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This ain’t your mama’s economy! February 1, 2014

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For over a decade, accountant Walter Burien has been trying to rouse the public over what he contends is a massive conspiracy and cover-up, involving trillions of dollars squirreled away in funds maintained at every level of  government.  His numbers may be disputed, but these funds definitely exist, as evidenced by the Comprehensive Annual Financial Reports (CAFRs) required of every government agency.  If they don’t represent a concerted government conspiracy, what are they for?  And how can they be harnessed more efficiently to help allay the financial crises of state and local governments?

The Elusive CAFR Money

Burien is a former commodity trading adviser who has spent many years peering into government books.  He notes that the government is composed of 54,000 different state, county, and local government entities, including school districts, public authorities, and the like; and that these entities all keep their financial assets in liquid investment funds, bond financing accounts and corporate stock portfolios. The only income that must be reported in government budgets is that from taxes, fines and fees; but the investments of government entities can be found in official annual reports (CAFRs), which must be filed with the federal government by local, county and state governments.  These annual reports show that virtually every U.S. city, county, and state has vast amounts of money stashed away in surplus funds.  Burien maintains that these slush funds have been kept concealed from taxpayers, even as taxes are being raised and citizens are being told to expect fewer government services.

Burien was originally alerted to this information by Lt. Col. Gerald Klatt, who evidently died in 2004 under mysterious circumstances, adding fuel to claims of conspiracy and cover-up.  Klatt was a an Air Force auditor and federal accountant, and it’s not impossible that he may have gotten too close to some military stash being used for nefarious ends.  But it is hard to envision how all the municipal governments hording their excess money in separate funds could be complicit in a massive government conspiracy.  Still, if that is not what is going on, why such an inefficient use of public monies?

A Simpler Explanation

I got a chance to ask that question in April, when I was invited to speak at a conference of Government Finance Officers in Missouri.  The friendly public servants at the conference explained that maintaining large “rainy day” funds is simply how local governments must operate.  Unlike private businesses, which have bank credit lines they can draw on if they miscalculate their expenses, local governments are required by law to balance their budgets; and if they come up short, public services and government payrolls may be frozen until the voters get around to approving a new bond issue.  This has actually happened, bringing local government to a standstill.  In emergencies, government officials can try to borrow short-term through “certificates of participation” or tax participation loans, but the interest rates are prohibitively high; and in today’s tight credit market, finding willing lenders is difficult.

To avoid those unpredictable contingencies, municipal governments will keep a cushion of from 20%  to 75% more than their budgets actually require.  This money is invested, but not necessarily lucratively.  One finance officer, for example, said that her city had just bid out $2 million as a 30-day certificate of deposit (CD) to two large banks at a meager annual interest of 0.11%.  It was a nice spread for the banks, which could leverage the money into loans at 6% or so; but it was a pretty sparse deal for the city.

Meanwhile, Back in California

That was in Missouri, but the figures I was particularly interested were for my own state of California, which was struggling with a budget deficit of $26.3 billion as of April 2010.  Yet the State Treasurer’s website says that he manages a Pooled Money Investment Account (PMIA) tallying in at nearly $71 billion as of the same date, including a Local Agency Investment Fund (LAIF) of $24 billion.  Why isn’t this money being used toward the state’s deficit?  The Treasurer’s answer to this question, which he evidently gets frequently, is that legislation forbids it.  His website states:

“Can the State borrow LAIF dollars to resolve the budget deficit?

“No. California Government Code 16429.3 states that monies placed with the Treasurer for deposit in the LAIF by cities, counties, special districts, nonprofit corporations, or qualified quasi-governmental agencies shall not be subject to either of the following:
“(a) Transfer or loan pursuant to Sections 16310, 16312, or 16313.
“(b) Impoundment or seizure by any state official or state agency.”

The non-LAIF money in the pool can’t be spent either.  It can be borrowed, but it has to be paid back.  When Governor Schwarzenegger tried to raid the Public Transportation Account for the state budget, the California Transit Association took him to court and won.  The Third District Court of Appeals ruled in June 2009 that diversions from the Public Transportation Account to fill non-transit holes in the General Fund violated a series of statutory and constitutional amendments enacted by voters via four statewide initiatives dating back to 1990.

In short, the use of these funds for the state budget has been blocked by the voters themselves.  Bond issues are approved for particular purposes.  When excess funds are collected, they are not handed over to the State toward next year’s budget.  They just sit idly in an earmarked fund, drawing a modest interest.

What’s Wrong with This Picture?

California’s budget problems have caused its credit rating to be downgraded to just above that of Greece, driving the state’s interest tab skyward.  In November 2009, the state sold 30-year taxable securities carrying an interest rate of 7.26%.  Yet California has never defaulted on its bonds.  Meanwhile, the too-big-to-fail banks, which would have defaulted on hundreds of billions of dollars of debt if they had not been bailed out by the states and their citizens, are able to borrow from each other at the extremely low federal funds rate, currently set at 0 to .25% (one quarter of one percent).  The banks are also paying the states quite minimal rates for the use of their public monies, and turning around and relending this money, leveraged many times over, to the states and their citizens at much higher rates.  That is assuming they lend at all, something they are increasingly reluctant to do, since speculating with the money is more lucrative, and investing it in federal securities is more secure.

Private banks clearly have the upper hand in this game.  Local governments have been forced to horde funds in very inefficient ways, building excessive reserves while slashing services, because they do not have the extensive credit lines available to the private banking system.  States cannot easily incur new debt without voter approval, a process that is cumbersome, time-consuming and uncertain.  Banks, on the other hand, need to keep only the slimmest of reserves, because they are backstopped by a central bank with the power to create all the reserves necessary for its member banks, as well as by Congress and the taxpayers themselves, who have been arm-twisted into repeated bailouts of the Wall Street behemoths.

How the CAFR Money Could Be Used Without Spending It

California, then, is in the anomalous position of being $26 billion in the red and plunging toward bankruptcy, while it has over $70 billion stashed away in an investment pool that it cannot touch.  Those are just the funds managed by the Treasurer.  According to California’s latest CAFR, the California Public Employees’ Retirement Fund (CalPERS) has total investments of $360 billion, including nearly $144 billion in “equity securities” and $37 billion in “private equity.”  See the State of California Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2009, pages 83-84.

This money cannot be spent, but it can be invested — and it can be invested not just in conservative federal securities but in equity, or stocks.  Rather than turning this hidden gold mine over to Wall Street banks to earn a very meager interest, California could leverage its excess funds itself, turning the money into much-needed low-interest credit for its own use.  How?  It could do this by owning its own bank.

Only one state currently does this — North Dakota.  North Dakota is also the only state projected to have a budget surplus by 2011.  It has not fallen into the Wall Street debt trap afflicting other states, because it has been able to generate its own credit through its own state-owned Bank of North Dakota (BND).

An investment in the State Bank of California would not be at risk unless the bank became insolvent, a highly unlikely result since the state has the power to tax.  In North Dakota, the BND is a dba of the state itself: it is set up as “the State of North Dakota doing business as the Bank of North Dakota.”  That means the bank cannot go bankrupt unless the state goes bankrupt.

The capital requirement for bank loans is a complicated matter, but it generally works out to be about 7%.  (According to Standard & Poor’s, the worldwide average risk-adjusted capital ratio stood at 6.7 per cent as of June 30, 2009; but for some major U.S. banks it was much lower: Citigroup’s was 2.1 per cent; Bank of America’s was 5.8 per cent.)  At 7%, $7 of capital can back $100 in loans.  Thus if $7 billion in CAFR funds were invested as capital in a California state development bank, the bank could generate $100 billion in loans.

This $100 billion credit line would allow California to finance its $26 billion deficit at very minimal interest rates, with $74 billion left over for infrastructure and other sorely needed projects.  Studies have shown that eliminating the interest burden can cut the cost of public projects in half.  The loans could be repaid from the profits generated by the projects themselves.  Public transportation, low-cost housing, alternative energy sources and the like all generate fees.  Meanwhile, the jobs created by these projects would produce additional taxes and stimulate the economy.  Commercial loans could also be made, generating interest income that would return to state coffers.

Building a Deposit Base

To start a bank requires not just capital but deposits.  Banks can create all the loans they can find creditworthy borrowers for, up to the limit of their capital base; but when the loans leave the bank as checks, the bank needs to replace the deposits taken from its reserve pool in order for the checks to clear.  Where would a state-owned bank get the deposits necessary for this purpose?

In North Dakota, all the state’s revenues are deposited in the BND by law.  Compare California, which has expected revenues for 2010-11 of $89 billion.  The Treasurer’s website reports that as of June 30, 2009, the state held over $18 billion on deposit as demand accounts and demand NOW accounts (basically demand accounts carrying a very small interest).  These deposits were held in seven commercial banks, most of them Wall Street banks: Bank of America, Union Bank, Bank of the West, U.S. Bank, Wells Fargo Bank, Westamerica Bank, and Citibank.  Besides these deposits, the $64 billion or so left in the Treasurer’s investment pool could be invested in State Bank of California CDs.  Again, most of the bank CDs in which these funds are now invested are Wall Street or foreign banks.  Many private depositors would no doubt choose to bank at the State Bank of California as well, keeping California’s money in California.  There is already a movement afoot to transfer funds out of Wall Street banks into local banks.

While the new state-owned bank is waiting to accumulate sufficient deposits to clear its outgoing checks, it can do what other startup banks do – borrow deposits from the interbank lending market at the very modest federal funds rate (0 to .25%).

To avoid hurting California’s local banks, any state monies held on deposit with local banks could remain there, since the State Bank of California should have plenty of potential deposits without these funds.  In North Dakota, local banks are not only not threatened by the BND but are actually served by it, since the BND partners with them, engaging in “participation loans” that help local banks with their capital requirements.

Taking Back the Money Power

We have too long delegated the power to create our money and our credit to private profiteers, who have plundered and exploited the privilege in ways that are increasingly being exposed in the media.  Wall Street may own Congress, but it does not yet own the states.  We can take the money power back at the state level, by setting up our own publicly-owned banks.  We can “spend” our money while conserving it, by leveraging it into the credit urgently needed to get the wheels of local production turning once again.  Ellen Brown (Global research writer and author)

You know if we all can just get together and say,  we’re taking back our economy out of the hands of Wall street and these too-big-too-fail ” behemoths” the taxpayer can jump start his /her financial future and keep it in the  hands of the people,  for the people,  by the people. The banks may control those in Washington but they sure as hell can’t control they states by which we live. Power to the people.  Bernard Ball (writer and author)

The Illusion of recovery! February 23, 2010

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In August of 2009, I wrote an article, Entering the Greatest Depression in History, in which I analyzed how there is a deep systemic crisis in the Capitalist system in which we have gone through merely one burst bubble thus far, the housing bubble, but there remains a great many others.

There remains as a significantly larger threat than the housing collapse, a commercial real estate bubble. As the Deutsche Bank CEO said in May of 2009, It’s either the beginning of the end or the end of the beginning.

Of even greater significance is what has been termed the bailout bubble in which governments have superficially inflated the economies through massive debt-inducing bailout packages. As of July of 2009, the government watchdog and investigator of the US bailout program stated that the U.S. may have put itself at risk of up to $23.7 trillion dollars.

[See: Andrew Gavin Marshall, Entering the Greatest Depression in History. Global Research: August 7, 2009]

In October of 2009, approximately one year following the great panic of 2008, I wrote an article titled, The Economic Recovery is an Illusion, in which I analyzed what the most prestigious and powerful financial institution in the world, the Bank for International Settlements (BIS), had to say about the crisis and recovery.

The BIS, as well as its former chief economist, who had both correctly predicted the crisis that unfolded in 2008, were warning of a future crisis in the global economy, citing the fact that none of the key issues and structural problems with the economy had been changed, and that government bailouts may do more harm than good in the long run.

William White, former Chief Economist of the BIS, warned:

The world has not tackled the problems at the heart of the economic downturn and is likely to slip back into recession. [He] warned that government actions to help the economy in the short run may be sowing the seeds for future crises.

August 7, 2009

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Why do we(taxpayer) coninue to ignore the fact that the nine mega-banks graced with $125 billion in taxpayer bailout money under the Troubled Asset Relief Program (TARP) were reported last week to be paying out billions of dollars in bonuses to their executives. At least 4,793 bankers and traders received more than $1 million each in bonus payments, although it was one of Wall Street’s worst years on record. After months of investigating banker compensation, New York Attorney General Andrew Cuomo said on July 30, “The repeated explanation from bank executives that bonuses are tied to performance in a manner designed to promote (national economic) growth does not appear to be accurate.”


To say that it was an understatement would be an understatement. The bonuses paid to executives not only were not tied to national economic growth but were not even tied to some reasonable percentage of company profits. In fact they were generally greater than the net income of the banks. Morgan Stanley, for example, had $1.7 billion in earnings and paid $4.475 billion in bonuses. Goldman Sachs had $2.3 billion in earnings and paid $4.8 billion in bonuses. JP Morgan Chase had $5.6 billion in earnings and paid $8.69 billion in bonuses. JP Morgan’s largesse involved showering 1,626 of its favorite execs and traders with bonuses of $1 million or more. For most people, a “bonus” is a few hundred dollars at Christmastime. A million dollars is what you work a lifetime to try to save, and few people reach that goal. Even Citigroup and Merrill Lynch, which have been called zombie banks, paid $5.33 billion and $3.6 billion in bonuses, respectively — although they lost more than $27 billion each in earnings. The bar for merit is apparently so low that you’re entitled to a bonus if your zombie bank simply keeps breathing!  


These blatantly inflated bonuses are just the last in a litany of abuses by those same profligate banks that nearly destroyed our economic system. If the derivatives on their books were “marked to market” (valued at what they would fetch on the market), the banks would be bankrupt, and their employees would be out of a job. Instead, they have been allowed to inflate the value of their “toxic” assets – and sell them to the U.S. government at the inflated value. Then they have taken the money they got from the government at these inflated prices and paid back the TARP money they received – allowing them to post inflated earnings and reward themselves with inflated bonuses! Many people feel that these bankers are thieves stealing from the public till who should be looking at jail time. But who is there to stop their parade of outrages? No one in Congress, the White House, or the news media is calling them on the carpet for it. As Senator Dick Durbin said recently, Wall Street owns Congress; and that is also true of the major media.


We may not be able to stop them, but we can join them. We the people need to play the bankers’ game ourselves. Even corporate giants such as General Motors and WalMart have now gotten into the banking game and are easing their credit problems by forming their own banks. The U.S. public sector is late to the party. States, counties, public universities could take the lucrative system the private banking industry has created for itself and turn it to productive use in the public interest.


Keeping the Banks Honest with Some Public Competition


In President Obama’s July 17 weekly address, he repeated his call for a public option in health care, in order to “increase competition and keep insurance companies honest” and to “put an end to the worst practices of the insurance industry.” The same call needs to be made for a public option in banking. In some countries, publicly-owned banks have operated alongside privately-owned banks for decades; and in those countries, the current crisis has served to show that public banks generally do a better job of serving the people and protecting their interests than their private counterparts. 


In Canada, the trendsetter in public banking is the province of Alberta. Alberta’s publicly-owned banking systemwas initiated during the Great Depression to give the private banks a run for the public’s money. According to a government publication titled “These Are the Facts: An Authentic Record of Alberta’s Progress, 1935-1948”:


“The Treasury Branch system enables the people to pool their financial resources and to use these resources for their mutual benefit thereby enabling them to progressively free themselves from the stranglehold of the existing financial monopoly. These Treasury Branches provide effective competition for chartered banks thereby ensuring banking services at reasonable rates.” 


From 1929 to 1933, the average annual income in Alberta had fallen from $548 to $212, a staggering 61 percent drop. Interest payments continued to bleed the farmers of cash, and taxes had increased. In 1935, Albertans decided they wanted a change and swept the Alberta Social Credit Party into power. In 1938, the system of Alberta Treasury Branches was set up literally as a branch of the provincial government. The stated goal of the ATB was to “provide the people with alternative facilities for gaining access to their credit resources.” Bankers initially scoffed at Alberta’s attempts to establish a competing economic system, but Albertans had high hopes and rushed to deposit their meager savings in the Treasury Branches. The government invested in the ATB only once, contributing $200,000 in 1938. That was all that was necessary, as the system was self-funding after that. By 1946, the ATB was turning an annual profit of $65,000. According to a booklet titled “Albertans Investing in Alberta 1938-1998,” by 1998 the ATB had remitted $68 million to the provincial government.  


In India, public sector banks also operate alongside private sector banks. Privatization has made significant inroads into the banking system but fully 80 percent of the country’s banks are still government-owned. Before the current crisis, neoliberals criticized India’s public banks for being oriented more toward serving the customer than turning a profit; but studies showed that the public sector banks were doing better than  the private sector banks in terms of customer satisfaction. Today, when the credit crisis has hit the aggressive private international banks particularly hard, customers are fleeing into the safety of public banks, which have emerged largely unscathed from the credit debacle. The public banks have been credited with keeping the country’s financial industry robust at a time when the private international banks are suffering their worst crisis since the 1930s.


In China, private-sector banking has also made some inroads; but state-owned banks still predominate. In a article in June 2009 “The Chinese Puzzle: Why Is China Growing When Other Export Powerhouses Aren’t?”, Brad Setser noted that nearly all countries relying heavily on exports for growth have experienced major downturns and remain in the doldrums — except for China. When China’s external markets fell off, the government turned its credit machine inward to domestic development. Its state-owned banks engaged in a huge increase in lending, with local governments and state enterprises borrowing on a large scale. The result was to create a real fiscal stimulus that put workers to work and got money circulating again in the economy.


In the United States, the trendsetter in public banking is the state of North Dakota, which has owned its own bank for nearly a century. North Dakota is one of only two states (along with Montana) that are currently not facing short falls. Ever since 1919, North Dakota’s revenues have been deposited in the state-owned Banks. Under the “fractional reserve” lending scheme open to all banks, these deposits are then available for leveraging many times over as loans. Other banks in the state do not see the BND as a threat because it partners with them and backstops them, serving as a sort of central bank for the state. BND’s loans are not insured by the Federal Deposit Insurance Corporation (FDIC) but are guaranteed by the state. North Dakota has plenty of money for student loans, makes 1% loans to startup farms, has the lowest job loss rate in the country, and is generally not feeling the pinch of the credit crisis at all.


Theory and Practice: The Proof Is in the Pudding


A bank charter brings with it the privilege of  simply creating cash as an accounting entry on the bank’s books. The flaw in the private banking scheme is that banks create the principal portion of their loans but not the interest, which is continually drawn off the top as profit. New borrowers must continually be found to take out new loans to create this extra profit, making private banking effectively a Pyramid Scheme; and like any pyramid scheme, it has mathematical limits. Today, those limits appear to have become a reality. Personal and national debts have gotten so large relative to incomes that it is no longer possible to maintain the fiction of solvency. We soon won’t have the money even to pay the interest on our existing debts, let alone to incur new ones. Public banking does not suffer from that flaw, because interest is not drawn out of the system but is returned to the public coffers. Public banking is thus mathematically sound and sustainable.


That is the theory, but there is nothing so persuasive as putting it to the test. Like with the public option in health care, we need to pit the public banking option against the private banking option and see which works best. My money is on the public option,where is yours?

Wreckage of greenspan bubble…we’re living it! July 1, 2009

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 The Commerce Department’s National Income and Product Accounts (NIPA) for May show that U.S. “savings” are now absorbing 6.9 percent of income.      

I put the word “savings” in quotation marks because this 6.9% is not what most people think of as savings. It is not money in the bank to draw out on the “rainy day” when one is laid off as unemployment rates rise. The statistic means that 6.9% of national income is being earmarked to pay down debt – the highest saving rate in 15 years, up from actually negative rates (living on borrowed credit) just a few years ago. The only way in which these savings are “money in the bank” is that they are being paid by consumers to their banks and credit card companies.           

Income paid to reduce debt is not available for spending on goods and services. It therefore shrinks the economy, aggravating the depression. So why is the jump in “saving” good news?            

It certainly is a good idea for consumers to get out of debt. But the media are treating this diversion of income as if it were a sign of confidence that the recession may be ending and Mr. Obama’s “stimulus” plan working. The Wall Street Journal reported that Social Security recipients of one-time government payments “seem unwilling to spend right away,” 1 while The New York Times wrote that “many people were putting that money away instead of spending it.”2  It is as if people can afford to save more.           

 The reality is that most consumers have little real choice but to pay. Unable to borrow more as banks cut back credit lines, their “choice” is either to pay their mortgage and credit card bill each month, or lose their homes and see their credit ratings slashed, pushing up penalty interest rates near 20%! To avoid this fate, families are shifting to cheaper (and less nutritious) foods, eating out less (or at fast food restaurants), and cutting back vacation spending. It therefore seems contradictory to applaud these “saving” (that is, debt-repayment) statistics as an indication that the economy may emerge from depression in the next few months. While unemployment approaches the 10% rate and new layoffs are being announced every week, isn’t the Obama administration taking a big risk in telling voters that its stimulus plan is working? What will people think this winter when markets continue to shrink? How thick is Mr. Obama’s Teflon? 

We are living in the wreckage of the Greenspan bubble           

As recently as two years ago consumers were buying so many goods on credit that the domestic savings rate was zero. (Financing the U.S. Government’s budget deficit with foreign central bank recycling of the dollar’s balance-of-payments deficit actually produced a negative 2% savings rate.) During these Bubble Years savings by the wealthiest 10% of the population found their counterpart in the debt that the bottom 90% were running up. In effect, the wealthy were lending their surplus revenue to an increasingly indebted economy at large.            

Today, homeowners no longer can re-finance their mortgages and compensate for their wage squeeze by borrowing against rising prices for their homes. Payback time has arrived – paying back bank loans, whose volume has been augmented to include accrued interest charges and penalties. New bank lending has hit a wall as banks are limiting their activity to raking in amortization and interest on existing mortgages, credit cards and personal loans.            

Many families are able to remain financially afloat by running down their savings and cutting back their spending to try and avoid bankruptcy. This diversion of income to pay creditors explains why retail sales figures, auto sales and other commercial statistics are plunging vertically downward in almost a straight line, while unemployment rates soar toward the 10% level. The ability of most people to spend at past rates has hit a wall. The same income cannot be used for two purposes. It cannot be used to pay down debt and also for spending on goods and services. Something must give. So more stores and shopping malls are becoming vacant each month. And unlike homeowners, absentee property investors have little compunction about walking away from negative equity situations – owing creditors more than the property is worth.        

Over two-thirds of the U.S. population are homeowners, and real estate economists estimate that about a quarter of U.S. homes are now in a state of negative equity as market prices plunges below the mortgages attached to them. This is the condition in which Citigroup and AIG found themselves last year, along with many other Wall Street institutions. But whereas the government absorbed their losses “to get the economy moving again” (or at least to help Congress’s major campaign contributors to recover), personal debtors are in no such favored position. Their designated role is to help make the banks whole by paying off the debts they have been running up in an attempt to maintain living standards that their take-home pay no longer is supporting.           

Banks for their part are slashing credit-card debt limits and jacking up interest and penalty charges. (I see little chance that Congress will approve the Consumer Financial Products Agency that Mr. Obama promoted as a flashy balloon for his recent bank giveaway program. The agency is to be dreamed about, not enacted.) The problem is that default rates are rising rapidly. This has prompted many banks to strike deals with their most overstretched customers to settle outstanding balances for as little as half the face amount (much of which is accrued interest and penalties, to be sure). Banks are now competing not to gain customers but to shed them. The plan is to offer steep enough payment discounts to prompt bad risks to settle by sticking rival banks with ultimate default when they finally give up their struggle to maintain solvency. (The idea is that strapped debtors will max out on one bank’s card to pay off another bank at half-price.)           

The trillions of dollars that the Bush and Obama administration have given away to Wall Street would have been enough to buy a great bulk of the mortgages now in default – mortgages beyond the ability of many debtors to pay in the first place. The government could have enacted a Clean Slate for these debtors – financed by re-introducing progressive taxation, restoring the full capital gains tax to the same rate as that levied on earned income (wages and profits), and closing the tax loopholes that effectively free finance, insurance and real estate (FIRE) sector from income taxation. Instead, the government has made Wall Street virtually tax exempt, and swapped Treasury bonds for trillions of dollars of junk mortgages and bad debts. The “real” economy’s growth prospects are being sacrificed in an attempt to carry its financial overhead.           

Banks and credit-card companies are girding for economic shrinkage. It was in anticipation of this state of affairs, after all, that they pushed so hard from 1998 onward to make what finally became the 2005 bankruptcy laws so pro-creditor, so cruel to debtors by making personal bankruptcy an economic and legal hell.           

 It is to avoid this hell that families are cutting their spending so as to keep current on their debts, against all odds that they can avoid default in today’s shrinking economy.

 Working off debt = “saving,” but not in liquid form           

People are putting more money away, but not into savings accounts. They are indeed putting it into banks, but in the form of paying down debt. To accountants looking at balance sheets, savings represent the increase in net worth. In times past this was indeed the result mainly of a buildup of liquid funds. But today’s money being saved is not available for spending. It merely reduces the debt burden being carried by individuals. Unlike Citibank, AIG and other Wall Street institutions, they are not having their debts conveniently wiped off the books. The government is not nice enough to buy back their investments that had lost up to half their value in the past year. Such bailouts are for creditors and money managers, not their debtors.      

The story that the media should be telling is how today’s post-bubble economy has turned the concept of saving on its head. The accounting concept underlying balance sheets is that a negation of a negation is positive. Paying down debt liabilities is counted as “saving” because one owes less.
This is not what people expected a half-century ago. Economists wrote about how technology would raise productivity levels, people would be living in near utopian conditions by the time the year 2000 arrived. They expected a life of leisure and prosperity. Needless to say, this is far from materializing. The textbooks need to be rewritten – and in fact, are being rewritten.3  

Keynesian economics turned inside-out           

Most individuals and companies emerged from World War II in 1945 nearly debt-free, and with progressive income taxes. Economists anticipated – indeed, even feared – that rising incomes would lead to higher saving rates. The most influential view was that of John Maynard Keynes. Addressing the problems of the Great Depression in 1936, his General Theory of Employment, Interest, and Money warned that people would save relatively more as their incomes rose. Spending on consumer goods would tail off, slowing the growth of markets, and hence new investment and employment.            

This view of the saving function – the propensity to save out of wages and profits –viewed saving as breaking the circular flow of payments between producers and consumers. The main cloud on the horizon, Keynesians worried, was that people would be so prosperous that they would not spend their money. The indicated policy to deter under-consumption was for economies to indulge in more leisure and more equitable income distribution.           

The modern dynamics of saving – and the increasingly top-heavy indebtedness in which savings are invested – are quite different from (and worse than) what Keynes explained. Most financial savings are lent out, not plowed into tangible capital formation and industry. Most new investment in tangible capital goods and buildings comes from retained business earnings, not from savings that pass through financial intermediaries. Under these conditions, higher personal saving rates are reflected in higher indebtedness. That is why the saving rate has fallen to a zero or “wash” level. A rising proportion of savings find their counterpart more in other peoples’ debts rather than being used to finance new direct investment.           

Each business recovery since World War II has started with a higher debt ratio. Saving is indeed interfering with consumption, but it is not the result of rising incomes and prosperity. A rising savings rate merely reflects the degree to which the economy is working off its debt overhead. It is “saving” in the form of debt repayment in a shrinking economy. The result is financial dystopia, not the technological utopia that seemed so attainable back in 1945, just sixty-five years ago. Instead of a consumer-friendly leisure economy, we have debt peonage.

To get an idea of how oppressive the debt burden really is, I should note that the 6.9% savings rate does not even reflect the 16% of the economy that the NIPA report for interest payments to carry this debt, or the penalty fees that now yield as much as interest yields to credit-card companies – or the trillions of dollars of government bailouts to try and keep this unsustainable system afloat. How an economy can hope to compete in global markets as an industrial producer with so high a financial overhead factored into the cost of living and doing business must remain for a future article to address.

Is it “Change” I don’t think so! February 16, 2009

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    Martin Wolf started off his Financial Times column today (February 11) with the bold question: “Has Barack Obama’s presidency already failed?”[1] The stock market had a similar opinion, plunging 382 points. Having promised “change,” Mr. Obama is giving us more Clinton-Bush via Robert Rubin’s protégé, Tim Geithner. Tuesday’s $2.5 trillion Financial Stabilization Plan to re-inflate the Bubble Economy is basically an extension of the Bush-Paulson giveaway – yet more Rubinomics for financial insiders in the emerging Wall Street trusts. The financial system is to be concentrated into a cartel of just a few giant conglomerates to act as the economy’s central planners and resource allocators. This makes banks the big winners in the game of “chicken” they’ve been playing with Washington, a shakedown holding the economy hostage. “Give us what we want or we’ll plunge the economy into financial crisis.” Washington has given them $9 trillion so far, with promises now of another $2 trillion– and still counting.

            A true reform – one designed to undo the systemic market distortions that led to the real estate bubble – would have set out to reverse the Clinton-Rubin repeal of the Glass-Steagall Act so as to prevent the corrupting conflicts of interest that have resulted in vertical trusts such as Citibank and Bank of America/Countrywide/Merrill Lynch. By unleashing these conglomerate grupos (to use the term popularized under Pinochet with Chicago Boy direction – a dress rehearsal of the mass financial bankruptcies they caused in Chile by the end of the 1970s) The Clinton administration enabled banks to merge with junk mortgage companies, junk-money managers, fictitious property appraisal companies, and law-evasion firms all designed to package debts to investors who trusted them enough to let them rake off enough commissions and capital gains to make their managers the world’s highest-paid economic planners.

            Today’s economic collapse is the direct result of their planning philosophy. It actually was taught as “wealth creation” and still is, as supposedly more productive than the public regulation and oversight so detested by Wall Street and its Chicago School aficionados. The financial powerhouses created by this “free market” philosophy span the entire FIRE sector – finance, insurance and real estate, “financializing” housing and commercial property markets in ways guaranteed to make money by creating and selling debt. Mr. Obama’s advisors are precisely those of the Clinton Administration who supported trustification of the FIRE sector. This is the broad deregulatory medium in which today’s bad-debt disaster has been able to spread so much more rapidly than at any time since the 1920s.

            The commercial banks have used their credit-creating power not to expand the production of goods and services or raise living standards but simply to inflate prices for real estate (making fortunes for their brokerage, property appraisal and insurance affiliates), stocks and bonds (making more fortunes for their investment bank subsidiaries), fine arts (whose demand is now essentially for trophies, degrading the idea of art accordingly) and other assets already in place.

            The resulting dot.com and real estate bubbles were not inevitable, not economically necessary. They were financially engineered by the political deregulatory power acquired by banks corrupting Congress through campaign contributions and public relations “think tanks” (more in the character of Orwellian doublethink tanks) to promote the perverse fiction that Wall Street can be and indeed is automatically self-regulating. This is a travesty of Adam Smith’s “Invisible Hand.” This hand is better thought of as covert. The myth of “free markets” is now supposed to consist of governments withdrawing from planning and taxing wealth, so as to leave resource allocation and the economic surplus to bankers rather than elected public representatives. This is what classically is called oligarchy, not democracy.

            This centralization of planning, debt creation and revenue-extracting power is defended as the alternative to Hayek’s road to serfdom. But it is itself the road to debt peonage, a.k.a. the post-industrial economy or “Information Economy.” The latter term is another euphemistic travesty in view of the kind of information the banking system has promoted in the junk accounting crafted by their accounting firms and tax lawyers (off-balance-sheet entities registered on offshore tax-avoidance islands), the AAA applause provided as “information” to investors by the bond-rating cartel, and indeed the national income and product accounts that depict the FIRE sector as being part of the “real” economy, not as an institutional wrapping of special interests and government-sanctioned privilege  acting in an extractive rather than a productive way.

             “Thanks for the bonuses,” bankers in the United States and England testified this week before Congress and Parliament. “We’ll keep the money, but rest assured that we are truly sorry for having to ask you for another few trillion dollars. At least you should remember our theme song: We are still better managers than the government, and the bulwark against government bureaucratic resource allocation.” This is the ideological Big Lie sold by the Chicago School “free market” celebration of dismantling government power over finance, all defended by complex math rivaling that of nuclear physics that the financial sector is part of the “real” economy automatically producing a fair and equitable equilibrium.

            This is not bad news for stockholders of more local and relatively healthy banks (healthy in the sense of avoiding negative equity). Their stocks soared and were by far the major gainers on Tuesday’s stock market, while Wall Street’s large Bad Banks plunged to new lows. Solvent local banks are the sort that were normal prior to repeal of Glass Steagall. They are to be bought by the large “troubled” banks, whose “toxic loans” reflect a basically toxic operating philosophy. In other words, small banks who have made loans carefully will be sucked into Citibank, Bank of America, JP Morgan Chase and Wells Fargo – the Big Four or Five where the junk mortgages, junk CDOs and junk derivatives are concentrated, and have used Treasury money from the past bailout to buy out smaller banks that were not infected with such reckless financial opportunism. Even the Wall Street Journal editorialized regarding the Obama Treasury’s new “Public-Private Investment Fund” to pump a trillion dollars into this mess: “Mr. Geithner would be wise to put someone strong land independent in charge of this fund – someone who can say no to Congress and has no ties to Citigroup, Robert Rubin or Wall Street.”[2]

            None of this can solve today’s financial problem. The debt overhead far exceeds the economy’s ability to pay. If the banks would indeed do what Pres. Obama’s appointees are begging them to do and lend more, the debt burden would become even heavier and buying access to housing even more costly. When the banks look back fondly on what Alan Greenspan called “wealth creation,” we can see today that the less euphemistic terminology would be “debt creation.” This is the objective of the new bank giveaway. It threatens to spread the distortions that the large banks have introduced until the entire system presumably looks like Citibank, long the number-one offender of “stretching the envelope,” its euphemism for breaking the law bit by bit and daring government regulators and prosecutors to try and stop it and thereby plunging the U.S. financial system into crisis. This is the shakedown that is being played out this week. And the Obama administration blinked – as these same regulators did when they were in charge of the Clinton administration’s bank policy. So much for the promised change!

            The three-pronged Treasury program seems to be only Stage One of a two-stage “dream recovery plan” for Wall Street. Enough hints have trickled out for the past three months in Wall Street Journal op-eds to tip the hand for what may be in store. Watch for the magic phrase “equity kicker,” first heard in the S&L mortgage crisis of the 1980s. It refers to the banker’s share of capital gains, that is, asset price inflation in Bubble #2 that the Recovery Program hopes to sponsor.

            The first question to ask about any Recovery Program is, “Recovery for whom?” The answer given on Tuesday is, “For the people who design the Program and their constituency” – in this case, the bank lobby. The second question is, “Just what is it they want to ‘recover’?” The answer is, the Bubble Economy. For the financial sector it was a golden age. Having enjoyed the Greenspan Bubble that made them so rich, its managers would love to create yet more wealth for themselves by indebting the “real” economy yet further while inflating prices all over again to make new capital gains.

            The problem for today’s financial elites is that it is not possible to inflate another bubble from today’s debt levels, widespread negative equity, and still-high level of real estate, stock and bond prices. No amount of new capital will induce banks to provide credit to real estate already over-mortgaged or to individuals and corporations already over-indebted. Moody’s and other leading professional observers have forecast property prices to keep on plunging for at least the next year, which is as far as the eye can see in today’s unstable conditions. So the smartest money is still waiting like vultures in the wings – waiting for government guarantees that toxic loans will pay off. Another no-risk private profit to be subsidized by public-sector losses.

            While the Obama administration’s financial planners wring their hands in public and say “We feel your pain” to debtors at large, they know that the past ten years have been a golden age for the banking system and the rest of Wall Street. Like feudal lord claiming the economic surplus for themselves while administering austerity for the population at large, the wealthiest 1% of the population has raised their appropriation of the nationwide returns to wealth – dividends, interest, rent and capital gains – from 37% of the total ten years ago to 57% five years ago and it seems nearly 70% today. This is the highest proportion since records have been kept. We are approaching Russian kleptocratic levels.

            The officials drawn from Wall Street who now control of the Treasury and Federal Reserve repeat the right-wing Big Lie: Poor “subprime families” have brought the system down, exploiting the rich by trying to ape their betters and live beyond their means. Taking out subprime loans and not revealing their actual ability to pay, the NINJA poor (no income, no job, no audit) signed up to obtain “liars’ loans” as no-documentation Alt-A loans are called in the financial junk-paper trade.

            I learned the reality a few years ago in London, talking to a commercial banker. “We’ve had an intellectual breakthrough,” he said. “It’s changed our credit philosophy.”

            “What is it?” I asked, imagining that he was about to come out with yet a new magical mathematics formula?

            “The poor are honest,” he said, accompanying his words with his jaw dropping open as if to say, “Who would have guessed?”

            The meaning was clear enough. The poor pay their debts as a matter of honor, even at great personal sacrifice and what today’s neoliberal Chicago School language would call uneconomic behavior. Unlike Donald Trump, they are less likely to walk away from their homes when market prices sink below the mortgage level. This sociological gullibility does not make economic sense, but reflects a group morality that has made them rich pickings for predatory lenders such as Countrywide, Wachovia and Citibank. So it’s not the “lying poor.” It’s the banksters’ fault after all!

            For this elite the Bubble Economy was a deliberate policy they would love to recover. The problem is how to start a new bubble to make yet another fortune? The alternative is not so bad – to keep the bonuses, capital gains and golden parachutes they have given themselves, and run. But perhaps they can improve in Bubble Economy #2.

            The Treasury’s newest Financial Stability Plan (Bailout 2.0) is only the first step. It aims at putting in place enough new bank-lending capacity to start inflating prices on credit all over again. But a new bubble can’t be started from today’s asset-price levels. How can the $10 to $20 trillion capital-gain run-up of the Greenspan years been repeated in an economy that is “all loaned up”?

            One thing Wall Street knows is that in order to make money, asset prices not only need to rise, they have to go down again. Without going down, after all, how can they rise up? Without a crucifixion for the economy, how can there be a resurrection? The more frenetic the price fibrillation, the easier it is for computerized buy-and-sell programs to make money on options and derivatives.

            So here’s the situation as I see it. The first objective is to preserve the wealth of the creditor class – Wall Street, the banks and the other financial vehicles that enrich the wealthiest 1% and, to be fair within America’s emerging new financial oligarchy, the richest 10% of the population. Stage One involves buying out their bad loans at a price that saves them from taking a loss. The money will be depicted to voters as a “loan,” to be repaid by banks extracting enough new debt charges in the new rigged game the Treasury is setting up. The current loss will be shifted the onto “taxpayers” and made up by new debtors – in both cases labor, onto whose shoulders the tax burden has been shifted steadily, step by step since 1980.

            An “aggregator” bank (sounds like “alligator,” from the swamps of toxic waste) will buy the bad debts and put them in a public agency. The government calls this the “bad” bank. (This is Geithner’s first point.) But it does good for Wall Street – by buying loans that have gone bad, along with loans and derivative guarantees and swaps that never were good in the first place. If the private sector refuses to buy these bad loans at prices the banks are asking for, why should the government pretend that these debt claims are worth more. Vulture funds are said to be offering about what they were when Lehman Brothers went bankrupt: about 22 cents on the dollar. The banks are asking for 75 cents on the dollar. What will the government offer?

            Perhaps the worst alternative is that is now being promoted by the banks and vulture investors in tandem: the government will guarantee the price at which private investors buy toxic financial waste from the banks. A vulture fund would be happy enough to pay 75 cents on the dollar for worthless junk if the government were to provide a guarantee. The Treasury and Federal Reserve pretend that they simply would be “providing liquidity” to “frozen markets.” But the problem is not liquidity and it is not subjective “market psychology.” It is “solvency,” that is, a realistic awareness that toxic waste and bad derivatives gambles are junk. Mr. Geithner has not been able to come to terms with how to value this – without bringing the Obama administration down in a wave of populist protest – any more than Mr. Paulson was able to carry out his original Tarp proposal along these lines.

            The hardest task for today’s banksters is to revive opportunities for creditors to make a new killing. (It’s the economy that’s being killed, of course.) This seems to be the aim of the Public/Private investment company that Mr. Geithner is establishing as the second element in his plan. The easiest free lunch is to ride the wave of a new bubble – a fresh wave of asset-price inflation to be introduced to “cure” the problem of debt deflation.

            Here’s how I imagine the ploy might work. Suppose a hapless family has bought a home for $500,000, with a full 100% $500,000 adjustable-rate mortgage scheduled to reset this year at 8%. Suppose too that the current market price will fall to $250,000, a loss of 50% by yearend 2009. Sometime in mid 2010 would seem to be long enough for prices to decline by enough to make “recovery” possible – Bubble Economy 2.0. Without such a plunge, there will be no economy to “rescue,” no opportunity for Tim Geithner and Laurence Summers to “feel your pain” and pull out of their pocket the following package – a variant on the “cash for trash” swap, a public agency to acquire the $500,000 mortgage that is going bad, heading toward only a $250,000 market price.

            The “bad bank” was not quite ready to be created this week, but the embryo is there. It will take the form of a public/private partnership (PPP) of the sort that Tony Blair made so notorious in Britain. And speaking of Mr. Blair, I am writing this from England, where almost every America-watcher I talk to has expressed amazement at Obama’s performance last week idealizing England’s counterpart to George Bush when it comes to unpopularity contests. Blair’s tenure in office was a horror story, not something to be congratulated for. He privatized the railroads and entering into the disastrous public/private partnership that doubled, tripled or quadrupled the cost of public projects by adding on a heavy financial overhead If Obama does not realize how he shocked Britain and much of Europe with his praise, then he is in danger of foisting a similar public/private financialized “partnership” on the United States

            The new public/private institution will be financed with private funds – in fact, with the money now being given to re-capitalize America’s banks (headed by the Wall St. bank’s that have done so bad). Banks will use the Treasury money they have received by “borrowing” against their junk mortgages at or near par to buy shares in a new $5 trillion institution created along the lines of the unfortunate Fanny Mae and Freddie Mac. Its bonds will be guaranteed. (That’s the “public” part – “socializing” the risk.) The PPP institution will have the power to buy and renegotiate the mortgages that have passed into the hands of the government and other holders. This “Homeowner Rescue Trust” will use its private funding for the “socially responsible” purpose of “saving the taxpayer” and middle class homeowners by renegotiating the mortgage down from its original $500,000 to the new $250,000 market price.

            Here’s the patter talk you can expect, with the usual Orwellian euphemisms. The Homeowners Rescue PPP will appear as a veritable Savior Bank resurrected from the wreckage of Bubble #1. Its clients will be families strapped by their mortgage debt and feeling more and more desperate as the price of their major asset plummets more deeply into Negative Equity territory. To them, the new PPP will say: “We’ve got a deal to save you. We’ll renegotiate your mortgage down to the current market price, $250,000, and we’ll also lower your interest rate to just 5.50%, the new rate. This will cut your monthly debt charges by nearly two thirds. Not only can you afford to stay in your home, you will escape from your negative equity.”

            The family probably will say, “Great.” But they will have to make a concession. That’s where the new public/private partnership makes its killing. Funded with private money that will take the “risk” (and also reap the rewards), the Savior Bank will say to the family that agrees to renegotiate its mortgage: “Now that the government has absorbed a loss (in today’s travesty of “socializing” the financial system) while letting let you stay in your home, we need to recover the money that’s been lost. If we make you whole, we want to be made whole too. So when the time comes for you to sell your home or renegotiate your mortgage, our Homeowners Rescue PPP will receive the capital gain up to the original amount written off.”

            In other words, if the homeowner sells the property for $400,000, the Homeowners Rescue PPP will get $150,000 of the capital gain. If the home sells for $500,000, the bank will get $250,000. And if it sells for more, thanks to some new clone of Alan Greenspan acting as bubblemeister, the capital gain will be split in some way. If the split is 50/50 and the home sells for $600,000, the owner will split the $100,000 further capital gain with the Homeowners Rescue PPP. It thus will make much more through its appropriation of capital gains (the new debt-fueled asset-price inflation being put in place) than it extracts in interest!

            This would make Bubble 2.0 even richer for Wall Street than the Greenspan bubble! Last time around, it was the middle class that got the gains – even if new buyers had to enter a lifetime of debt peonage to buy higher-priced homes. It really was the bank that got the gains, of course, because mortgage interest charges absorbed the entire rental value and even the hoped-for price gain. But homeowners at least had a chance at the free ride, if they didn’t squander their money in refinancing their mortgages to “cash out” on their equity to support their living standards in a generation whose wage levels had stagnated since 1979. As Mr. Greenspan observed in testimony before Congress, a major reason why wages have not risen is that workers are afraid to strike or even to complain about being worked harder and harder for longer and longer hours (“raising productivity”), because they are one paycheck away from missing their mortgage payment – or, if renters, one paycheck or two away from homelessness.

            This is the happy condition of normalcy that Wall Street’s financial planners would like to recover. This time around, they may not be obliged to make their gains in a way that also makes middle class homeowners rich. In the wake of Bubble Economy #1, today’s debt-strapped homeowners are willing to settle merely for a plan that leaves them in their homes! The Homeowners Rescue PPP can appropriate for its stockholder banks and other large investors the capital gains that have been the driving force of U.S. “wealth creation,” bubble-style. That is what the term “equity kicker” means.

            This situation confronts the economy with a dilemma. The only policies deemed politically correct these days are those that make the situation worse: yet more government money in the hope that banks will create yet more credit/debt to raise house prices and make them even more unaffordable; credit/debt to inflate a new Bubble Economy #2.

            Lobbyists for Wall Street’s enormous Bad Bank conglomerates are screaming that all real solutions to today’s debt problem and tax shift onto labor are politically incorrect, above all the time-honored debt write-downs to bring the debt burden within the ability to pay. That is what the market is supposed to do, after all, by bankruptcy in an anarchic collapse if not by more deliberate and targeted government policy. The Bad Banks, having demanded “free markets” all these years, fear a really free market when it threatens their bonuses and other takings. For Wall Street, free markets are “free” of public regulation against predatory lending; “free” of taxing the wealthy so as to shift the burden onto labor; “free” for the financial sector to wrap itself around the “real” economy like parasitic ivy around a tree to extract the surplus.

            This is a travesty of freedom. As the putative neoliberal Adam Smith explained, “The government of an exclusive company of merchants, is, perhaps, the worst of all governments.” But worst of all is the “freedom” of today’s economic discussion from the wisdom of classical political economy and from historical experience regarding how societies through the ages have coped with the debt overhead.


How to save the economy from Wall Street

            There is an alternative to ward all this off, and it is the classic definition of freedom from debt peonage and predatory credit. The only real solution to today’s debt overhang is a debt write-down. Until this occurs, debt service will crowd out spending on goods and services and there will be no recovery. Debt deflation will drag the economy down while assets are transferred further into the hands of the wealthiest 10 percent of the population, operating via the financial sector.

            If Obama means what he says, he would use his office as a bully pulpit to urge repeal the present harsh creditor-oriented bankruptcy law sponsored by the banks and credit-card companies. He would campaign to restore the long-term trend of laws favoring debtors rather than creditors, and introduce legislation to restore the practice of writing down debts to reflect the debtor’s ability to pay, imposing market reality to debts that are far in excess of realistic valuations.

            A second policy would be to restore the power of state attorneys general to bring financial fraud charges against the most egregious mortgage lenders – the prosecutions that the Bush Administration got thrown out of court by claiming that under an 1864 National Bank Act clause, the federal government had the right to override state prosecutions of national banks – and then appointing a non-prosecutor to this enforcement position.

            On the basis of reinstated fraud charges, the government might claw back the bank bonuses, salaries and bank earnings that represented the profits from America’s greatest financial and real estate fraud in history. And to prevent repetition of the past decade’s experience, the Obama Administration might help popularize a new psychology of debt. The government could encourage “the poor” to act as “economically” as Donald Trumps or Angelo Mozilo’s would do, making it clear that debt write-downs are a right.

            Also to ward off repetition of the Bubble Economy, the Treasury could impose the “Tobin tax” of 1% on purchases and options for stocks, bonds and foreign currency. Critics of this tax point out that it can be evaded by speculators trading offshore in the rights to securities held in U.S. accounts. But the government could simply refuse to provide deposit insurance and other support to institutions trading offshore, or simply could announce that trades in such “deposit receipts” for shares would not have legal standing. As for trades in derivatives, depository institutions – including conglomerates owning such banks – can simply be banned as inherently unsafe. If foreigners wish to speculate on financial horse races, let them.

            Financial policy ultimately rests on tax policy. It is the ability to levy taxes, after all, that gives value to Treasury money (just as it is the inability to collect on debts that has depreciated the value of commercial bank deposits). It is easy enough for fiscal policy to prevent a new real estate bubble. Simply shift the tax system back to where it originally was, on the land’s site-rental value. The “free lunch” (what John Stuart Mill called the “unearned increment” of rising land prices, a gain that landlords made “in their sleep”) would serve as the tax base instead of burdening labor and industry with income taxes and sales taxes. This would achieve the kind of free market that Adam Smith, John Stuart Mill and Alfred Marshall described, and which the Progressive Era aimed to achieve with America’s first income tax in 1913. It would be a market free of the free lunch that Chicago Boys insist does not exist.  But the recent Bubble Economy and today’s Bailout Sequel have been all about getting a free lunch.

            A land tax would prevent housing prices from rising again. It is the most hated tax in America today, largely because of the disinformation campaign that has been mounted by the real estate interests and amplified by the banks that stand behind them. The reality is that taxing land appreciation rather than wages or corporate profits would save homeowners from having to take on so much debt in order to obtain housing. It would save the economy from seeing “wealth creation” take the form of the “unearned increment” being capitalized into higher bank loans with their associated carrying charges (interest and amortization).

            The wealth tax originally fell mainly on real estate. The most immediate and politically feasible priority of the Obama Administration thus should be to repeal the Bush Administration’s drastic tax cuts for the top brackets and its moratorium on the estate tax. The aim should be to bring down the polarization between creditors and debtors that has concentrated over two-thirds of the returns to wealth in the richest 1% of the population.

            If alternatives to the Bubble Economy such as these are not promoted, we will know that promises of change were mere rhetoric, Tony Blair style.


$$$Banks can give you as …$$$ you need ! January 15, 2009

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Bankers will tell you that they do not create money.  At a 10% reserve requirement, they simply lend out 90% of their deposits.  The catch is that their “deposits” include the money they have written into their customers’ accounts as loans.  That is how loans are made: numbers are simply written into the accounts of borrowers, as many reputable authorities have attested.  Here are two of them, dating back to when officials were either more aware of what was going on or more open about it:


“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan.  The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone.  It’s new money, created by the bank for the use of the borrower.”


        – Robert B. Anderson, Treasury Secretary under Eisenhower, in an interview

 reported in the August 31, 1959 issue of U.S. News and World Report


“Do private banks issue money today?  Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”


          Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)                         


The process by which banks create money was detailed in a revealing booklet put out by the Chicago Federal Reserve titled Modern Money Mechanics.2  The booklet was periodically revised until 1992, when it had reached 50 pages long.  It is written in somewhat difficult prose, but here are a few relevant passages:  


“The actual process of money creation takes place primarily in banks.” [p3]


Translation: banks create money.


“In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency.” [p3]


Translation: banks can create as much money as they want by writing loans into their borrowers’ accounts, limited only by (a) legal reserve requirements (money that must be held in reserve – traditionally about 10% of outstanding deposits and loans) or (b) the amount of money they will need to keep on hand to pay any depositors who might come for their money (also traditionally about 10%). 


“Banks may increase the balances in their reserve accounts by depositing checks and proceeds from electronic funds transfers as well as currency.” [p4]


Translation: the “reserves” that count toward the reserve requirement include currency, deposited checks, and electronic funds transfers.  (Note that the “deposits” created as loans are excluded from this list of allowable reserves: the bank cannot just keep bootstrapping loans on top of loans but must have money from external sources backing up its liabilities equal to about 10% of its loans and deposits.)


“The money-creation process takes place principally through transaction accounts [accounts that can be drawn on without restriction].”  [p2]


“ With a uniform 10 percent reserve requirement, a $1 increase in reserves would support $10 of additional transaction accounts.” [p49]


Translation: $1 deposited by a customer can be fanned into $10 in loans.


“In the real world, a bank’s lending is not normally constrained by the amount of excess reserves it has at any given moment. Rather, loans are made, or not made, depending on the bank’s credit policies and its expectations about its ability to obtain the funds necessary to pay its customers’ checks and maintain required reserves in a timely fashion.” 


Translation: In practice, banks issue loans without worrying too much about whether they have the reserves to cover them.  If they come up short, they can just borrow them:


“[Since] the individual bank does not know today precisely what its reserve position will be at the time the proceeds of today’s loans are paid out. . . . many banks turn to the money market – borrowing funds to cover deficits or lending temporary surpluses.” [p50]


“[A] bank may [also] borrow reserves temporarily from its Reserve Bank. . . .

[However], banks are discouraged from borrowing [Reserve Bank] adjustment credit too frequently or for extended time periods.” [p29]


Translation: If the bank finds at the end of the accounting period that its reserves do not come to the required 10% of its outstanding loans and deposits, it can simply borrow the reserves it needs from the money market or its Federal Reserve Bank.


A 2002 article posted on the website of the Federal Reserve Bank of New York noted that today, few banks are constrained by reserve requirements at all:


“Since the beginning of the last decade, required reserve balances have fallen dramatically. The decline stems in part from regulatory action: the Federal Reserve eliminated reserve requirements on large time deposits in 1990 and lowered the requirements on transaction accounts in 1992. But a far more important source of the decline in required reserves has been the growth of sweep accounts.  In the most common form of sweeping, funds in bank customers’ retail checking accounts are shifted overnight into savings accounts exempt from reserve requirements and then returned to customers’ checking accounts the next business day. Largely as a result of this practice, today only 30 percent of banks are bound by a reserve balance requirement.”3


Even without official reserve requirements, however, banks must keep enough money on hand to meet withdrawals or checks written against the accounts of their depositors; and that generally means about 10% of outstanding deposits and loans, as moneylenders discovered centuries ago.  But if the banks come up short, they can borrow this money from the money market or the Federal Reserve; and if the Fed comes up short, it can create new reserves.4  So why the current credit crunch?  What is limiting bank lending? 


One answer is that borrowers are simply “tapped out” and not in a position to take out as many loans as they used to.  When housing and the stock market crashed, consumers no longer had home or stock equity to borrow against.5  But to the extent that the blockage is with the banks themselves, it is not caused by the reserve requirement.  Something else is putting the squeeze on credit . . . . Stay tuned, because I’m gonna tell ya what the real problem is, and how to stop the bleeding. these things they’re talking about on local news and msnbc, cnn, well; you the ones, they’re not telling you the real truth, however, I will.  


It’s coming fast, with fury! November 25, 2008

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Continuation from previous blog. Refer to home page. Structured finance is a term that designates a sector of finance where risk is transferred via complex legal and corporate entities. It’s not as confusing as it sounds. Take a mortgage-backed security (MBS), for example. The mortgage is issued by a bank (the loan originator) which then sells the mortgage to a brokerage where it is chopped up into tranches (pieces of the loan) and sold in a pool of mortgages to investors that are looking for a rate that is greater than Treasurys or similar investments. The process of transforming debt (“the mortgage”) into a security is called securitization. At one time, the MBS was a reasonably safe investment because the housing market was stable and there were relatively few foreclosures. Thus, the chance of losing one’s investment was quite small.

In the early years of the Bush administration, Wall Street took advantage of the gigantic flow of capital coming into the country ($700 billion per year via the current account deficit) by creating more and more MBSs and selling them to foreign banks, hedge funds and insurance companies. It was real gold rush. Because the banks were merely the mortgage originators, they didn’t believe their own money was at risk, so they gradually lowered lending standards and issued millions of loans to unqualified applicants who had no job, no collateral and a bad credit history. Securitization was such a hit, that by 2005, nearly 80 percent of all mortgages were securitized and the traditional criteria for getting a mortgage was abandoned altogether. Subprimes, Alt-As and ARMs flourished, while the “30 year fixed” went the way of the Dodo. Lenders were no longer constrained by “creditworthiness”; anyone with a pulse and a pen could get approved. The mortgages were then shipped off to Wall Street where they were sold to credulous investors.

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