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Why We're Screwed
July 24, 2012 | L. Randall Wray
As the Global Financial Crisis rumbles along in its fifth year, we read
the latest revelations of bankster fraud, the LIBOR scandal. This
follows the muni bond fixing scam detailed a couple of weeks ago, as
well as the J.P. Morgan trading fiasco and the Corzine-MF Global
collapse and any number of other scandals in recent months. In every
case it was traders run amuck, fixing "markets" to make an easy buck at
someone's expense. In times like these, I always recall Robert
Sherrill's 1990 statement about the S&L crisis that "thievery is
what unregulated capitalism is all about."
After 1990 we removed what was left of financial regulations following
the flurry of deregulation of the early 1980s that had freed the thrifts
so that they could self-destruct. And we are shocked, SHOCKED!, that
thieves took over the financial system.
Nay, they took over the whole economy and the political system lock,
stock, and barrel. They didn't just blow up finance, they oversaw the
swiftest transfer of wealth to the very top the world has ever seen.
They screwed workers out of their jobs, they screwed homeowners out of
their houses, they screwed retirees out of their pensions, and they
screwed municipalities out of their revenues and assets.
Financiers are forcing schools, parks, pools, fire departments, senior
citizen centers, and libraries to shut down. They are forcing national
governments to auction off their cultural heritage to the highest
bidder. Everything must go in firesales at prices rigged by
twenty-something traders at the biggest and most corrupt institutions
the world has ever known.
And since they've bought the politicians, the policy-makers, and the
courts, no one will stop it. Few will even discuss it, since most
university administrations have similarly been bought off - in many
cases, the universities are even headed by corporate "leaders" - and
their professors are on Wall Street's payrolls.
We're screwed.
Bill Black joined our department in 2006. At UMKC
(and the Levy Institute) we had long been discussing and analyzing the
GFC that we knew was going to hit, using the approaches of Hyman Minsky
and Wynne Godley. Bill insisted we were overlooking the most important
factor, fraud. To be more specific, Bill called it control fraud, where
top corporate management runs an institution as a weapon to loot
shareholders and customers to the benefit of top management. Think Bob
Rubin, Hank Paulson, Bernie Madoff, Jamie Dimon and Jon Corzine. Long
before, I had come across Bill's name when I wrote about the S&L
scandal, and I had listed fraud as the second most important cause of
that crisis. While I was open to his argument back in 2006, I could
never have conceived of the scope of Wall Street's depravity. It is all
about fraud. As I've said, this crisis is like Shrek's Onion, with fraud
in every layer. There is, quite simply, no part of the financial system
that is not riddled with fraud.
The fraud cannot be reduced much less eliminated. First, there are no
regulators to stop it, and no prosecutors to punish it. But, far more
importantly, fraud is the business model.
Further, even if a financial institution tried to buck the trend it
would fail. As Bill says, fraud is always the most profitable game in
town. So Gresham's Law dynamics ensure that fraud is the only game in
town.
As Sherrill said, without regulation, capitalism is thievery. We stopped regulating the financial system, so thieves took over.
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A century ago Veblen analyzed religion as the quintessential capitalist
undertaking. It sells an inherently ephemeral product that cannot be
quality tested. Most of the value of that product exists only in the
minds of the purchasers, and most of that value cannot be realized until
death. Dissatisfied customers cannot return the purchased wares to the
undertakers who sold them - there is no explicit money back guarantee
and in any event, most of the dissatisfied have already been undertaken.
The value of the undertaker's institution is similarly ephemeral,
mostly determined by "goodwill". Aside from a fancy building, very
little in the way of productive facilities is actually required by the
religious undertaker.
But modern finance has replaced religion as the supreme capitalistic
undertaking. Again, it has no need for production facilities - a fancy
building, a few Bloomberg screens, greasy snake-oil salesmen, and some
rapacious traders is all that is required to separate widows and orphans
from their lifesavings and homes. Religious institutions only want 10%;
Wall Street currently gets 20% of all the nation's output (and 40% of
profits), but won't stop until it gets everything.
There is rarely any recourse for dissatisfied customers of financial
institutions. Few customers understand what it is they are buying from
Wall Street's undertakers. The product sold is infinitely more
complicated than the Theory of the Trinity advanced by Theophilus of
Antioch in 170 A.D., let alone the Temple Garments (often called Magic
Underwear by nonbelievers) marketed today. That makes it so easy to
screw customers and to hide fraud behind complex instruments and
deceptive accounting.
A handful of thieves running a modern Wall Street firm can easily run up
$2 trillion in ephemeral assets whose worth is mostly determined by
whatever value the thieves assign to them.
And that is just the start. They also place tens of trillions of dollars
of bets on derivatives whose value is purely "notional". The thieves
get paid when something goes wrong - the death of a homeowner, worker,
firm, or country triggers payments on Death Settlements, Peasant
Insurance, or Credit Default Swaps. To ensure that death comes sooner
rather than later, the undertaker works with the likes of John Paulson
to handpick the most sickly households, firms and governments to stand
behind the derivative bets.
And the value of the Wall Street undertaker's firm is almost wholly
determined by euphemistically named "goodwill" - as if there is any good
will in betting on death.
With these undertakers running the show, it is no wonder that we are
buried under mountains of crushing debt - underwater mortgages, home
equity loans, credit card debt, student loans, healthcare debts, and
auto-related finance. Simply listing the kinds of debts we owe makes it
clear how far along the path of financialization we have come:
everything is financialized as Wall Street has its hand in every pot.
Thirty years ago we could still write of a dichotomy - industry versus
finance - and categorize GE and GM as industrial firms, with Goldman
Sachs as a financial firm. Those days are gone, with GM requiring a
bail-out because of its financial misdealings (auto production was just a
sideline business used to burden households with debt owed to GMAC, the
main business line), and Goldman Sachs buying up all the grain silos to
run up food prices in a speculative bubble. Obamacare simply fortifies
the Vampire Squid's control of the healthcare industry as it inserts its
strangling tentacles into every facet of life.
Food? Financialized. Energy? Financialized. Healthcare? Financialized.
Homes? Financialized. Government? Financialized. Death? Financialized.
There no longer is a separation of the FIRE (finance, insurance, and
real estate) and the nonFIRE sectors of the economy. It is all FIRE.
Everything is complexly financed. In the old days a municipal government
would sell a twenty year fixed rate bond to finance a sewage system
project. Now they hire Goldman to create complex interest rate swaps (or
even more complex constant maturity swaps, swaptions, and snowballs) in
which they issue a variable rate municipal bond and promise to pay the
Squid a fixed rate while the Squid pays them a floating rate linked to
LIBOR - which is rigged by the Squid to ensure the municipality gets
screwed. Oh, and the municipal government pays upfront fees to Goldman
for the sheer joy of getting screwed by Wall Street's finest.
The top four US Banks hold $171 Trillion worth of derivative deals like
this. Derivatives are really just bets by Wall Street that we will get
screwed - it is all "insurance" that pays off when we fail. Everything
is insured - by them against us.
What is healthcare "insurance", really? You turn over your salary to
Wall Street in the hope that should you need healthcare, they will allow
your "service provider" to provide it. But when you need the service,
Wall Street will decide whether it can be provided.
Oh, and Wall Street's undertakers have also placed a bet that you will
die sooner than you expect, so it wins twice by denying the coverage.
Finally, US real estate - the RE of the FIRE - underlies the whole kit
and caboodle. That is the real story behind the GFC: given President
Clinton's budget surpluses and the simultaneous explosion of private
finance, there simply was not enough safe federal government debt to
collateralize all the risky debt issued by financial institutions to one
another back in the mid 1990s. Wall Street needed another source of
collateral.
You see, all the top financial institutions are dens of thieves, and
thieves know better than to trust one another. So lending to fellow
thieves has to be collateralized by safe financial assets - which is the
traditional role played by Treasuries. But there were not enough of
those to go around so Wall Street securitized home mortgages that were
sliced and diced to get tranches that were supposedly as safe as Uncle
Sam's bonds. And there were not enough quality mortgages, so Wall Street
foisted mortgages and home equity loans onto riskier borrowers to
create more product.
Never content, in order to suck more profit out of mortgages, Wall
Street created "affordability" products - mortgages with high fees and
exploding interest rates - that it knew would go bad. Even that was not
enough, so the Squids created derivatives of the securities
(collateralized debt obligations - CDOs) and then derivatives squared
and cubed - and then we were off and running straight toward the GFC.
Wall Street bet your house would burn, then lit a firebomb in the basement.
Mortgages that were designed to go bad would go bad. CDOs that were designed to fail would fail.
Suddenly there was no collateral behind the loans Wall Street's thieves
had made to one another. Each Wall Street thief looked in the mirror and
realized everything he was holding was crap, because he knew all of his
own debt was crap.
Hello Uncle Sam, Uncle Timmy, and Uncle Ben, we've got a problem. Can you spare $29 Trillion to bail us out?
And that is why we are screwed.
I see two scenarios playing out. In the first, we allow Wall Street to
carry on its merry way, as the foreclosure crisis continues and Wall
Street steals all homes, packaging them into bundles to be sold for
pennies on the dollar to hedge funds. All wealth will be redistributed
to the top 1% who will become modern day feudal lords with the other 99%
living at their pleasure on huge feudal estates.
You can imagine for yourselves just what you're going to have to do to pleasure the lords.
This will take years, maybe even a decade or more, but it is the long
march Wall Street has formulated for us. To be sure, "formulated" should
not be misinterpreted as intention. No one sat down and planned the
creation of Western European feudalism when Rome collapsed. To be sure,
the modern day feudal lords on Wall Street certainly conspire - to rig
LIBOR and muni bond markets, for example - and each one individually
wants to take as much as possible from customers and creditors and
stockholders. But they are not planning and conspiring for the
restoration of feudalism. Still, that is the default scenario - the
outcome that will emerge in the absence of action.
In the second, the 99% occupy, shut down, and obliterate Wall Street.
Honestly, I have no idea how that can happen. I am waiting for
suggestions.
Professor L. Randall Wray
is Professor of Economics at the University of Missouri-Kansas City,
Research Director with the Center for Full Employment and Price
Stability and Senior Research Scholar at The Levy Economics Institute.
