought Congressional approval to securitize subprime loans. Congress subsequently declined to reform their irresponsible, and Federal-Reserve-Bank-blessed lending practices, even after they were caught cooking their books. Fanny and Freddy executives grew wealthier and more powerful.

Exploiting the myth of eternally rising housing values, mortgage brokers persuaded the gullible to buy homes they couldn't afford; commercial banks knowingly bundled bad mortgages and sold them to Wall Street; investment banks knowingly sold larger bundles called “CDOs” to institutional clients; bond raters knowingly gave the CDOs triple-A ratings; insurers knowingly underwrote them; investment banks paid themselves high interest rates to hold the worst mortgages; and the Federal Accounting Standards Board knowingly allowed investment banks to hide their risky mortgages offshore and off their balance sheets.

At each level up the chain, greedheads grew wealthier and more powerful. They bought Congressional decisions for shamefully small change.

People with no down payment, bad credit, and insufficient incomes knowingly mortgaged homes with adjustable interest rates. Homeowners with equity knowingly borrowed heavily against it to buy crap from China. Other consumers, wooed by an onslaught of inducements from credit card companies with extortionate interest rates, knowingly ran up massive debt. Credit card issuers grew wealthier and more powerful.

Private equity funds mushroomed in size. Their mangers made questionable investments in businesses and allowed those businesses to leverage risky amounts of debt. Lenders knowingly wrote loan agreements so lax, they were jokingly referred to as “covenants light.” Greedheads grew in wealth and influence.

The most irresponsible borrowers of all were the Reagan, Bush I, and Bush II administrations, with the collusion of both parties. While the current administration makes noises about “bringing democracy to the Middle East,” it has scant ability to influence the undemocratic Chinese regime that holds a trillion dollars in U.S. debt.

Recklessness and greed were so widespread, one might conclude that Americans are bad people. More explanatory is understanding that our economic institutions encourage bad behavior, corrupting political and social institutions. The tepid “change” that Barack Obama and John McCain promise will make little difference. Only transforming institutions at their roots will. The financial meltdown is an excellent example of why.

Embedded in the very economic institutions that gave us democracy and paid for our way of life was the dynamic that is now undermining both. The type of economic transaction that began rising to dominance 400 years ago was the first and only that began with capital, used it to purchase materials and human labor, and sold the resulting products and services for more capital than it started with.

The capitalist who merely consumes this profit will soon cease to be a capitalist. Capital must continually expand or die. Profit is reinvested where it yields the highest possible rate of profit, whether or not such investments injure the common good. As this expansion becomes globalization, multinational corporations' obligation to pursue profit by any means necessary must necessarily vitiate loyalty to governments, their people, and the planet itself. All become instruments toward maximizing profit.

An argument for unfettered markets that once had merit was that competition produces the best products at the lowest prices. But another dynamic inherent in our financial institutions is that at the end of each round of competition, there are fewer competitors in the ring, with greater wealth and power.

So great is that wealth and power that they manipulate the policies of other institutions to accumulate more wealth and power.

J.P. Morgan eats Bear Stearns and Washington Mutual; Bank of America eats Merrill Lynch and Countrywide Financial; Citigroup eats Wachovia; Nomura and Mitsubishi snack on Lehman Brothers and Moran Stanley. As incumbents in a market become fewer and more powerful, cooperating to dominate that market and public policies affecting it becomes more advantageous than competing within it.

During the Bush II administration, the richest 400 Americans have increased their wealth by $670 Billion, while 6 million Americans slipped into poverty. Five million lost their health insurance. IRS data show that in the last two years, income gains for the top one-tenth of 1 percent of Americans equaled those of the bottom half.

When the most powerful firms reap the worldwind of reckless greed, government throws up its hands, saying that, “They're too big to be allowed to fail.” Imagine the trouble that JP Morgan, Bear Stearns, and Merrill Lynch can get into as they digest their meals.

Concentrated wealth buys the public policy and those who implement it. Pick any industry. Its top executives take turns changing places with its top regulators. Secretary Henry Paulson came to the Treasury from investment bank Goldman Sachs, which itself made a tidy bundle by selling subprime bonds short. Like Claude Raines in Casablanca, Paulson now looks at those in his industry who lost high-stakes gambles and says, “I'm shocked! Shocked that gambling is going on here!” And as in Casablanca, a house employee says, “Here are your winnings, Mr. Paulson.” In 2006, his bonus alone was $38 million; his personal net worth is half a billion.

The financial collapse appeared to happen in the space of a week. Throughout 2007, leaders like Paulson and Fed Chairman Bernanke told us that the damage was “contained,” despite their full knowledge of the foregoing. They lied. That is their job within today's economic and political institutions. The bailout is to be guided by the most knowledgeable “consultants,” that is…investment bankers, and to be underwritten by…bond insurers.

All but a few of the greedheads who created the meltdown were working legally within our financial institutions. The problem is our institutions themselves. John McCain and Barack Obama both present themselves as “change agents.” McCain, who at last reporting received $6.8 million in financial industry contributions, claims that bad people caused the meltdown. Obama, who received $9.8 million, claims that the only change necessary is to elect himself and other Democrats, who will increase regulation.

Economic institutions that concentrate such enormous wealth and power mutilate democracy. The laws that they will allow to pass will make patchwork improvements, while leaving the intrinsic institutional dynamics intact.

They will do little to reduce the coming hardships. Insufficient credit will curtail planned expansions, doom construction projects and squeeze out small businesses, throwing their workers into unemployment. The current rate of 9,800 home foreclosures a day will increase. Fewer Americans will go to college, while more will sink into poverty. Most small businessmen will continue to blindly identify with corporate giants while getting hosed by them.

Perhaps as they suffer, Americans will begin discussing real institutional change. Or not.

Comments

[Trade Meme]

Great post. Thanks for the analysis.

[Somervillen00b]

At minimum, more regulations are necessary enforcing transparency and the maximum size these companies can get. I doubt Gramm will do it. That leaves us with Obama. Bill, I'm surprised you cannot admit that the Obama team has the best economic plan, as many economists have acknowledged. Could it be that you are not ready for a black President?

[Bill Shelton]

"Bill, I'm surprised you cannot admit that the Obama team has the best economic plan, as many economists have acknowledged."

"Best economic plan" compared to what? Certainly not compared to what is really necessary.

[William Hurst]

Bill, does Barack Hussein Obama have an economic plan? When he is sworn in as this nations 44th President, he will arrive in Washington having not defeated John McCain but as someone who has defeated President George Bush. If it were anyone but Bush that happened to be President right now, it would force people to actually look at a candidates qualifications to become this nation next leader. People are so consumed with hatred for Bush that they would vote for anyone or anything as long as it is not him. Another example of this is, in New Hampshire is Jean Shaheen running against John Sununu or George Bush? Another fine example how is Deval doing and wouldn't Kerry Healey look better right now.

[JARfromWard3]

From what I've seen, the two large parties' candidates "economic plans" both involve abdicating more power to the FED. Today's "emergency" interest rate cut will only, in my opinion, serve as short term salve. Long term--and this would be a worse (vs. worst) case scenario, it will devalue the US Dollar at a time when monetary policy should be geared toward strengthening it.

Keynes didn't consider the phenomena of stagflation, and could never really explain it. The time may have come to give Mises and Austrian Economics a try. There's no perfect solution, but anything is better than the BS that Paulson, Bernanke, et al are feeding us presently. Unfortunately, I don't see it happening with either McCain or Obama, who both seem stuck on this bizarre concept of Capitalism on the way up and Socialism on the way down. That is NOT a sustainable economic model.

Just my opinions.

73
JAR

[Truth Fan]

I watched the debate last night. Neither of the candidates had anything insightful to say about our economic state of affairs. They didn't offer any solutions that promised a clear break with the past.

I remember when Americans were shocked by the Savings and Loan crisis and how much the bailout cost. Then there were the Enrons and World Coms who exploited consumers and states with the blessing of elected officials. They got caught, but all but a tiny few kept their booty. They went on to get richer and screw other people, while their former employees lost their savings.

Now we've got this mess created by huge financial institutions. And you're right, the result is only going to be even bigger financial institutions, with more power, and more ability to do whatever they want.

Our so called leaders don't lead, they react. And the voters are sheep. Maybe I'm imagining it, but when I was young in the 50s and 60s, more people seemed to have the ability of critical thinking. Television and the newspapers are so dumbed down, you can't do anything with the "news" they report.

I appreciate what you're doing here, Bill, and I appreciate your independence. You're taking something that is very complicated and going to the essentials of it. That's where we have to start, not putting band aids on a tumor. I hope that it will push people who read it outside of their normal habits of thinking just a little bit.

[The Patriot]

And the real change must be a tax on standing wealth of those who amassed trillions....their accounts must be frozen worldwide, so that their fortunes do not escape, so that the inflation needed to offset what they have taken off the table is halted, and their weaalth is taken back to right the system. Otherwise, everyone of modest means will subsidize their windfalls in the higher energy and food prices they will pay.
But I do not attribute this greed to
a random set of opportunistic happenstances, rather I believe that Bush and his consorts planned this swindle from the start. He's not as dumb as he pretends to be...his exit strategy requires he look unknowing.
Where are you on these thought, Bill?

[NewSomervillian]

Here's my take as an Eastern European transplant: during the Cold War, the Western Bloc and the Eastern Bloc achieved cohesion amongst their people through what essentially boiled down to decades of brainwashing about the superiority of their respective economic and political systems. Then the Eastern Bloc crumbled, and its peoples were rudely awakened to the fact that not only was their system not superior, but that the Western capitalist ways they eagerly embraced also brought about insecurity and poverty. Meanwhile, the Western Bloc, and specificaly the US, never had that moment of paradigm-shifting illumination. Americans still sincerely believe in their superiority as a nation, and as a political and economic system. It is political suicide for any candidate to try to imply that capitalism is not the answer. That's why I think nationalizing or strongly overseeing critical financial institutions in this time of major economic crisis is so hard for the public here to swallow, even though it's completely obvious to an outsider like me. Let's hope Obama has more radical change up his sleeve once he's in power, because I certainly don't have any illusions about McCain.