According to Workforce Management the broker-dealers from the once-careening-into-bankruptcy-and-now-taxpayer-funded-AIG will NOT be paid bonuses from AIG. Sounds good, right? After all these broker-dealers are part of the same group that put together the toxic financial packages (CDOs & CDSs; see links) that turned into garbage, exploded in our collective faces, and helped drag the company down. They also helped insure that AIG would need an $85 billion taxpayer funded bailout, for no other reason than they screwed up big time.
In a real business - and in a real market economy - if you put together a deal that exploded in your face and threatened your company with insolvency some people would expect to get fired. If you walked away with cash in the process some people might even be brought up on charges, and could be looking at hard time. But in this Alice in Wonderland economy that's not the case.
It turns out that AIG's brokers will get paid for their incompetence and greed. But not by AIG. Instead, they're getting paid by AIG. Huh? Here's how it works.
Since AIG (and other financial firms) ran into a hail of fire for planning to reward their broker-dealer screw-ups with bonuses they decided to forego paying out bonuses about 6 months ago. Instead AIG is going to allow companies like SagePoint Financial - a subsidiary created by AIG - to pay out bonuses.
Got that? AIG, the parent company that's on the hook for tens of billions in losses manufactured by broker-dealers, and their shoddy business practices, is not paying out bonuses. AIG created subsidiaries like SagePoint (part of the AIG Advisor Group Inc., which includes FSC Securities Corp. and Royal Alliance Associates Inc) will go ahead and pay out bonuses. Nice.
Here's the real fun part. The bonuses aren't called bonuses. They're called "business-building loans" because - at least on paper - they're supposed to be paid back. Only they don't have to be paid back. Why? Because the loans (i.e. bonuses) are structured in way so that they don't have to be paid back. As Workforce points out, they're really "forgivable" loans, that happen to double as "retention bonuses."
See what I mean by "Alice in Wonderland Economy"?
So, you all can rest easy. AIG's mess will not grow because they're not paying out bonuses to reward incompetence. Instead, AIG subsidiaries will do their dirty work. All is good. As Alice might say, "If it had grown up, it would have made a dreadfully ugly child; but it makes rather a handsome pig, I think."
Hey, I think I just saw a rabbit go down a hole ...
Some of you might recall that back in October of 2009 I wrote "You Can't Turn a Pinto Into a Mustang." At the time I was using Ford cars to explain how - in the real world - you can't take a piece of crap car (Pinto) and suddenly revalue it and get classic car (Mustang) prices. That is, of course, unless you're one of the financial institutions that can take advantage of a Jan. 1, 2009 government ruling which says "Go ahead, revalue the toxic crap you own ... we don't mind."
In my October post I explained (by using Ford cars as a metaphor) how the Financial Accounting Standards Board's (FASB) 2009 ruling effectively allows America's financial institutions to ...
Level I: Price their financial instruments according to everyday market prices, known as the "mark-to-market" method.
Level II: Price their financial instruments according to what similar assets might sell for if more of them were around and/or sold. On this, think assessed value on hard to value antiques or one of a kind goods.
Level III: Ignore Level I and Level II pricing methods and simply make shit up ... known in the accounting world as the "mark-to-make-believe" method.
All too often, it appears that America's financial institutions are using Level III mark-to-make-believe methods to make up their prices. What I didn't explain at the time are the details behind the game. Here's how it's happening ...
It turns out that when FASB implemented "Statement 157" on January 1, 2009 - in addition to directing financial firms on how to assess "fair value" for their goods (Levels I, II, or III) - it also left a loophole wide enough for William "The Refrigerator" Perry to walk through.
More specifically, FASB rules allow America's financial institutions to ask for a pricing waiver on financial instruments if they don't like the numbers from Level I or Level II methods. This is akin to a homeowner who hopes to secure a loan on their house being able to say, "I don't like the value my house was assessed from the Level I or Level II methods. I want a waiver so I can apply mark-to-make-believe (Level III) methods ... yeah, I want to let Peter Rabbit assess the value of my house."
Put another way, you get another shot at reassessing the value of your house at a price that has nothing to do with what it's really worth. Making matters worse, other financial institutions, the American taxpayer Federal government, and other unsuspecting market players have to play along with the charade and accept the price too.
To be sure, the financial firms have to fill out some extra paper work to gain access to the mark-to-make-believe (Level III) pricing method. The FASB does have it's standards (wink, wink). But what's a few more fairy tales penned in an economy that already has an Alice in Wonderland character to it? Once you're down the rabbit hole does it really matter if you burrow deeper?
Gaining access to mark-to-make-believe (Level III) method is the result of a loophole that says if your financial asset is exposed to "forced liquidation or distress sale" conditions you can apply for a waiver. As you might guess, given the market conditions of the past year, virtually any toxic financial instrument created on Wall Street could qualify for a Level III categorization, as long as the financial firm is willing to do the paper work.
And just like that, a toxic CDO or an SIV (which are akin to financial toilets), can be revalued to some made up number that makes Wall Street's financial mandarins feel better about themselves. More importantly, because of Tim Geithner's hare-brained scheme - which allows financial firms to use their toxic crap as collateral for new money - financial firms can dump their repriced assets on the American taxpayerFederal Reserve for new loans, credit, and profits.
To be sure, the market value of the product may still be in the toilet. But who cares? As long as the book value of the instrument hasn't collapsed we can all make believe that our banks are doing just fine. Thank you FASB.
In the end, it's because of FASB (which is under the SEC) that Wall Street's biggest players (1) have been able to maintain the illusion that their assets and their financial institutions are worth more than they really are, and (2) can go to Uncle Sam for more loans and credit guarantees, using collateral that's toxic and/or has tanked in value.
So, yes, if you work in Wall Street's Alice in Wonderland world, it appears you can turn a Pinto into a Mustang.
No matter how you slice it, the aughts - or the first decade of the 21st century - were an economic bust for Middle America. In fact, the Washington Post's Neil Irwin called it the "lost decade" (click on graph to enlarge).
How bad was it? Whatever jobs we thought had been created were wiped out by the market collapse that occurred between 2007 and 2009.
The primary reason for this development is that market analysts and media pundits drank the free market Kool-Aid that was being peddled at the time (incredibly, this same Kool-Aid talk is now making a comeback). In a few words the free market happy talk works like this: Trust market players, they will do the right thing.
Ooops.
What people missed was how all the free market happy talk was really the delusional babble of analysts and media pundits who ignored how a bubble economy had been built on growing consumer debt, favorable legislation, and deregulation. Worse, the bubble economy had been super-charged by market players who operated as if they were in a casino rather than as real investors in a capitalist economy.
Why did the market experts ignore this? Because they don't know how markets really work in today's casino economy. In a few words our casino economy works like this: You're on your own, market players can do what they can to take your money. They own the House.
A bit harsh? Perhaps. But I don't think so. Here's why.
In a wonderful (if somewhat overly technical) review of how some of America's biggest institutional players gamed the system, Yves Smith outlined how companies like Goldman Sachs and Morgan Stanley deceived market players into buying certain market products. The problem was that Goldman Sachs and Morgan Stanley were betting that these same products would fail.
The details of the deals are somewhat complex, but it would be akin to me selling you a car but then delivering you a lemon. Or, as I wrote about in October, it would be akin to me selling you a Classic '65 Mustang but sending you a piece of crap Pinto. Your argument would be "It's not the model I want." My argument (or Goldman Sachs' argument) would be "Hey, a Ford's a Ford." In the real world, unless you're seriously clueless - or just plain stupid - this wouldn't be tolerated. And if it were, the seller could still be charged with fraud.
But in today's Alice in Wonderland Economy companies like Goldman Sachs and Morgan Stanley think that they are not only entitled to sell you crap, but that if you lose money you should have known better because everyone can lose if they go through the wrong door.
As Yves Smith points out this kind of thinking is "irrelevant" when you consider many of the institutional investors who got taken for a ride (like union or state pension funds) were not equal partners in setting up the deals, nor were they given access to the same models that companies like Goldman and Morgan had for assessing deals. Worse, most of the deals were managed, "meaning they were effectively blind pools."
What does all of this mean in plain English? Goldman and Morgan were effectively selling crappy Pintos and getting Classic '65 Mustang prices. Their argument? Not that it was good business. Because it wasn't (collaborating with rating agencies is not good business). Instead, they're banking on the "it was legal" argument.
They knew they would get away with it because pension fund plans (for example) had neither the expertise, personnel, nor the models to assess the games firms like Goldman and Morgan were playing. Pension funds and the American taxpayer were effectively played as suckers.
As I point out in my book, what we have today is an economy based on wealth extraction, not it's creation. Worse, it's being extracted in a casino economy built on bubbles, industry lies (see esp. the rating agencies), favorable legislation, and debt.
In the next few months we're going to hear some good news on the economic front. Don't be misled by the Kool-Aid talk sure to follow. Think about it, $10-20 trillion in market bailouts and other guarantees should buy us some good news. But with consumer debt, favorable legislation, and deregulation continuing unabated what we're actually going to see is more smoke & mirrors.
In spite of recent bailouts, favorable legislation, and regular money dumps from the Federal Reserve, we don't have socialism in America. Not even close. This is the case even if you count government safety nets, which don't cost anywhere near what we've committed or disbursed to Wall Street since 2008 (at least $13 trillion). But if you're going to make the "socialism in America" argument this is how you might want to start .... ______________________________________
In an effort to explain the logic behind market economics, in my book I tell the story of Russia's peasant economies after the October Revolution of 1917. One of the biggest problems Russia ran into was getting peasant farmers to produce. Things took a turn for the worse during Russia's Civil War (c. 1918-1922), when the nation was faced with frustrated revolutionaries and mass starvation. This was a critical moment since Russian revolutionaries wanted to sell surplus agricultural production to facilitate industrialization. But there were no surpluses.
While agriculture production increased with the introduction of the New Economic Policy in 1921, the program was abandoned by Josef Stalin and replaced with forced collectivization. Not surprisingly, agriculture production slipped, again.
To better understand why revolutionary peasants weren't producing surpluses - which were necessary to help fund industrialization - teams of anthropologists were sent to study peasants societies throughout Russia. This was a tremendous undertaking as it meant spending months, and even years, at a time in distant rural communities. But the findings were extraordinary.
PEASANT STUDIES & "UNCLE JOE"
Headed by researchers like Aleksander Chayanov, various institutes studied and learned about peasant societies throughout Russia. One key finding was that peasants would work until they had enough to feed their families, and not much beyond this point. As I point out in my book, they learned that subsistence peasant households didn't particularly care about wage or price incentives. Instead, for a variety of reasons (discussed in class), they focused primarily on the “use-value” of a good in the immediate term rather than its “exchange-value” in a market. Producing more than what they needed was viewed as “drudgery.”
Though the findings of Chayanov and others were instructive because they helped explain what was wrong with collectivization in the Russian countryside, they didn’t sit well with Stalin. He wanted to know how he could get peasants to produce. As a result, because of his own paranoia's and twisted world views, he saw the reports emerging from the countryside as an unwarranted defense of rich kulaks (productive peasant farmers). All he knew was that the revolutionary state demanded surpluses, and the peasants weren't producing.
Stalin saw traitors in his midst.
After Stalin took control of Russian agriculture the studies done by Chayanov and others were virtually ignored by the Soviet state, and many of the institutes were closed. But this was just the beginning. Repression and purges in the early 1930s were followed with large-scale disappearances of "non-revolutionaries."
Chayanov was among those branded a non-revolutionary. He was arrested, tried, and then shot on the same day in 1937 [photo below is not Chayanov].
In Stalin's world, the Russian revolution and the worker's paradise would be a success, even if he had to use the levers of the state to spin lies, send misfits to labor camps, or kill his political enemies (both real and imagined). This is where it gets interesting.
TRICKLE DOWN THEORY, SOVIET STYLE ...
While Chayanov's story is instructive for what it tells us about peasant economies (and capitalism; a topic for another day), it's also significant because of what it tells us about Russian revolutionaries and die-hard Bolsheviks like Stalin. They were so committed to their theories of socialism that they would use the state - which was supposed to wither away according to Karl Marx, mind you - to make sure that agriculture surpluses were created and transferred to the more productive industrial sector.
It was deemed unimportant that the state became increasingly repressive as it forced collectivization on peasants, suppressed living standards in the countryside, and then transferred resources from Russia's agriculture sector to industry and the city. The needs of backward peasants could be put off.
Part of the rationale for this line of thinking was that Stalin believed peasants would soon benefit from the availability of manufactured goods, agriculture equipment, and other products that would eventually reach the countryside. As Cambridge economist Ha-Joon Chang points out, this was trickle down theory, Soviet style.
I tell this story because, as Ha-Joon Chang suggests in 23 Things They Don't Tell You About Capitalism, policymakers today who claim to be die-hard capitalists and free marketeers are actively using the state - which is supposed to stay out of the marketplace, mind you - to bailout Wall Street, facilitate money dumps when markets fail, and to rewrite the rules to suit the needs of a specific class.
At the same time, by using the state to pursue union-busting trade agreements (while doing little for labor), winking at weak immigration laws (which helps suppress prices and wages), and then ignoring collapsing wage and living standards for America's middle class, America's policy makers are acting very much like Stalin's Politburo.
They're even promising that by transferring wealth to a designated productive class that the benefits will eventually reach those at the bottom. And they've been doing this for the better part of 30 years, in spite of a history of spectacular failures and budget deficits.
Like Stalin's planning authorities, today's proponents and willing recipients of bailouts, money dumps, and favorable legislation understand the importance of using the state to create and transfer wealth from one sector of the economy to another. With more than $4 trillion disbursed, and a total of 13 trillion in tax payer backed dollars committed to Wall Street's collapse, you can be sure of this.
But this is precisely the problem.
As I point out in my book (Ch. 11), by using the state to transfer wealth to achieve market results (profitability), America’s bailed out and subsidized market players are on no firmer intellectual ground than the Soviet Union's Vladimir Lenin and Joseph Stalin. Pushing for and accepting government favors, while speaking admiringly of the wonders of the market, imposes an Alice in Wonderland character on modern markets in America.
Seriously, at what point do we stop using the resources and authority of the state to prop up failed banks, wink at market busting Wall Street schemes, and continue to believe in the value of disastrous trickle down market ideology?
Wow. Check this out. Banks around the world will have to roll over (refinance) debt amounts between $5 trillion and $15 trillion over the next two years. That's a chunk of change. The primary problem is that banks could find it harder and harder to find the money to roll over debt as asset prices continue to slide downward. The banks will need some real magic. This is where friends from my youth, Rocky & Bullwinkle, come in.
The real trick comes in the form of some real regulatory stupidity (courtesy of the Financial Accounting Standards Board, or FASB) that allows America’s financial institutions to revalue the price of their toxic assets. I’ll leave it to market sociopaths to explain "the market" rationale, which you can find here. The end result is to create a world where Alice in Wonderland math governs our market environment, but how it works is really pretty simple.
Regulating Market Prices Out of the Market
Imagine you own a home before 2008. You likely watched a slow bleed process as it's market price tumbled over the past two years. Your $500,000 home is now worth $250,000 (or something like that). Because you have powerful neighbors who don't want to see their homes lose value if you walk away and leave an empty house (called a strategic default) they get the banks to legally allow you to reinflate the value of your home on their books.
The best part of getting another shot at reassessing the value of your home is that you can maintain previous debt levels, or borrow against the home, as if little happened to your houses market price. To be sure, it's really not that simple. But the concept applies (I've written in greater detail about the process here, here, and here). The end result, though, is that we effectively regulate market prices right out of the market. Same hat trick, different result.
The problem with this regulatory maneuver is that this is not being done for your home. You don't get to use the regulatory tools that the banks have access to. Like handicap parking it’s only available to a certain class of banks. In this case it's (FASB, Statement 157) only available to the incompetent sociopaths who run America’s biggest financial institutions.
Taking the Market Prices Out of the Market
By allowing America's financial institutions to re-price their toxic assets two things happen. Both will help solve our bankster's trillion dollar problem above.
ASSETS ROLLED OVER/GAME CONTINUES: It allows banks and governments, who had to rollover loans in 2009, to pretend the assets they underwrote are worth more than they actually are.
FINANCIAL AND LEGAL BAILOUT: It shields private equity firms in our shadow banking system (private investors) who “invested“ in toxic assets. They escape culpability and investor lawsuits.
And, just like that, our nation’s financial institutions are able to go to the Federal Reserve and Treasury Department and say, "Let us use these repriced (toxic) assets as collateral for a new loan. You can go ahead and keep the asset if I stop paying (wink, wink)."
Flush with bailout cash, new credits, new guarantees, and government approved unicorn methods to revalue their assets, and it should come as no surprise that America's financial institutions have continued to live in a make believe world drenched in irresponsibility and never ending
How Banksters Will Stick Us With the Bill
In 2008 only 2.7% of BofA’s failing loans were backstopped by the American taxpayer. In 2009 that number jumped 20.5%! Take a look at the numbers. But wait, it gets worse. These bad assets - which the Federal Reserve and the financial industry like to call "legacy assets" - are being dumped on the American taxpayer. This is how it's being done.
In order to put America's toxic, or legacy, assets on life-support (while putting more money into the banking system) we created something called a Term Asset-Backed Securities Loan Facility (TALF). In real simple terms TALFs are government-backed loans. They can be accessed by those who hold financial crap, or non-performing securities. To better understand the concept let's use our home example from above.
If TALFs were available to America's home owners they would be able to use their homes to get a loan from the bank, even if they're upside down on the loan. Unfortunately, TALF loans are only made available to America's largest and most powerful financial players through the Federal Reserve of New York (and, no, President Obama's Making Home Affordable Program doesn't even come close to TALF).
Here's the real good part.
The big financial players don't need to put up any good collateral for the loans they get. They can use their poorly performing toxic assets as collateral. Best of all, they can revalue these assets upward, courtesy of the federal government. If the collateral doesn't pay off you and I are stuck with the bill.
How much will this add up to? We don't know just yet. But we do know that the Federal Reserve has made at least $1 trillion available for these TALF products, and another $1.45 trillion for non-performing assets in the housing market.
Put another way, don’t worry about the banks. They’ll get their money to rollover their loans. The American taxpayer, however, will be stuck with the toxic assets and the affects of an austerity program that’s just beginning to take shape.
Have you ever had a friend or an acquaintance that strutted around, announcing to the world that he was a "self-made" man? You know the kind. Their parents paid for tutors, paid their college expenses, and then lined up jobs and money for their investments after they got out of college. Even when they fell on their face, family friends and contacts looked the other way and gave them a chance because "he's really a nice kid" who comes from a good family.
If this sounds like George W. Bush, it's not coincidental.
Well, guess what? We have the same dynamics working in the banking industry today.
JP Morgan Chase just announced quarterly "profits" of $3.6 billion. Representatives from JP Morgan Chase pointed to increased trading, income from fixed-income markets, and other jargon-laced market developments as the motor behind growing profits. What JP Morgan Chase left out is that their profits - and their existence - are really the result of more than $20 trillion in taxpayer funded bailouts and other government guarantees.
Think about it. Without his family name, their friends, and their financial networks our former president would have been, at best, an asterisk in American history. Similarly, without government subsidies, bailouts, and legislated protections for the industry, JP Morgan Chase and other banks would be headed for history's ash heap.
Even if JP Morgan Chase were the best run financial institution in the world (they're not) their existence and profits today are completely dependent on taxpayer money making other financial institutions whole. Without this, their incredibly stupid bets and poor investments would be paying perhaps 35 cents on the dollar (if it paid out at all), instead of the full value they're getting now.
Still, we get this nonsense from what is supposed to be a respected market analyst:
“[JP Morgan Chase's] revenue growth was very impressive,” said Anthony Polini, an analyst at Raymond James & Associates. “They’re benefiting from a turn in the economy and they’re asserting their dominance.”
If Anthony Polini were to tell the truth (or had a clue) he would have said the following:
The market bailout was great for JP Morgan Chase. Having the federal government use taxpayer money to fund the industry's stupidity and greed really benefited every player in the industry. With guaranteed bailouts, JP Morgan Chase not only looks healthy but they will be able to make big profits well into the future.
Market players like Anthony Polini, however, don't understand what's going on so they couch their "analysis" in superficial market lingo, which makes it appear that they have a grip on what's happening.
But he's not the only one in the industry doing this. Take this snippet from the CEO of JP Morgan Chase, James Dimon:
“While we are seeing some initial signs of consumer credit stability, we are not yet certain that this trend will continue ... Despite the near-term uncertainty about the path of the economy, our strong capital position and underlying earnings power will enable us to continue to invest in our businesses, creating a lasting franchise for many years to come.”
If I run this through my "Truth-O-Meter" this is what Dimon is really saying:
After the first big wave of foreclosures and employee pink-slips the federal government did little to nothing to protect America's middle class. This was great for us because it told us which side the government was going to take in this mess. We can only hope this continues ... As well, the trillion dollar guarantees that our industry got will go a long way in covering both our bad bets and the stupid decision-making of others in our industry. This will allow us to continue making big profits at taxpayer expense, no matter how much money we actually lose, long into the future.
With taxpayer dollars and other market guarantees totaling almost $24 trillion there's a certain Alice in Wonderland quality to Wall Street crowing about revenue growth and their investments paying off, as if they're legitimate "market" developments. They're not. They are subsidized and pumped up profits paid for by the American taxpayer.
The post below is reworked from a post I did six years ago. I've updated it so that it coincides with current political developments.
*********************
Last week our Republican-led House of Representatives took another step towards transferring hundreds of billions of dollars to America's richest class, and denying millions of Americans health care. On Thursday the U.S. Congress passed their version of a tax bill that shifts wealth and resources from the poor and middle-classes to the rich. Promising that money and resources will eventually trickle down to those at the bottom if the rich have more money to play with is an old scam. It goes back even farther than when Ronald Reagan proposed the idea in 1980. Indeed, many might be surprised to learn the Soviet Union helped invent the scam when their socialist experiment first revealed itself to be a failure in the 1920s. Simply put, Soviet revolutionaries needed the big hand of the Russian state to make their "stateless" communist utopia come to life. Similarly, Republican free marketeers today are using "big government" and favorable legislation to transfer massive amounts of wealth to the already rich. It's the only way their "government bad-free/markets good" dystopia can work. Somehow, arguing "our free markets can only succeed if we use the state to transfer massive amounts of wealth to those who already have a lot of money" isn't a ringing endorsement for free markets, or entrepreneurialism. Seriously, how does having billions of dollars dumped in your lap through favorable legislation make you an entrepreneur? A peak into the Soviet Union's failed experience with their version of trickle down economics can help us understand how intellectually and ideologically bankrupt the Republican's "Tax Cuts and Jobs Act" billion dollar wealth transfer really is.
*********************
THE SETTING While explaining the logic behind market economics, in my book I discuss how Russia's peasant economies worked after the 1917 October Revolution. The biggest challenge Russia's revolutionaries had was getting peasant farmers to produce.
While agriculture production increased with the introduction of the New Economic Policy in 1921 - which included incentives for some peasants - the program was eventually abandoned by Josef Stalin. It was replaced with forced labor and collectivization. Not surprisingly, agriculture production slipped.
To better understand why revolutionary peasants weren't producing surpluses - which were necessary to help fund industrialization - teams of Russian anthropologists were sent to study peasants societies. This was a tremendous undertaking as it meant spending months, and even years, at a time in distant rural communities.
PEASANT STUDIES & "UNCLE JOE" Headed by researchers like Aleksander Chayanov, numerous institutes sent teams to study peasant societies throughout Russia. A key finding was peasants would work until they had enough to feed their families, and not much beyond this point, even with favorable market prices. Specifically, they learned that subsistence peasant households - those who survive week to week - didn't particularly care about wage or price incentives. Instead, they focused primarily on things they could use immediately rather than what they could exchange for money in a market. Producing more than what they needed was viewed as “drudgery.”
Though the findings of Chayanov and others were instructive, because they helped explain both the culture behind peasant societies and what was wrong with collectivization in the Russian countryside, they didn’t sit well with Stalin. He wanted to know how he could get peasants to produce; not why they didn't produce. Because of his paranoia's and twisted world views, Stalin saw the reports emerging from the countryside as an unwarranted defense of Russia's productive peasant farmers (the kulaks). Because the revolutionary state demanded surpluses, and the peasants weren't producing, Stalin saw traitors in his midst.
The studies done by Chayanov and other anthropologists were virtually ignored by the Soviet state, and many of the institutes were closed. But this was just the beginning. Repression and purges in the early 1930s were followed with large-scale disappearances of "non-revolutionaries."
in part because of his findings, Chayanov was among those branded a non-revolutionary. He was arrested, tried, and then shot on the same day in 1937 [photo below is not Chayanov].
Russian Peasants in detention during the 1930s.
In Stalin's world, the Russian revolution and the worker's paradise would be a success, even if he had to use the levers of the state to spin lies, send misfits to labor camps, or kill his political enemies - both real and imagined. This is where it gets interesting.
TRICKLE DOWN THEORY, SOVIET STYLE ... AMERICAN STYLE Chayanov's story is instructive for what it tells us about capitalism and peasant economies. It's also significant because of what it tells us about Russian revolutionaries and die-hard Bolsheviks like Stalin. They were so committed to their theories of socialism that they used the state - which was supposed to wither away according to Karl Marx, mind you - to make sure that agriculture surpluses were created and transferred to the more productive industrial sector.
Increasing productivity required that the state become increasingly repressive as it forced collectivization on peasants, suppressed living standards in the countryside, and then transferred resources from Russia's rural sector to industry and the city. The needs of the political and industrial oligarchs in Moscow meant that the needs of the poor and "backward" peasants could be put off.
Part of the rationale for this line of thinking was Stalin believed peasants would one day benefit from the availability of manufactured goods, agriculture equipment, and other products that would eventually reach the countryside. As Cambridge economist Ha-Joon Chang pointed out, this was Soviet style trickle down economics.
This real life story is important because Congressional Republicans are in the process of conceptually pursuing similar tactics. By taking resources (tax dollars, health care subsidies, removing deductions, etc.) from America's poor and working classes, and then transferring that wealth to America's oligarchs, congressional Republicans are subsidizing and guaranteeing the wealth of America's financial elites. The irony here is that congressional Republicans claim to be die-hard capitalists, and free marketeers, but are actively using the big hand of the state to prop up and enrich America's financial titans. An orthodox paradox, if there ever was one. Think about it. The state bailed out Wall Street after their reckless gambling and financial stupidity collapsed the economy in 2008.
In fact, since 2008 repressive hand of "the state" has dumped almost $5 trillion into the same corrupt financial sector that collapsed the American economy.
At the same time, by using the state to pursue union-busting trade agreements, winking at weak immigration laws (which helps suppress prices and wages), and then ignoring collapsing middle-class wage and living standards, our Republican-led Congress is acting very much like Stalin's Politburo. Both use the heavy hand of the state to transfer resources and make sure their market ideas "work." Hooray for Ayn Rand, and Karl Marx.
Today, once again, our Republican-led Congress is promising that by deregulating and transferring wealth to the America's oligarchs the benefits will eventually reach those at the bottom. They've been making this promise for the better part of 37 years now, in spite of a very robust history of spectacular market failure (2008), record budget deficits, and a national debt that now stands at $20.5 trillion.
CONCLUDING THOUGHTS
Like Stalin's planning authorities, our Republican-led Congress - and the willing private sector recipients of bailouts, money dumps, cover ups and favorable legislation (like today's GOP tax legislation) - understand the importance of using the state to transfer wealth from one sector of the economy to another. It's the meat behind Wall Street's raging bull market today.
By using the state to transfer wealth to achieve market results, and guarantee new levels of "profitability," America’s bailed out and subsidized market players are on no firmer intellectual ground than the Soviet Union's Vladimir Lenin and Joseph Stalin. Pushing for and accepting government favors, while speaking admiringly of the wonders of the market, imposes an Alice in Wonderland character on modern markets in America.
The 2017 Republican-led tax plan along with the 2008 market bailout are glaring examples of how market players in America depend on the state for both their market "successes," and need big government to cover up for their spectacular market failures.
The Republican tax plan is Soviet-Style trickle down economics, plain and simple. And, yes, many in our GOP-led Congress would have been very comfortable in Stalin's Politburo.
In this NY Times' article, "Trying to Rein In ‘Too Big to Fail’ Institutions," K. Tarullo, an appointee of President Obama’s, is quoted saying that breaking up big the banks is “more a provocative idea than a proposal.” Why would he say this? Because any talk of doing anything that might upset market players "has provoked fears on Wall Street."
Simply put, Wall Street is afraid of how reforms would both regulate them and strip away bankruptcy protections now available to the "too big to fail" institutions.
Imagine that. Wall Street collapses the American economy ... then they tap into a taxpayer funded bailout to the tune of $23.7 trillion ... and policymakers are afraid of upsetting them by taking away their market guarantees?
Does this make sense to anyone? While it does here, apparently it doesn't in Europe.
The Europeans are moving to deal with their market meltdown - which was intricately woven into ours - by mandating and provoking changes like splitting ING, the Dutch insurance and banking firm, into two companies. One firm would focus on banking, the other would focus on insurance. The rationale is simple: Having two big like-minded firms under one roof can create a group-think environment that is both incestuous and uncompetitive.
The incredible thing is that we learned this lesson after 1929, when we saw how large financial firms had taken depositor, investor, and insurance funds and dumped them into markets with little or no concern for their clients. Disregard for client interests was encouraged by the immediate and reckless drive for more fees, commissions, market share, and profits. This is what brought us the Glass-Steagall Act in 1933.
In a few words, Glass-Steagall was the cornerstone of a larger regulatory wall that kept insurance, banking, and investment houses separated and regulated. What followed after WWII was the largest growth and wealth creation spurt in human history. This regulatory regime started to unravel in the 1970s, and was dragged down when Ronald Reagan became president. It was dismantled completely in 1999 by President Clinton (notice, no smiles in the FDR photo).
Mervyn King, governor of the Bank of England, argues that we need to bring these Depression-era common sense policies back to America. In a speech last week he said:
There are those who claim that such proposals [like Glass-Steagall] are impractical. It is hard to see why ... What does seem impractical, however, are the current arrangements. Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.
What we have today is an Alice in Wonderland approach to markets that includes massive market guarantees, record bonuses to the executives of collapsed institutions, strangled credit for small business, government-sanctioned credit card rip-offs, the continued arrogance of Wall Street, and Wall Street fears that they will not have bankruptcy protections.
Remember how the derivative market helped get our financial institutions into trouble, and then helped collapse our economy? Well, after handing over trillions of dollars in taxpayer guarantees, loans, and credits to cover the derivative losses of our financial institutions derivatives are making a comeback.
After watching the value of derivative contracts drop to a little over $100 trillion at the end of 2008, our failed financial institutions are writing more derivative contracts than ever. According to the FDIC the total value of derivative contracts has now reached about $135 trillion. To give you an idea of what this means $135 trillion represents almost 10 times what America will buy and sell this year (2009 GDP Forecast for America = $14.26 trillion).
Check out this derivative graph (click on all the graphs to enlarge):
For those of you still having trouble with the concept of a derivative let me make this simple. They are contracts that derive their value from something that hasn't happened yet. I know, I know ... it's still kind of fuzzy. So, think of a scalper who buys tickets and creates a game package.
For example, scalpers who gamble and buy tickets and then rent hotel rooms for this year's Super Bowl are now hoping that the undefeated Colts and undefeated Saints continue the pace all the way to the Big Game. Every football fan will want to be there. But what if things sour for the Colts and the Saints? Let's say that the Houston Texans and the Carolina Panthers somehow stumble their way into the Big Game as 9-7 teams. Guess what? You're probably looking at a loss. You're especially in big trouble if you purchased lots of tickets and rented lots of rooms. But you're really REALLY screwed if you made purchases or made payouts with the anticipated profits from an undefeated Colts-Saints Super Bowl.
In the real world this is what happens when you spend money (make bets) on products (game tickets) that "derive" their value from events that must happen (Colts-Saints going undefeated all the way to the Super Bowl) for a payout.
But big finanical institutions and commerical banks don't live in the real world. They live in an Alice in Wonderland Economy, courtesy of you and me. They have learned that they don't have to worry about being criminally stupid. The American taxpayer will bail them out, with no penalty to alter behavior.
Must be nice.
Today the same commercial banks that helped bring this economic mess upon us are making bets on the direction of interest rate contracts and foreign currencies, once again anticipating big payouts. So what are they banking on, you ask? A couple of things. Here we see they're betting on $188 trillion in foreign currencies and future interest rates.
Let me say this again. Rather than try and make money by lending to small business and entrepreneurs who will create jobs our biggest commerical banks are upping the ante and making trillion dollar bets on the direction of interest rates and other currencies. And they're able to do this because Tim Geithner, Ben Bernanke, and Hank Paulson did not pushing for penalties and new guidelines for our bailed out financial incompetents when we handed them their cash.
As a final insult to the American taxpayer, who financed the banking bailout - and who are now struggling to pay the bills - commerical banks have cut back on consumer credit. They've cut over a trillion dollars in credit card lines over the past year. Check this graph out ...
Worse - as if it could get worse - among the "derivative contracts" that our financial titans are betting on include the mortgage and credit card debt that you and I are now paying. In a few words, they are betting that you and I will keep paying our bills. They have turned our debt into "debt contracts" that they've bundled together (as CDOs) and sold to one another. They are now betting that we will pay no matter how much they raise interest rates (which they are confident about, in part, because of the 2005 bankruptcy law changes).
So, this is what we have: (1) You provide the reliable and secure debt contracts with your steady mortgage and credit card payments; (2) You provide the taxpayer money to guarantee bailouts on the stupid bets our financial institutions make; and (3) The banks continue betting like the greedy drunken fools that they are with no penalty for past stupidity. What could possibly go wrong?
There's more. Much more. So check out this FDIC site on "Commercial Bank Graphs and Data Points." It's not pretty.
OK, let's assume that you're upside down on your house. You owe more than your house is worth. Still, you walk into a bank and are able to get a government-guaranteed loan based on the promise that the house eventually will create enough wealth (equity) so that you can pay off the loan. Imagine, getting a $250,000 loan (it's market value today) on a house when you owe $350,000.
You can use the money for many things, until the market recovers. Better yet, since there's a government guarantee, you could even walk away and leave the bank with your house if the market doesn't recover. Heads I win, tails you lose.
Many of you who owe more than your house is worth are probably thinking, Wouldn't that be nice? Well, this is exactly what Wall Street's financial titans have access to with the Federal Reserve's $2.45 trillion legacy asset program (one of many such programs).
So, what's a legacy asset? In a few words, legacy assets are the fine sounding name that the financial sector and the Federal Reserve gave to debt investments that were not paying off after last year's market panic. In your world a legacy asset would be a house that is upside down. On Wall Street legacy assets are debt contracts (home loan mortgages, credit cards, or other debts) that were sold to market players as money making instruments, but are no longer being paid. They are bad debts.
In the real world, non-performing debts would be written off, and the lender (or the industry) would learn a very hard lesson about reckless lending. Not so in our Alice in Wonderland Economy.
Here's how we got to this point.
ROOTS OF "LEGACIES" ... ASSET BACKED SECURITIES
Starting about 25-30 years ago once-promising debt contracts were bundled up and sold to market players. Over time we would call these bundled up debt contracts "asset backed securities" (ABS). Market players purchased these ABS products because America's middle-class could always be counted on to make regular payments over the life of the loans they took out. Your credit card payment or your home mortgage payment are the real assets here.
Because of vigorous lobbying by the financial sector, bankruptcy and foreclosure laws were tightened up to help make sure this would happen (see especially the Bankruptcy Act of 2005). Over time market players got giddy and even started making big (and incredibly stupid) bets on these debt products paying off. These were trillion dollar bets that dwarfed the size of our national economy, and threatened our economic viability.
As we now know, things didn't work out too well. Credit and loans between financial institutions dried up. The market collapsed. People lost their jobs. Market players who made big stupid bets (called credit default swaps) didn't have the money to pay their bets.
Market players and financial institutions who thought America's middle-class would make their (ABS) investments pay off went nuts. They even blamed consumers for not paying their bills, even when they couldn't pay the stupid bets they had made.
No matter how you looked at it, the ABS markets were in trouble.
FROM ABSs TO "LEGACY ASSETS"
This explains, in part, why the Bush and Obama administrations swung into action. With the help of the financial sector and the Federal Reserve they created a nifty sounding name to deal with collapsed ABS markets. They called them "legacy assets." They were still worth crap, but at least "legacy assets" sounded better than "liability" or what they were, dying assets.
Legacy assets ... it's a nice name for a dying instrument. Kind of like euthanasia. Except instead of killing someone painlessly - especially someone suffering from an incurable illness - we put our tumor riddled and dying financial assets on life support. Here's how.
To put America's legacy assets on life-support we created something called Term Asset-Backed Securities Loan Facility (TALF). In real simple terms TALFs are government-backed loans. They can be accessed by those who hold financial crap, or non-performing ABSs. To better understand the concept let's use our home example from above.
If TALFs were available to America's home owners they should be able to use their homes to get a loan from the bank, even if they're upside down on the loan. Unfortunately, TALF loans are only made available to America's largest and most powerful financial players by the Federal Reserve of New York (and, no, President Obama's Making Home Affordable Program doesn't even come close to TALF; it's a joke).
Here's the real good part.
The big financial players don't need to put up any good collateral for the loans they get. They can use their poorly performing ABSs as collateral. If the collateral doesn't pay off then you and I are stuck with the bill (see "What happens if a borrower does not repay its loan?"). How much will this add up to? We don't know just yet. But we do know that the Federal Reserve has made at least $1 trillion available for these TALF (ABS) products, and another $1.45 trillion for non-performing assets in the housing market.
This is well above the $1.5 trillion that Presidents Bush and Obama made available via the Congress-approved bailouts.
WHAT WE'RE LOOKING AT ...
So, how well are things going? No one is quite sure, especially since there's no telling how bad markets really are because of our bailout-driven, re-inflated economy (not to mention the impact of mark-to-market garbage inflation). But we do know that the TALF terms are quite good for Wall Street, especially given the terms that the credit card and mortgage companies give middle-class America. Consider the following:
1. No Pre-Payment penalties (unlike many home loan contracts).
2. Principal rather than interest paid first.
2. TALF loans can continue if underlying product is paid off (TALF's % rate terms make this attractive).
Over 2009 we know that at least $50 billion has been lent out for "legacy assets" (via TALF) either in the form of mortgage backed loans or other debt-driven instruments (credit card debt, student loan debt, car loans, etc.). The Federal Reserve has already lent money for products that may not be worth the amount of the loan. Either way, market players have been able to generate cash for necessities - like their bonuses - and can walk away from the loan if the underlying product doesn't pay off.
Again, heads they win, tails we lose.
But the U.S. taxpayer is told not to worry about being taken for a ride. Somehow, rigged "stress" tests in a bailed out industry are supposed to give us confidence that "markets" will work and the Fed will get our money back. And besides, the only way these the product can fail - according to the NY Fed - is if "extremely unlikely economic circumstances" appear (you know, like in 2008).
With record bonuses continuing to occur, in a bailed out and undisciplined market, somehow this doesn't inspire confidence.
- Mark
UPDATE: For an overview of what productive, non-financial, legacy assets are supposed to look like click here.
