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by MICHAEL HUDSON
When the financial bubble burst in September 2008, U.S. and European governments responded by shifting bank losses onto their own balance sheets. The pretense is that real growth cannot resume until the banks and speculators are “made whole.” To cover the cost of bailing out the banks, governments now are trying to run budget surpluses. This adds fiscal deflation to the debt deflation left in the bubble’s wake, shrinking the economy at large. Governments are raising taxes (or simply print new debt to swap for the financial sector’s bad loans and gambles) to reimburse financial institutions whose lending and outright gambling (not to mention the excursion into financial fraud) caused the crisis.
This financial and fiscal austerity is unnecessary – and counter-productive. The aim is to save the financial sector, not the economy. The working assumption is that bank lending must revive growth by clearing balance sheets for the next debt bubble. As TARP Special Inspector General Neil Barofsky has described, “saving the banks” has been a euphemism for saving Wall Street from losses, not to mention criminal prosecution.
Federal Deposit Insurance Corporation regulator Sheila Bair has described how depositors at Citibank and Bank of America could have been saved without keeping the banks’ speculative web of gambles and junk mortgage loans on the books. The FDIC could have treated these megabanks like it did Washington Mutual and other failed institutions, wiping out their stockholders and counterparty claims for their bad trades and liars’ loans. This would have annulled the overgrowth of speculative gambles and high-risk deposits that had no connection with retail banking. Taking over Citicorp as majority stockholder would have enabled the FDIC to renegotiate its mortgages downward for borrowers in negative equity. As a public ward, the bank could have fired its bad officers rather than letting them give themselves bonuses. None of this was done. The idea of a public option in banking was anathema.
Likewise, Barofsky’s Bailout memoir explains how the $182 billion loan to the insurance giant AIG could have been done as a takeover – on terms that segregated its British derivatives gambling unit (operating under Gordon Brown’s notoriously “light touch” at the Financial Services Authority) from the parent company’s basic “bread and butter” insurance operations. This would have saved the Treasury from having to pay Goldman Sachs and other counterparties, including French banks.
Neither the Treasury nor AIG protested against paying these counterparties. The ideological compact between winners and losers was that the gambling contracts were sacred. If losers could not pay, the government would lend them the money to do so. Wall Street’s Las Vegas was deemed essential. This was the logical conclusion of repealing Glass-Steagall and intermixing investment banking and CDO derivatives with the financial system’s basic deposit and lending functions.
By saving high finance (and much of low finance) and pushing the loss onto the economy at large, government’s policy preserved the financial system’s dominance – on the pretense that this was necessary to revive the economy, not bury it under a mountain of debt.
Barofsky is especially scathing when it comes to Tim Geithner’s claim that it was not possible to oblige AIG’s counterparties to “take a haircut” on its loans because French law did not permit banks to lose money.
Geithner’s team undercut any chance of getting relief for the taxpayer by deciding that no one concession would be accepted unless all of the banks agreed to the exact same percentage reduction. The New York Fed officials told us that for this reason, after the regulator overseeing AIG’s French bank counterparties told them that it would be against French law to accept less than full value for the bonds, the negotiations effectively ended. (Bailout, pp.184-87.)
This deception was put forth in a panic atmosphere to bamboozle Congress into letting Geithner (then head of the New York Federal Reserve) and Treasury Secretary Hank Paulson pay Goldman Sachs (Paulson’s alma mater) and other Wall Street’s heavy winners. But there was no truth to the claim that French law prevented banks from taking a loss, or that the U.S. Government had to apply the same giveaway offer to Wall Street. When Barofsky subsequently called the French regulator, she emphasized that she had not ‘slammed the door’ on negotiations and had been more than ready to engage in them with the Fed as long as they were at a high level and universal. But she told us that the Fed officials had never seriously pursued that option, commenting that she had been surprised when the Fed officials had never called back. When I asked her about the Fed’s assertion that it would be illegal under French law to agree to a discount, she said that the French government could have waived that restriction.
The effect was to funnel “tens of billions of dollars of government money … directly to the banks. We therefore labeled the deal what it was, a ‘backdoor bailout of the banks.’” This inspired AIG’s head, Maurice R. Greenberg, to sue the U.S. Government, claiming that it “used billions of dollars from A.I.G. to settle credit-default swaps the insurer had with banks like Goldman Sachs, which received $12.9 billion in winning bets against AIG on CDOs (collateralized debt obligations). The deal, according to the lawsuit, empowered the government to carry out a ‘backdoor bailout’ of Wall Street.” (Ben Protess and Michael J. De La Merced, “Rescued by a Bailout, A.I.G. May Sue Its Savior,” The New York Times, January 8, 2013.)
It seems ironic that the main protest against the giveaway by the Federal Reserve Board and Treasury has been mounted not by U.S. voters but by the Mr. Greenberg arguing that the Treasury used AIG simply as a throughput vehicle to reward Wall Street with its casino winnings. True, as Barofsky explains (pp. 180f.):
The deal was a gross distortion of the normal functions of the market. In a bailout-free world, instead of being saved by the government, AIG would have been unable to make its cash collateral payments to the banks and gone into bankruptcy. As a result, the banks would have been left with the CDOs and stuck with their continued declines in value. Those losses would have punished the banks for what had been bad and risky bets – i.e., assuming that AIG would be able to meet all of its obligations. In market parlance, each of the banks would have borne the ‘counterparty risk’ of doing business with AIG and suffered the consequences of betting on the wrong counterparty. Instead they were paid out in full. In that respect, Geithner’s opening of the spigot of taxpayer cash for AIG was more of a bailout of the banks than it was for AIG itself.
It didn’t have to be this way. But AIG took the loan rather than seeing the company go bankrupt. One can only wish that Congress had been assertive as the corporate raider Carl Icahn was when he wrote in a New York Times op-ed (“We’re Not the Boss of A.I.G.,” The New York Times, March 29, 2009): “What the government should have gotten was board representation in return for its large investment in A.I.G.” It could have involved wiping out AIG stockholders and upper management – a fact that prompted The New York Times to characterize Mr. Greenberg’s suit as “an audacious display of ingratitude.” Shouldn’t he (or at least his fellow AIG stockholders, who have refrained from joining his suit) have been grateful to the government for lending AIG enough to pay the Wall Street giants?
The government certainly had good reason not to take public liability for AIG’s bad gambles. But it could have taken over the “bread and butter” business of the sorts regulated by state insurance agencies. Instead, Treasury fought against state regulatorswho sought to take over local AIG business. From the vantage point of what was best for the economy west of Wall Street, everything was done upside down. After the ratings agency downgraded the CDO’s that AIG had guaranteed by treating insurance premiums “as free money,”[1] AIG’s goose was cooked.
Perhaps the most notorious example of how accommodating Geithner was after becoming Treasury Secretary was his approval of paying AIG’s reckless London office $180 million in bonuses. Barofsky accuses Treasury officials of doing little “to oversee the taxpayers’ $40 billion investment. For example, they could have forced AIG to renegotiate the terms of the contracts as a condition of the additional $30 billion in TARP funds that they had announced several days after learning about the imminent bonus payments.” Instead of alerting Congress and the public to the options available, “Treasury and Geithner stood behind the ‘sanctity’ of the executives’ contracts.”
The Clinton Administration refused to regulate CDO gambles, adopting the deregulatory Rubinomics ideology of Larry Summers, Ayn Rand disciple Alan Greenspan and Wall Street campaign contributors. So AIG was under no obligation to hold any reserves for losses against its bets. Little has changed under President Obama. The moral is that fictitious economic theory as public relations for the financial sector has heavy real-world costs (which academics call “externalities,” not included in free-market balance sheet of costs in benefits).
Why pay anything at all? That is the real question that needs to be discussed. Why didn’t the Treasury simply take over AIG’s insurance operations, letting its counterparties and creditors fight over the London gambles that caused its insolvency? Wiping out its stockholders would have made the U.S. Government 100% owner rather than merely 80%. It would not have had to let Goldman collect on its $13.8 billion bet. Goldman and other CDO speculators would have found themselves in a position akin to bettors at a Las Vegas casino whose bank had been broken, standing in line to divvy up their winnings from what was left. Wouldn’t this have been a good thing for the government’s fiscal position and hence for U.S. taxpayers?
Barofsky calculates $23.8 trillion in overall underwriting aimed to “get the banks lending again,” producing more debt. Including the $5.3 trillion for the mortgage financing agencies Fannie Mae and Freddie Mac, the overall Wall Street bailout added some $13 trillion to U.S. Government debt. This was a policy choice. The bailout was the largest government giveaway in American history since the railroad land grants of the mid-19th century. The choice was based on a fictitious image of reality – but is having disastrous real-world consequences.
There is no reason why the financial system would collapse and people lose their retail deposits or ATMs would run out of money if the gambling arms of the banks that lost couldn’t pay the gamblers on the winning end. Gamblers can afford to lose – or, if they cannot, their activity is decoupled from that of the “real” economy. They have run off the track, and that is that. The problem could be cured by doing what Glass-Steagall used to do before President Clinton repealed it in 1999: segregate the “good bank” from the “bad bank” departments at Citibank and other Too Big To Fail institutions.
This is the great increase in government debt that is now leading to today’s demands for austerity to “make taxpayers pay.”
Today’s post-bubble austerity blames the victim, taxing consumers and wage earners to provide governments with enough revenue to pay banks for their financial losses and misdeeds. So matters are brought back to the classic political issue of Who/Whom. Who will absorb the losses – at whose expense? Will government rule on behalf of the economy, or its creditors?
The U.S. and European governments assume that the solution to clean up the financial wreckage is for economies to “borrow their way out of debt,” by creating yet a new bubble. The new article of faith is that high finance cannot lose; only the economy can be made to suffer losses, regardless of responsibility.
There is an alternative, of course. It requires overcoming today’s tunnel vision to undo the economy’s tragic detour that led to the bubble, the bailout, austerity, and economic polarization between creditors (the 1%) and the 99% in debt to them. The bank lobbyists’ narrative underlying the claim that governments need to bail out the banks at the expense of the “real” economy is that austerity will enable debts to be paid down by enough so that people can begin to borrow again. A new bubble will rescue us – and this time it will be better managed.
The counter-narrative is to recognize the financial sector comprises the Liabilities side of the economy’s balance sheet of assets and debts. As such, it has become a separate and indeed a perverse mirror image of the “real” production and consumption economy. A new debt bubble cannot succeed as a solution based on the economy “borrowing its way out of debt” in an attempt to re-inflate real estate and other asset prices. More bank lending will only impoverish the economy more, indebting the bottom 99% further to the 1%.
The dream is that borrowing can become part of increase the Magic of Compound Interest, continuing to enrich a financial overclass. But this cannot go on for long. It is a fantasy for governments to accept the financial lobbyist’s dream that the way to pull the economy out of austerity and debt deflation is to create a new bubble – to restore real estate as a speculative activity, to “create wealth” by re-inflating asset prices. It cannot be done honestly.
Michael Hudson’s book summarizing his economic theories, “The Bubble and Beyond,” is available on Amazon. His latest book is Finance Capitalism and Its Discontents. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, published by AK Press. He can be reached via his website, mh@michael-hudson.com
[1] Yves Smith, http://www.nakedcapitalism.com/2013/...-geithner.html
When the financial bubble burst in September 2008, U.S. and European governments responded by shifting bank losses onto their own balance sheets. The pretense is that real growth cannot resume until the banks and speculators are “made whole.” To cover the cost of bailing out the banks, governments now are trying to run budget surpluses. This adds fiscal deflation to the debt deflation left in the bubble’s wake, shrinking the economy at large. Governments are raising taxes (or simply print new debt to swap for the financial sector’s bad loans and gambles) to reimburse financial institutions whose lending and outright gambling (not to mention the excursion into financial fraud) caused the crisis.
This financial and fiscal austerity is unnecessary – and counter-productive. The aim is to save the financial sector, not the economy. The working assumption is that bank lending must revive growth by clearing balance sheets for the next debt bubble. As TARP Special Inspector General Neil Barofsky has described, “saving the banks” has been a euphemism for saving Wall Street from losses, not to mention criminal prosecution.
Federal Deposit Insurance Corporation regulator Sheila Bair has described how depositors at Citibank and Bank of America could have been saved without keeping the banks’ speculative web of gambles and junk mortgage loans on the books. The FDIC could have treated these megabanks like it did Washington Mutual and other failed institutions, wiping out their stockholders and counterparty claims for their bad trades and liars’ loans. This would have annulled the overgrowth of speculative gambles and high-risk deposits that had no connection with retail banking. Taking over Citicorp as majority stockholder would have enabled the FDIC to renegotiate its mortgages downward for borrowers in negative equity. As a public ward, the bank could have fired its bad officers rather than letting them give themselves bonuses. None of this was done. The idea of a public option in banking was anathema.
Likewise, Barofsky’s Bailout memoir explains how the $182 billion loan to the insurance giant AIG could have been done as a takeover – on terms that segregated its British derivatives gambling unit (operating under Gordon Brown’s notoriously “light touch” at the Financial Services Authority) from the parent company’s basic “bread and butter” insurance operations. This would have saved the Treasury from having to pay Goldman Sachs and other counterparties, including French banks.
Neither the Treasury nor AIG protested against paying these counterparties. The ideological compact between winners and losers was that the gambling contracts were sacred. If losers could not pay, the government would lend them the money to do so. Wall Street’s Las Vegas was deemed essential. This was the logical conclusion of repealing Glass-Steagall and intermixing investment banking and CDO derivatives with the financial system’s basic deposit and lending functions.
By saving high finance (and much of low finance) and pushing the loss onto the economy at large, government’s policy preserved the financial system’s dominance – on the pretense that this was necessary to revive the economy, not bury it under a mountain of debt.
Barofsky is especially scathing when it comes to Tim Geithner’s claim that it was not possible to oblige AIG’s counterparties to “take a haircut” on its loans because French law did not permit banks to lose money.
Geithner’s team undercut any chance of getting relief for the taxpayer by deciding that no one concession would be accepted unless all of the banks agreed to the exact same percentage reduction. The New York Fed officials told us that for this reason, after the regulator overseeing AIG’s French bank counterparties told them that it would be against French law to accept less than full value for the bonds, the negotiations effectively ended. (Bailout, pp.184-87.)
This deception was put forth in a panic atmosphere to bamboozle Congress into letting Geithner (then head of the New York Federal Reserve) and Treasury Secretary Hank Paulson pay Goldman Sachs (Paulson’s alma mater) and other Wall Street’s heavy winners. But there was no truth to the claim that French law prevented banks from taking a loss, or that the U.S. Government had to apply the same giveaway offer to Wall Street. When Barofsky subsequently called the French regulator, she emphasized that she had not ‘slammed the door’ on negotiations and had been more than ready to engage in them with the Fed as long as they were at a high level and universal. But she told us that the Fed officials had never seriously pursued that option, commenting that she had been surprised when the Fed officials had never called back. When I asked her about the Fed’s assertion that it would be illegal under French law to agree to a discount, she said that the French government could have waived that restriction.
The effect was to funnel “tens of billions of dollars of government money … directly to the banks. We therefore labeled the deal what it was, a ‘backdoor bailout of the banks.’” This inspired AIG’s head, Maurice R. Greenberg, to sue the U.S. Government, claiming that it “used billions of dollars from A.I.G. to settle credit-default swaps the insurer had with banks like Goldman Sachs, which received $12.9 billion in winning bets against AIG on CDOs (collateralized debt obligations). The deal, according to the lawsuit, empowered the government to carry out a ‘backdoor bailout’ of Wall Street.” (Ben Protess and Michael J. De La Merced, “Rescued by a Bailout, A.I.G. May Sue Its Savior,” The New York Times, January 8, 2013.)
It seems ironic that the main protest against the giveaway by the Federal Reserve Board and Treasury has been mounted not by U.S. voters but by the Mr. Greenberg arguing that the Treasury used AIG simply as a throughput vehicle to reward Wall Street with its casino winnings. True, as Barofsky explains (pp. 180f.):
The deal was a gross distortion of the normal functions of the market. In a bailout-free world, instead of being saved by the government, AIG would have been unable to make its cash collateral payments to the banks and gone into bankruptcy. As a result, the banks would have been left with the CDOs and stuck with their continued declines in value. Those losses would have punished the banks for what had been bad and risky bets – i.e., assuming that AIG would be able to meet all of its obligations. In market parlance, each of the banks would have borne the ‘counterparty risk’ of doing business with AIG and suffered the consequences of betting on the wrong counterparty. Instead they were paid out in full. In that respect, Geithner’s opening of the spigot of taxpayer cash for AIG was more of a bailout of the banks than it was for AIG itself.
It didn’t have to be this way. But AIG took the loan rather than seeing the company go bankrupt. One can only wish that Congress had been assertive as the corporate raider Carl Icahn was when he wrote in a New York Times op-ed (“We’re Not the Boss of A.I.G.,” The New York Times, March 29, 2009): “What the government should have gotten was board representation in return for its large investment in A.I.G.” It could have involved wiping out AIG stockholders and upper management – a fact that prompted The New York Times to characterize Mr. Greenberg’s suit as “an audacious display of ingratitude.” Shouldn’t he (or at least his fellow AIG stockholders, who have refrained from joining his suit) have been grateful to the government for lending AIG enough to pay the Wall Street giants?
The government certainly had good reason not to take public liability for AIG’s bad gambles. But it could have taken over the “bread and butter” business of the sorts regulated by state insurance agencies. Instead, Treasury fought against state regulatorswho sought to take over local AIG business. From the vantage point of what was best for the economy west of Wall Street, everything was done upside down. After the ratings agency downgraded the CDO’s that AIG had guaranteed by treating insurance premiums “as free money,”[1] AIG’s goose was cooked.
Perhaps the most notorious example of how accommodating Geithner was after becoming Treasury Secretary was his approval of paying AIG’s reckless London office $180 million in bonuses. Barofsky accuses Treasury officials of doing little “to oversee the taxpayers’ $40 billion investment. For example, they could have forced AIG to renegotiate the terms of the contracts as a condition of the additional $30 billion in TARP funds that they had announced several days after learning about the imminent bonus payments.” Instead of alerting Congress and the public to the options available, “Treasury and Geithner stood behind the ‘sanctity’ of the executives’ contracts.”
The Clinton Administration refused to regulate CDO gambles, adopting the deregulatory Rubinomics ideology of Larry Summers, Ayn Rand disciple Alan Greenspan and Wall Street campaign contributors. So AIG was under no obligation to hold any reserves for losses against its bets. Little has changed under President Obama. The moral is that fictitious economic theory as public relations for the financial sector has heavy real-world costs (which academics call “externalities,” not included in free-market balance sheet of costs in benefits).
Why pay anything at all? That is the real question that needs to be discussed. Why didn’t the Treasury simply take over AIG’s insurance operations, letting its counterparties and creditors fight over the London gambles that caused its insolvency? Wiping out its stockholders would have made the U.S. Government 100% owner rather than merely 80%. It would not have had to let Goldman collect on its $13.8 billion bet. Goldman and other CDO speculators would have found themselves in a position akin to bettors at a Las Vegas casino whose bank had been broken, standing in line to divvy up their winnings from what was left. Wouldn’t this have been a good thing for the government’s fiscal position and hence for U.S. taxpayers?
Barofsky calculates $23.8 trillion in overall underwriting aimed to “get the banks lending again,” producing more debt. Including the $5.3 trillion for the mortgage financing agencies Fannie Mae and Freddie Mac, the overall Wall Street bailout added some $13 trillion to U.S. Government debt. This was a policy choice. The bailout was the largest government giveaway in American history since the railroad land grants of the mid-19th century. The choice was based on a fictitious image of reality – but is having disastrous real-world consequences.
There is no reason why the financial system would collapse and people lose their retail deposits or ATMs would run out of money if the gambling arms of the banks that lost couldn’t pay the gamblers on the winning end. Gamblers can afford to lose – or, if they cannot, their activity is decoupled from that of the “real” economy. They have run off the track, and that is that. The problem could be cured by doing what Glass-Steagall used to do before President Clinton repealed it in 1999: segregate the “good bank” from the “bad bank” departments at Citibank and other Too Big To Fail institutions.
This is the great increase in government debt that is now leading to today’s demands for austerity to “make taxpayers pay.”
Today’s post-bubble austerity blames the victim, taxing consumers and wage earners to provide governments with enough revenue to pay banks for their financial losses and misdeeds. So matters are brought back to the classic political issue of Who/Whom. Who will absorb the losses – at whose expense? Will government rule on behalf of the economy, or its creditors?
The U.S. and European governments assume that the solution to clean up the financial wreckage is for economies to “borrow their way out of debt,” by creating yet a new bubble. The new article of faith is that high finance cannot lose; only the economy can be made to suffer losses, regardless of responsibility.
There is an alternative, of course. It requires overcoming today’s tunnel vision to undo the economy’s tragic detour that led to the bubble, the bailout, austerity, and economic polarization between creditors (the 1%) and the 99% in debt to them. The bank lobbyists’ narrative underlying the claim that governments need to bail out the banks at the expense of the “real” economy is that austerity will enable debts to be paid down by enough so that people can begin to borrow again. A new bubble will rescue us – and this time it will be better managed.
The counter-narrative is to recognize the financial sector comprises the Liabilities side of the economy’s balance sheet of assets and debts. As such, it has become a separate and indeed a perverse mirror image of the “real” production and consumption economy. A new debt bubble cannot succeed as a solution based on the economy “borrowing its way out of debt” in an attempt to re-inflate real estate and other asset prices. More bank lending will only impoverish the economy more, indebting the bottom 99% further to the 1%.
The dream is that borrowing can become part of increase the Magic of Compound Interest, continuing to enrich a financial overclass. But this cannot go on for long. It is a fantasy for governments to accept the financial lobbyist’s dream that the way to pull the economy out of austerity and debt deflation is to create a new bubble – to restore real estate as a speculative activity, to “create wealth” by re-inflating asset prices. It cannot be done honestly.
Michael Hudson’s book summarizing his economic theories, “The Bubble and Beyond,” is available on Amazon. His latest book is Finance Capitalism and Its Discontents. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, published by AK Press. He can be reached via his website, mh@michael-hudson.com
[1] Yves Smith, http://www.nakedcapitalism.com/2013/...-geithner.html
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