By L. Randall Wray
A version of this post first appeared at "Great Leap Forward”, my EconoMonitor blog.
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 JPMorgan Chase 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 fire sales (pun intended) 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.
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’s banking brethren 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 the FIRE sector aka 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 use to repo against the explosion of collateralized OTC derivatives positions taken on by financial institutions with one another starting back in the mid 1990s. Wall Street needed another source of collateral for financial leverage.
You see, all the top financial institutions are dens of thieves, and thieves know better than to trust one another. So (derivatives) transactions between fellow thieves have 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.