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Article by Rodrigue Tremblay - "Financial Bankruptcy, the US Dollar, and the Real Economy"
RODRIGUE TREMBLAY is a prominent Canadian-born economist with a Ph.D. from Stanford University. he can be reached at rodrigue.tremblay@yahoo.com He is a former Woodrow Wilson fellow and a Ford International Fellow. He is now professor emeritus at the University of Montreal, after having occupied the positions of full professor of economics at the University of Montreal, president of the North American Economics and Finance Association, president of the Canadian Economics Society, and advisor to numerous organizations. From 1976 to 1979, he was minister of Industry and Commerce in the Quebec government. He is presently vice-president of the International Association of French-speaking Economists.
Residential mortgage-backed security (RMBS) are created when mortgage lenders sell their loans (and the risks associated with such loans) to banks, which package them together and slice them into different classes before selling them to (gullible) investors. This process, called “asset securitization” is the method whereby interests in mortgage loans and other receivables are packaged, underwritten, and sold in the form of “asset-backed securities”. This is financial alchemy, through which subprime mortgage loans are transformed into AAA-rated paper for unsuspecting investors.
Some of these artificial or derivative securities are low-grade quality, and when their prices fall because borrowers cannot meet their interest or capital payments, such financial instruments become quickly “illiquid” or unsalable, since nobody wants to touch them. They become fictitious capital. Those who hold them, investors, banks or other types of lenders, are stuck with them: they cannot sell them and they cannot borrow while placing such shaky assets as collateral. These are the imprudent lenders and investors that central banks now are trying to bail out.
During the French Revolution (1789-1799), the Jacobins (the Neocons of the day) had the brilliant idea of issuing securities, called “assignats,” based on the properties (buildings and lands) the government had taken away from the Church and its religious orders. The new securities were quickly “monetized” into fiat money and transformed into readily available cash. This caused a massive hyperinflation and a subsequent deflation.
Mind you, this was not the first time that 18th-century France lived an experience of inflationary finance, since a similar incident took place three quarters of a century before, between 1716 and 1720, when Scottish banker and businessman John Law (1671-1729) led France into a fiat money fiasco and engineered a land-backed securities scheme known as the Mississippi Bubble. John Law’s earlier experiment and the French Revolution assignats debacle should be clear reminders of the danger and folly of “monetizing” illiquid assets-based securities.
Like all “Ponzi schemes,” such pyramidings of debts with no liquid assets behind them are bound to implode sooner or later. And that is what we are witnessing today, i.e., the implosion of unfunded credit derivatives-based “Ponzi schemes”. In 1998-2000, we got an idea of what could happen when portfolios are highly leveraged and laden with derivative financial products with the collapse of one large hedge fund, the Long-Term Capital Management.
Some of these artificial or derivative securities are low-grade quality, and when their prices fall because borrowers cannot meet their interest or capital payments, such financial instruments become quickly “illiquid” or unsalable, since nobody wants to touch them. They become fictitious capital. Those who hold them, investors, banks or other types of lenders, are stuck with them: they cannot sell them and they cannot borrow while placing such shaky assets as collateral. These are the imprudent lenders and investors that central banks now are trying to bail out.
During the French Revolution (1789-1799), the Jacobins (the Neocons of the day) had the brilliant idea of issuing securities, called “assignats,” based on the properties (buildings and lands) the government had taken away from the Church and its religious orders. The new securities were quickly “monetized” into fiat money and transformed into readily available cash. This caused a massive hyperinflation and a subsequent deflation.
Mind you, this was not the first time that 18th-century France lived an experience of inflationary finance, since a similar incident took place three quarters of a century before, between 1716 and 1720, when Scottish banker and businessman John Law (1671-1729) led France into a fiat money fiasco and engineered a land-backed securities scheme known as the Mississippi Bubble. John Law’s earlier experiment and the French Revolution assignats debacle should be clear reminders of the danger and folly of “monetizing” illiquid assets-based securities.
Like all “Ponzi schemes,” such pyramidings of debts with no liquid assets behind them are bound to implode sooner or later. And that is what we are witnessing today, i.e., the implosion of unfunded credit derivatives-based “Ponzi schemes”. In 1998-2000, we got an idea of what could happen when portfolios are highly leveraged and laden with derivative financial products with the collapse of one large hedge fund, the Long-Term Capital Management.
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