Into the Abyss: Of Ponzi Schemes and the Myth of the Self-regulating Market
Special to Canadian Dimension March 23, 2008
…For the April issue of ‘Mayday’..
Don’t Worry, Be Happy
Speaking before the Economic Club of New York on March 14, President George Bush declared that the US economy was “the envy of the world” and that the present financial crisis was merely a “rough patch”. He further intoned that, “in a free market, there’s going to be good times and bad times. That’s how markets work.” Ah, reassuring stuff.
This was just hours after the US Federal Reserve had stepped in to rescue Bear Stearns, the fifth largest US investment bank, and only one day after the collapse of Carlyle Capital Corporation, one of the largest and most profitable equity firms in the country. Still, it was almost two years after the beginning of the implosion of the US housing bubble whence up to 2 million American families have since lost their homes and where another million are expected to be uprooted and rendered homeless over the coming year.
In the intervening period there have also been runs on banks in both England and Germany. Moreover, a world-wide credit crunch has ensued as the bad paper in the mortgage securities ‘industry’ has rippled outwards towards HMS Corporate Titanic and where a similar tidal wave of fraudulent paper has sent investors scurrying for the life rafts.
Parroting Herr Bush, the business media pundits have been falling over themselves in the rush to assure us that this isn’t what it all really looks like, that everything’s actually alright, that the economy is fundamentally sound, and that the market is just executing a little ‘correction’.
Suffice it to say that history, probity and contextual analysis have never exactly been strong points of the talking heads.
Déjà Vu
If anything is clear about the present economic crisis it is that the parallels with the beginning of the Great Depression in 1929 are both substantive and striking. Thus, in both cases is / was the ground for the crisis laid and preceded by 1) a housing bubble that imploded, 2) the crowding out of real investment by speculative investment, 3) an mounting imbalance in world trade, 4) a prolonged assault upon labour, 5) a profound polarization of wealth and increase in inequality, and 6) a more or less total lack of regulation of the financial system.
These six factors are / were, of course, intimately interrelated. Inequality, for example, has, historically, led to a narrowing of consumption. Moreover, the increase in wealth concentration has inevitably shifted the surplus capital into speculative, as opposed to productive, investments. As such, the United States, which was responsible for 30% of world GDP in 2003, is now, a mere five years later, producing only 25% of world GDP, a dramatic shift.
Inequality, itself, has – both in the US and Canada - been further expanded and entrenched through blatantly regressive tax policies. In the United States, Bush & Co. have, since 2000, issued $5 trillion in tax cuts, 80% of which have accrued to the rich and to corporations. [In Canada, just as a ‘for instance’, $55 billion of the Employment Insurance fund has, over the last few years, been siphoned off into general revenue, thence to tax gifts to the wealthy and to corporations]. In terms of national income, the wealthiest 1% of Americans now take home over 22% of the pie compared to ‘just’ 9% when Bush first entered office. Similar figures apply to the 1920’s.
Meanwhile, wages are, in real terms, lower today than they were in the early ‘70’s. Standards of living have only been maintained by people working longer hours and by deploying two-income families. In the States this has been supplemented by the housing bubble whereby owners have been able to maintain consumption by borrowing against the increasing value of their homes.
The housing bubble itself was initiated, in part, by the lavish monetary policy of the US Federal Reserve over the last eight years whose easy credit initiatives were a knock-on result of the need to overcome the even earlier liquidity and credit crises that arose from the previous real estate and dot.com speculative bubbles. Here we see the system lurching from one crisis to another by employing the very measures that guarantee the creation of the next crisis. This, in all truth, is reckoned by great and discerning minds as ‘financial wisdom’ and ‘hard-headed business acumen’.
Another part of the housing bubble – and credit crisis in general – has resulted from the elimination (progressing from the Reagan through the Clinton and Bush Administrations) of any semblance of financial regulatory oversight. With this deficit in regulation has arisen a bewildering array of new financial ‘investment vehicles’ and structures. The very Byzantine nature of these new investment toys, coupled with the revolution in information technologies and, hence, ‘globalization’ of investment practices has led to a further de facto de-regulation of global investment activity simply by virtue of the difficulty in monitoring such activities.
Complex though they are, it is nevertheless worth taking a glance at these little investment ‘toys’ just to see what all the fuss is about.
‘Ponzi’ By Any Other Name
At the heart of the so-called ‘securitization revolution’ are the little beasts called ‘derivatives’. At its most basic a derivative is simply a financial instrument derived from other such instruments. An interesting example are ‘interest rate swaps’ whereby Companies A & B engage in a wholly fictional transaction by ‘loaning’ each other, say, $100 million, each betting on the opposite direction in which interest rates are likely to swing. The loser pays the winner the eventual difference in the rate.
The key here is that derivatives have no intrinsic value. Their value is derived from either real things or other instruments that were themselves based on real things. This pyramiding of purely fictional and speculative financial offerings is what, in all seriousness, accounts for the vast majority of market activity. Indeed, only about 3% of all market transactions involves monies for new share offerings that go into the expansion of actual productive assets. The rest is, more or less, sheer gambling.
Just to drive this point home it is noteworthy that though global GDP is somewhere shy of $50 trillion, the derivative market alone is ‘worth’ upwards of $500 trillion. And, of course, all that activity, all those broker fees, all the real, crinkly cash profits remitted to these market playerz are paid for by someone, i.e. you, through regressive taxes, the destruction and fiscal strangulation of social programs, the price of consumer goods, etc. In essence, such activity amounts to a vast transfer of wealth from one sector of society to another. Badda-bing, badda-boom.
Now, one small part of this ‘derivative’ pyramid scheme involved the infamous subprime mortgages (mortgages whose loan conditions were less, far less, than sound). Though the mortgages themselves were based on real assets, they were then bundled together in the hundreds or thousands, repackaged with other shady (often fictitious) ‘financial instruments’ and sold off, either whole or in part, as Collateralized Debt Obligations (CDO’s). These were then traded like bananas all over the globe.
The kicker here is that these CDO’s were often packaged with equally risky (and, again, often fictional) ‘asset backed corporate commercial paper’ (ABCP). So, when the subprime mortgage market started to unravel, so too did the ABCP’s begin their march to the precipice. As much of this fictional financial gambling was based on ‘leveraged’ transactions (i.e. paid for, a la 1929, on margin), the calling in of markers has now begun to cascade through the whole tottering edifice. Thus, the banks have become reluctant to lend out money in part because they need to cover their own highly exposed investment posteriors, and in part because there is growing uncertainty as to the solvency of their, otherwise, pillar-of-the-community corporate clients. It’s all so confusing.
The ripple effect has been further amplified by the selling of financial ‘insurance’ whereby risk was spread around so thin through the entire financial community that no body, it seemed, could get hurt; a ‘miracle’ of financial wizardry. The niggling little problem, of course, was that the whole system was then linked together like so many fissionable neutrons awaiting detonation. The only question now is how large will be the implosion.
One Market Under God…
There have, of course, been bubbles and recessions before and the question rightly arises as to why this one should be thought any different, that is, any worse. The answer is that not only is the scale of the problem so much greater this time, but the latitude for ameliorating it is so much less.
In the former instance, the culprit resides in both the dramatic increase in the globalization of financial interconnectedness, as well as the exponential and unregulated surge in derivatives trading itself. In the latter case, the options for staving off financial recession have already been largely exhausted in dealing with the bursting of previous speculative bubbles. Consumer spending, for instance, which has oft been relied upon in the past to buoy the economy has, with the decline in real wages and the fall of the housing market, been finally tapped out. Consumer, public, and corporate debt are at an all time high, and interest rates are about as low as they can go. In addition, the US government deficit, trade deficit and military budget are ruinously high. Indeed, much of the cost of the imperial wars in Iraq and Afghanistan are, in fact, paid for by foreign creditors, and they’re getting mighty wary of a bad bet. In short, there’s not much left in the kitty.
It is, finally, worth asking at this juncture how those who believe in the beneficence of the unregulated ‘free market’ are able to maintain their faith, for faith it must be. Certainly there is, at present, no rational or empirical basis for their belief. But then, there never really was. Looking back over the greater part of the past eight centuries or so one finds that the equilibrium of the market was always a slim exception to the rule. The myth of the self-regulating market is, it would appear, merely another linguistic device designed to rationalize and mask unregulated greed. A reflection, if you like, of the free-flowing Freudian Id. This and no more.
Antony Black tal1@cogeco.ca