WHY JP MORGAN'S BILLION DOLLAR DERIVATIVE DEBACLE MATTERS

A few years back officials from Goldman Sachs and JP Morgan Chase went in front of Congress to defend the practice of  betting trading for and against complex investment products that are also known as derivatives. Their argument was that derivatives allowed them to hedge their trades, which is critical for "risk management." This is what "sophisticated investors" and "smart money" do we were told.

What they were really defending was the practice of trading in artificial markets that produce little - if any - economic value.

Conceptually what Goldman and JP Morgan want everyone to believe is that they were doing little more than what the country farmer does. You know, the guy who hedges his bets when he plants corn just in case the wheat crop doesn't produce. Instead Goldman and Morgan executives sounded like a bunch of hucksters peddling toxic crap from the back of a showman's wagon.

Are they really con men? In my view, yes. In the aggregate their efforts at "risk management" in derivative markets amounts to little more than financial snake oil.

Con men or not it really didn't matter what they said in the hearings because many members of Congress are financial and economic illiterates (don't believe me ... check this out). Many only understand economic concepts if they fit on a bumper sticker.

What Goldman and Morgan executives were really trying to do was defend the practice of selling their clients certain products - some of which were designed to fail - with the idea that they could get another client to bet against it. For JP Morgan and Goldman Sachs it didn't matter who won the bet because they collect fees on both ends.

And they they certainly didn't have to worry about the derivative products once they dumped them on others either. They could always hide behind the market refrain caveat emptor ... you know, buyer beware.

Because many members of Congress are financial illiterates - who do the bidding of Wall Street - the executives of both firms gave testimony and left Washington with only a public slap on the hand. Business as usual would be the result. Bonuses were paid out. Mergers continued.

Not surprisingly, after appearing in front of Congress JP Morgan paid a $153 million fine to the SEC for misleading investors, while Goldman Sachs was caught rigging the game against their clients, and then made big bets with FDIC backed money (though they claim it's their money). But along the way the biggest banks got even bigger ...

And the casino continued.

Why do I bring all of this up (again)? Simple. JP Morgan's recent derivative debacle has them losing 2 ... 5 .... or 8 billion dollars. Nobody knows how much just yet. Even they aren't sure (they claim). JP Morgan would like everyone to believe that it's all an anomaly. They even let go of a few culprits (with the now standard golden parachute for screwing up).

My primary concern is that we have been here before.

Now I could take us back to the S&L debacle, the 1987 scare, the LTCM Fed-orchestrated bailout, or even back to 1929 (or any number of other "unforeseen" market failures). But let's not go there. Instead, let's go back even further to see how the "smart money" did things a really long time ago, and then decide whether what we're seeing today is really an anomaly.

The following is drawn from Chapter 4 of my book The Myth of the Free Market:

In A Short History of Financial Euphoria, John Kenneth Galbraith discusses the famous case of “Tulipomania” in Amsterdam at the beginning of the seventeenth century. What started as simple prestige for those who possessed novel tulip bulbs turned into wild speculation over successive price increases throughout 1636.

Specifically, competition over tulips turned into mania, with single bulbs trading for new carriages and homes, or fetching as much as $25-50,000 each. Demand reached such heights the Amsterdam Stock Exchange developed a futures market for the bulb. This market, as well as the dreams of many speculators, would collapse under the weight of its own nonsense and spectacular avarice.

As sellers demanded their tulip contracts be enforced, they were disappointed when their petitions fell on the deaf ears of the courts. Because the market had little to do with the production of actual goods and services, the courts viewed Tulipomania as little more than a gambling operation. As is the case throughout these histories, panic, default, and bankruptcy followed. Galbraith wrote “no one knows for what reason” the speculation and mania ended, but there’s little doubt common sense finally prevailed in a market spun out of control by deluded buyers and sellers.

Now replace "Tulips" in the story with "derivatives" and ask yourself how much has really changed since 1636. With at least a hundred trillion in derivative bets (or more) placed by Americas biggest banks we need to think about what this means for our nation today. Like our Tulip-crazed market players above, many of today's biggest market gamblers are simply interested in extracting wealth from artificial markets.

Oh, look at the pretty flowers ...

Anyways, we need to remember that at the hearings Goldman Sachs' executives sat in front of Congress and brazenly dodged questions as to whether it's their responsibility to "act in the best interest of their clients" (FF to 25:30 in this clip). What this suggests is that simply making money is the dominating mind-set of Wall Street — even if it means deliberately burning clients, or creating the conditions for another market meltdown (which they never see happening).

The focus on wealth extraction instead of wealth creation has been widespread in America for some time now. The following from Chapter 10 of my book helps illustrate the point:

Founded by a group of Wall Street hotshots and leading academics with Nobel prizes on their resumés, Long-Term Capital Management (LTCM) was created in the 1990s to search markets for price anomalies in goods that had shown historical relationships. It didn’t matter, for example, why the price of toothpaste was diverging from the price of tooth brushes; the fact that a price divergence existed was all that traders needed to make a move.

But LTCM was not trading in tooth brushes and toothpaste. They were trading in complex financial instruments that, according to their formulas, had price relationships that rarely diverged. Because the price anomaly in each “product” that they tracked was small, LTCM had to spend big to make money.

After securing hundreds of millions from investors, no doubt impressed with their pedigreed analysts, LTCM still had to borrow big to make their wagers pay off. At its height, LTCM was highly leveraged and owed investors and banks billions of dollars ...

In many ways, LTCM had fallen into the same trap as the purchasers of tulips. The company was comprised of speculators who wanted to make a quick buck. As Martin Mayer put it: "The work done at LTCM, while not illegal or sinful, was totally without redeeming social value. This is not 'investing'; it enables the production of no goods or useful services. It is betting."

LTCM came crashing down in 1998 after Russia defaulted on loans, an event that neither LTCM’s computer models nor it's Nobel laureates in economics anticipated ... The company owed so much money to the banks that the Federal Reserve of New York stepped in and brought the banks to LTCM. The Federal Reserve wanted to make sure that LTCM didn’t suddenly dump their assets to pay the banks.

The Federal Reserve feared that if LTCM was forced to sell its assets they would depress markets by forcing losses on others. The Federal Reserve’s then new chairman, Alan Greenspan, even went so far as to testify that an LTCM “fire sale” could have ended prosperity in our time. The Federal Reserve had to intervene to — in what has become by now a standard refrain — “save the system.”

At the end of the day, if you are betting on the price direction of tulips (the Dutch) ... or betting on the price direction of market anomalies (LTCM) ... or betting on the price direction of derivative products (Wall Street / JP Morgan Chase) one thing is clear. You are not investing (or even hedging). You are gambling.

These guys shouldn't be on Wall Street. They should be on the Vegas strip ... far away from taxpayer funded bailouts.

- Mark

ADDENDUM: With the biggest recipients of taxpayer bailout money controlling over 90 percent of the $135 to $592 Trillion derivative market (yes, that's $592 Trillion) we need to ask more questions about the conditions that created the financial holes at JP Morgan Chase, led to the collapse of MF Global Financial, and other slow drip market "aberrations" coming out of Wall Street. This is especially the case when you consider that the global derivatives market - which takes its cue from the United States - has grown to about $1.14 quadrillion (that's 15 zeroes)

With the total U.S economy producing about $15 trillion in goods and services in 2011 this should be cause for concern.

THE SUPER RICH HAVE NOT EARNED THEIR MONEY ...

Those of you who read this blog regularly (or my book) won't find anything new in this piece, which I synopsize below. It says in plain English that favorable legislation, industry bailouts, market subsidies, wealth extraction, and simple greed are now the backbone behind modern markets in America. It just says it in another way.  

From Paul Buchheit at Common Dreams.org, we get five reasons that help explain how the super rich have not earned their money.


1. They've Taken All the Middle Class Wage Increases
In 1980 the richest 1% of America took one of every fifteen post-tax income dollars. Now, according to IRS figures, they take THREE of every fifteen (doc) post-tax income dollars. They've tripled their cut of America's income pie. That's a trillion extra dollars a year ...

2. They've Mismanaged Key American Industries
We have the most expensive health care system in the world. Failing banks have survived because of taxpayer bailouts. Management-approved shortcuts have led to workplace deaths and chemical leak disasters. Companies lobby for cap and trade laws so their profits can pay for their pollution ...

3. They've Benefited from 50 Years of Public Research
The very rich have made their fortunes in good part because of taxpayer-funded research at the Defense Advanced Research Projects Agency (the Internet), the National Institute of Health, the National Science Foundation, and numerous other government agencies ...

4. They've Increased Their Incomes By Not Paying Taxes
The richest 10% own 80% of the stock market, providing billions in "unearned income" that is taxed at less than half the rate of income earned through real work ...

5. They've Contributed Little to Society
The richest individuals and corporations have shown little regard for the majority of Americans who depend on sound financial management for their economic security. According to sources such as the New York Times and ProPublica, Wall Street firms including JPMorgan, Citigroup, Bank of America, and Goldman Sachs have been repeatedly charged with fraud only to avoid punishment by paying a fraction of their profits in fines ...


What all of this points to is that many of our modern "rugged individualists" do NOT represent the go-it-alone market entrepreneur many like to believe exists and dominate our market system. When it comes to making the magic of the market work, there are numerous (and I mean numerous) factors at work.

You can read Bruchheit's entire piece, with links, here.

- Mark

THESE REPUBLICANS UNDERSTAND FREE MARKET MYTHS

Get government off my back? Hardly (as I've pointed out previously). Check out what this republican business owner thinks of government supported Ex-Im Bank lending programs ...

“There’s not a bank in the United States that’s going to loan money to that customer of mine in Argentina to buy my airplane,” said David Ickert, vice president of finance at Air Tractor, which makes crop-dusting and firefighting airplanes in Olney, Tex. “There is not a free-market system that operates like that. It does not exist. We need the Ex-Im Bank, period.”

Long story short? Industry, Wall Street and all types of business owners work the system in order to make an extra buck. From subsidies to favorable legislation and bailouts, they all work to sustain our "free market" system. Getting certified as a certain type of business helps too. Here's a partial list of what helps qualify you as a small businesses, which are necessary for government subsidies.

Read what other private sector republicans really think of government assistance, when it comes to their business interests, here.

- Mark

FEDERAL RESERVE SUPPORTS MASK LARGER PROBLEM(S)

I've been saying this for some time now. The Federal Reserve has been helping to manage and keep our economy afloat for years. In the modern era, when the Federal Reserve (i.e. the Fed) intervenes in the economy it does so in ways that props up the market, which helps keep our economy moving along. It did so with trillion dollar money dumps immediately after the market collapse of 2008. It continues to do so with other market supporting tools today.

The problem with their actions is that they are not being done to clean out the market imperfections that brought us the 2008 market collapse. Instead, we're getting market infected band aids that are simply masking larger problems.

This is a distinct shift from the #1 job of any central bank, which is to guard the integrity of the currency.

Helping us to understand the Fed's actions is this article, "Measuring the Effect of the Zero Lower Bound on Medium- and Longer-Term Interest Rates." In the article, authors Eric Swanson and John Williams demonstrate that Fed interest rate policies, and their purchases of bonds and securities, have been very effective at managing market expectations. This has worked to keep our economy moving along, as I've pointed out many times (with the Fed's Quantitative Easing I, Quantitative Easing II, and Quantitative Easing III  programs).  
 
These activities have worked so well that ordinary Americans not only can't see that there is no real free market, but they no longer care to look for the man behind the curtain.
 

 
   
The problem with this is that we now have the appearance of normalcy, so we keep on dancing towards Emerald City, as if everything is fine. 
 
 

 
But things aren't OK. We're living off of borrowed time. History's whispering in our ear, but we don't seem to see or care about the coming calamity.

I'll have more to say about this in a coming post, later this week.

- Mark

UPDATE: The CEO and co-CIO of PIMCO, Mohamed A. El-Erian, agrees with me that market valuations are dependent on central bank policies. Specifically, what's been helping to keep markets afloat are the money dumps (or, as El-Erian puts it, the "aggressive provision of liquidity") from the Federal Reserve and the European Central Bank.

MORTGAGE SETTLEMENT = PAYOUT AND THE CHANCE TO DO IT AGAIN

OK, it looks like a settlement on the mortgage mess has been reached. Rather than go into the details, or discuss how "wonderful" the $26 billion penalty is, the good people at nakedcapitalism.com have put together a wonderful list of 12 Reasons to Hate the Mortgage Settlement.

It's pretty much what I've been writing about our real estate and banking mess for years now, but it's nice to see it synopsized.

Because the article at nakedcapitalism may be a bit long, I've synopsized the first seven points here:

1. FORGERY HAS A PRICE: The price of forgery and fabricating documents is now officially $2000 per loan. Not only is this amount a fraction of the cost of the legal expenses when foreclosures are challenged, but no one goes to jail for forgery. Take that, 300 years of real estate law.

2. TAXPAYER PAYS (again): The $26 billion sticker price penalty actually involves only $5 billion of bank money. The rest is your money. Mortgages that have been securitized will be written down, which means CDO investors will get Fannie and Freddie (who are now backed by the American taxpayer) to pick up the tab for their losses. Unfortunately, the size of your pension funds, 401 (k)s, etc. will take a hit too, which means reduced assets and income for your portfolio and retirement account(s). So you actually pay twice. Nice.

3. BANKS GET OFF: $5 billion divided among the big banks means nothing. Freddie and Fannie putbacks to the major banks have been running at that level each quarter.

4. BANK BAILOUT (again): $20 billion makes bank second liens sounder. This deal is a stealth bailout that strengthens bank balance sheets at the expense of the broader public.

5. ENFORCEMENT IS A JOKE: The first layer of supervision is the banks reporting on themselves. Seriously.

6. SERVICERS WON'T COMPLY WITH THE AGREEMENT: The history of servicer consent decrees is clear. Even though the banks said they wouldn't engage in criminal acts again (like forgery for paperwork they couldn't locate) in exchange for not being prosecuted, the banks and the servicers have failed to comply. Robo signings, among other activities, continue because the industry wants to bury the bodies.

7. CONSENT DECREE RENDERED TOOTHLESS: When Nevada and Arizona caved on the Countrywide settlement suit Bank of America rejoiced. It proved that failing to comply with a consent degree has no consequences 

You should read the entire article, and the follow up pieces too. Long story short? No penalties, another backdoor bailout, and another market collapse in the future. Only the next one will be worse than in 2008 because the banks haven't learned any lessons.

Oh, and they're going to try and do the same thing on a global level with the emerging markets. 

- Mark

WHAT FREE MARKET? UNCLE SAM WANTS YOU TO SPEND ...

In my classes I always make the case that we don't have a free market. The very visible hand of the state is involved in subsidizing and encouraging purchases and other activities that many of us simply take for granted. Uncle Sam wants you to spend, and to spend on things that are supposed to make us all better off (at least that's the way the programs are sold to us).

Let's take employer provided health insurance, for example. I'm sure most of you look for jobs with employer provided health insurance, and are thankful when you find a job that can provide it, right? Well, guess what? Your employer doesn't actually pay for your health insurance. You do. And so does your neighbor.

Your employer might pay the insurance provider, but your employer then gets reimbursed by the federal government (i.e. the American taxpayer) for the expense. While the process is called a tax deduction, it's also the essence of fiscal policy; i.e. when congress creates legislation that encourages certain economic activities over others. Over the next four years the medical plan your employer "provides" will cost the U.S. taxpayer over $1 trillion. 

Below I've attached a brief list of several major tax deductions designed to encourage spending & investment, and what they will cost the U.S. taxpayer this year (over $600 billion) and a few years down the road.

One thing should be clear from this list. The federal government - at the request of industry lobbyists - is doing a lot to keep our "free market" afloat (just ask Mitt Romney). Whether you agree with the long list of write-offs and deductions is another matter.

- Mark

UPDATE: Click here for tax expenditure estimates for fiscal years 2014-2018.

THIS IS WHY MORE AMERICANS SHOULD BE IN THE STREETS

Yesterday we had an interesting conversation in class about the global economy and America's debt load. Students wanted to know why we're accumulating so much debt. I explained, apart from reckless policy decisions made under President Bush, that we're lending or committing massive amounts of money - backed by the American taxpayer, mind you - with little or no understanding of where it ends up.

One egregious example was when half a trillion dollars was transferred to Europe's central banks. Federal Reserve Chair Ben Bernanke couldn't track or explain it's final whereabouts. Seriously, even after trying to check his notes, Federal Reserve Chair Ben Bernanke had no clue about the final destination of half a trillion dollars. That's $500,000,000,000. Check it out here.

Look, accounting for a half a trillion dollars shouldn't be that difficult. Back in 2009 half a trillion dollars amounted to approximately one-half of what all of America produced and sold (GDP) in one month ...

Not being able to account for the monetary equivalent of one-half of America's total economic output for a month is akin to you and me not knowing where half our paycheck goes every month. Most people can explain where one-half of their paycheck goes every month.

I know I can. And I can do it without notes too.

But wait. It gets better (or is that worse?). Half a trillion dollars is small potatoes when we consider the trillion dollar transactions that the Federal Reserve couldn't account for back in May of 2009. Actually, it was about $9.7 trillion. But who's counting, right?

Fortunately, for us, there were several independent bean counters who figured out where the money was going. And they have nice interactive graphs that explain where the money went. Here's The Atlantic Monthly with a nice interactive of "The Fed's Cash Machine" ... in May of 2009.

If Bernanke was too busy saving the world during May of 2009 to read the The Atlantic Monthly he could have checked out Bloombergs interactive of the $9.7 trillion that we've encumbered ... back in February of 2009!

So, how many of you have heard Washington's courageous politicians talk about the trillions in future obligations that we've been put on the hook for to save Wall Street? But I'm sure you've heard plenty about taxing the bottom 50% of Americans who pay no income tax, right?

But consider this. The bottom 50% earn or own the equivalent of $1.5 trillion, total. This means we could confiscate everything the bottom 50% earn or own this year - and then turn them into industrial slaves - and we still wouldn't come close to paying what we've paid as a down payment on the 2008 market collapse.

At the end of the day, as I explained in class, we're looking at several problems here.

First, all of the money we've made available to Wall Street and the biggest banks is being used to clean up toxic assets and the failed market bets that created our bubble economy. The result is that many market players now look solvent and successful when, in fact, many should be under indictment.

Also, I have a problem with Federal Reserve officials who often don't know - or claim not to know - who ultimately gets the money we lend or make available. Playing stupid with our money is not a quality we should encourage.

Look, as early as December 2008 I found a trillion dollar hole in the Federal Reserves balance sheets. It didn't take as long as you might think. If I can find a trillion dollar obligation made with taxpayer backed dollars don't you think Federal Reserve officials should be able to explain where it went? Me too.

Next - getting back to Bernanke and that mysterious half a trillion dollars we discussed above - we need to keep in mind that the European Union could collapse under a series of national defaults (hello Greece). This is a problem because we lent the money to the EU, not to individual European nations. If the European Union collapses the EU may never pay back the hundreds of billions they've borrowed. This is a distinct possibility since Europe is essentially using debt to pay off debt, and because the language in the Fed's loan contracts to Europe effectively allows roll overs in perpetuity.

This means that what we've lent to Europe would stay on our books as debt. Nice.

Long story short? We've accumulated trillions in debt obligations that Congress neither signed off on, nor seem overly concerned about. And it's all been done in the name of saving Wall Street and the biggest banks.

Even if most ordinary Americans don't understand the specifics, they intuitively understand the larger implications. This is why they are pissed off at Wall Street. It's really that simple.

- Mark

BILL O'REILLY: THIS WEEKS VILLAGE IDIOT

While defending Wall Street and the big banks, Fox's Bill O'Reilly asked why there haven't been any investigations into Wall Street criminality if what they did was so bad. In an exchange with Cornell West and Tavis Smiley, O'Reilly argued that there is "no evidence" of wrongdoing because "they didn't violate any laws!"

What an idiot.

We haven't had big investigations - let alone convictions - after the 2008 market collapse because we dumped trillions in taxpayer funded bailouts and other guarantees into the financial sector. In the process we effectively removed the threat of receivership, bankruptcy, disgrace, or the full force of our legal system from Wall Street's horizon. This is the way our legal and political system works for white collar executives with money.

So, it's not that there wasn't illegality and theft in the lead up to 2008. It's just that the rules of the game prevents our financial mandarins from having to account for their actions. And, yes, this undermines the integrity of our market system.

Specifically, O'Reilly needs to take a look at:


Purified Toxic Crap ...
Bailouts essentially turned straw into gold by using taxpayer funded cash, to purchase toxic "legacy assets" for example. To date, well over $5 trillion in watered stock, bad assets, and toxic securities have been pretty much cleaned up (forcibly) by the U.S. government taxpayer. If the worst is cleaned up, what do you go after?

Information Blackouts ...
One of the cornerstones of any market economy - and any democracy - is transparency. Without it you can't get good information. Guess what? Bailout payout information was deliberately withheld from the public on orders from current Secretary of Treasury Tim Geithner. With an information blackout the most toxic and ethically challenged market instruments have been able to fly under the radar (and then get cleaned up).

Out of Court Legal Settlements ...
Instead of entering into court battles - which are critical for building precedent and case law - financial firms like Goldman Sachs routinely pay fines into the hundreds of millions of dollars. This is chump change when you look at the trillions the financial industry has hauled in (and the trillions more we're on the hook for). It's hard to get convictions when you can pay a taxpayer subsidized fine and walk away.

Right to Sue is Waived ...
At the center of all the toxic payouts in 2008 was A.I.G. In exchange for getting bailout cash, A.I.G. was forced to give up it's right to sue Wall Street firms in court. In a few words, A.I.G. was given an offer they couldn't refuse: Take the money and shut up, or you don't get any help at all (and you might even get caught up in a legal dragnet too). But it gets better (or is that worse?). At one point during the height of the market crisis in 2008 the Federal Reserve demanded unusual national security procedures before it would share or supply critical A.I.G. bailout related documents.

For whatever reason, none of this adds up for Bill O'Reilly.

So, to simplify, you can't be sued or convicted if the problem is purified with a pile of taxpayer backed cash ... information is deliberately withheld or distorted ... you pay record fines to avoid court trials ... and if the initial keystone bailout institution is told they can't sue as a condition for receiving taxpayer money.

Let me repeat the point. You can't get investigations - let alone sued - if the state intervenes to help you bury the financial bodies. It's that simple.

If you understand this you know why Bill O'Reilly is this weeks Village Idiot.

- Mark

Addendum: As you can imagine, things haven't gotten any better over the years. Corporate America is busy playing Blame Games, and are suing one another for selling toxic crap to one another. Similarly, we're learning about the usual political stonewalling and massive lobbying of state attorney generals, which prevents or undermines larger investigations. All of this is critical for understanding why there haven't been any investigations because of how the FBI acknowledged that "mortgage fraud was substantial" as early as January 2008.

UPDATE: Here's Robert Reich with more examples of Wall Street seeking and getting legislative and legal cover from Washington.

SECONDARY MARKETS AND VULTURE CAPITALISM

When I discuss the issue of development and underdevelopment, among the topics I cover are debt and the rise of secondary markets. What are secondary markets, you ask? I'm over simplifying but, in a few words, they're like financial flea markets where market players buy and sell debt and other market instruments that may have been "marked down" or discounted. 

This impacts development because when financial players (or banks) find, or think, they won't get paid for the loans and debt that they underwrite they will sell it to other market players at a discount. It's like the 99 cents store buying books in bulk when they don't sell. But unlike the 99 cent store, the market players who purchase discounted debt don't settle for 99 cents. They pursue avenues for negotiating settlements, or getting countries to pay as much of their debt as possible.

As you can imagine, this means pursuing high cost legal and political efforts. It also means using the levers of the state (i.e. government officials, state courts, and international institutions) to get debtor nations to pay out. Threats and legal pressures are applied. In fact, without the levers of the state, there would be few to no payouts at all.

And the payoffs are big, as you will learn from this article on vulture capitalists.

- Mark

THE FED'S TRILLION DOLLAR BACK DOOR BAILOUT(S)

This shouldn't be a surprise to anyone. But I'm sure it is. Thanks to a Bloomberg investigation, many are now learning the details behind the Federal Reserve's $1.2 trillion back door bailout for Wall Street's biggest financial institutions. I've been writing about it for some time already (see links below), so I wasn't going to post on this when it came out last week. But it's important, so I'll make a few short comments. 

Simply put, the nation's biggest banks like "Citigroup, Bank of America​, Morgan Stanley​, and Goldman Sachs, along with dozens of others, received about $1.2 trillion in loans from an alphabet soup of Fed supplementary lending programs."

In the FYI category, you and I don't have access to any of the Fed's loan programs. Just the banks. Sweet.

How did this happen, you ask? Simple, as I wrote about then, the Federal Reserve opened up the equivalent of new "teller windows" to deal with our collapsing institutions in 2007. Since then the Fed has lent Wall Street's biggest banks at least $1 trillion to deal with their financial mess. While I suggest you check out Bloomberg's cool interactive, here's what it looks like in chart form ...

While Bloomberg's interactive refers to the money lifelines as "secret" that really isn't the case. The information has been out there. I've been blogging about the "Fed's cash machine," the money dumps, and the Fed's numerous handouts immediately after the market collapsed in 2008. In fact, I started writing about financial favors for Wall Street long before the market collapsed in 2008 (see this, this, this, and this).

Throughout the money dump Wall Street's largest "let the market work" institutions have been encouraging it all.

The incredible thing is that none of this has been a secret. It's just that no one was paying attention ... or they didn't care ... or they didn't think middle America could figure it out ... take your pick.

Whatever you want to believe, it's one of the reasons I've been saying for years that we don't have a free market. It's also why I've saying that our banks are insolvent, even if they appear liquid. They may have access to money, but they're still sitting on toxic assets that could wipe them out if they were forced to log them in at market value ... and if we had a government that would force them to live by market values.

Instead, through the Fed's miracle cash machine they've been granted bailout after bailout, and one regulatory favor after another.

Sigh ...

- Mark

BERNANKE'S SPEECH ... IT'S DEJA VU ALL OVER AGAIN

OK, I couldn't just leave this alone as an "update" to my post from yesterday. I have to elaborate ...

It's déjà vu all over again. It was February 2007. Markets were in a tizzy over stocks that went crazy days before. Ben Bernanke came out after the market took a tumble and said that "markets were working well" and that he expected the U.S. economy to pick up. In June of 2008 he would add, “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.” Oops.

Then we have Bernanke's other pre-market collapse gaffes, which include predicting 5% unemployment through 2011.

Look, Bernanke's mistakes aren't him simply saying inflation is going to be 2.5% when it turns out to be 3.1% They are numerous, and they are huge. This link helps us understand how he and the Federal Reserve have become the chief apologists and enablers of Wall Street.

But wait, there's more.

Back in September 2008, right in the middle of our market collapse, Fed Chair Bernanke supported granting Treasury Secretary Hank Paulson Czar-like authority to do what he wanted with $700 billion dollars. No looking at what actually caused the mess, just hand over the money. No strings attached. Seriously. No strings attached.

Rosy pictures before. No questions asked afterwards. Move along, nothing to see here. Nice, if you're a market player on Wall Street.

Fast forward 4 1/2 years to August 26, 2011 (i.e. today). Markets were worked up over recent roller coaster rides on Wall Street, and what appears to be an imminent recession. Federal Reserve Chairman Ben Bernanke gave a much anticipated talk in Wyoming and said that the U.S. is on track for long-term economic growth. While he also announced that no new economic stimulus measures were on the table, he did leave open the possibility of more action by the Fed if another recession looks likely.

Now, where have I heard this kind of open-ended murky talk before?

Oh yeah, I started writing about the Fed's "everything is fine" pep talks almost as soon as I started my blog, back in 2007. I kept talking about our collapsing economy throughout 2008, right up until the market collapsed. And through it all, Mr. Bernanke was painting a rosy picture ...

At the end of the day, it really doesn't matter. It's business as usual in Washington and on Wall Street. You and I are going to pick up the tab, like we did the last time. And it could well be done in a way that nobody notices (as I discuss here and here).

If we look at Bernanke's track record, and translate his Fed-speak talk at Jackson Hole this afternoon, we should know that the die has been cast. And we should all be seeing the same thing. We're in trouble. Expect another money dump (i.e. a quantitative easing stimulus).

It really is déjà vu all over again.

- Mark

SO MUCH FOR TRICKLE DOWN ECONOMICS ...

This should close the door on the idea that free markets allocate resources best. From "The Triumph Of  'Trickle Up' Economics" ...

From 1947 to 1992, the top 5 percent of all families never consumed more than 17 percent of the national "aggregate income." But since 1993, that top 5 percent has never earned less than 20 percent of the national bundle.

The only way to justify this is if you believe that the top 5 percent are smarter, harder working, and more deserving than everyone else. They're not.
 

 
The article is short, and has some holes, but you can read it here.

- Mark

HOW BANKS ARE RIPPING OFF THE AMERICAN TAXPAYER

I can't see how this is a surprise to anyone ...

In a recently released study from the Congressional Research Service we learn that the nation's largest banks profited off of our nation's financial crisis-era programs by borrowing cash for almost-zero percent interest. Then they lent it back to the federal government at substantially higher interest rates.

Yeah, that's right, deliberately low interest rate programs - designed and justified with the idea of getting money into the hands of ordinary middle-class Americans - were hijacked by banks who borrowed cheap money from Uncle Sam (a.k.a. the American taxpayer). They then showed their appreciation by hoarding it (for their rainy days).

And when it suited their interests they lent it back to Uncle Sam and the American taxpayer at higher rates.

Let's see, where I have seen this before ...

Oh, yeah. I've been writing about these dynamics for years now. So have others, like one of my favorites, Barry Ritholtz.

The worst part is that trillions - perhaps as much as $9 trillion - was spent, lent, credited, or guaranteed ("encumbered") by the Federal Reserve over the past years, but no one really knew where the money was going. Yeah, that's right, the people who are supposed to be following and tracking where our money goes are about as clueless as Chief Wiggins.

But nobody pays attention to this stuff because getting people to take a look at how America's economy really works (especially with Maiden Lane, TALF, and other trillion dollar corporate welfare giveaways) is akin to getting Americans to line up for a root canal. It might be good for them, but they simply won't do it.

So, we continue to live a lie, believing in the myth that the banks do the right thing and that "free markets work best."

Sigh ...

- Mark

WHY FORECLOSURE IS A LUCRATIVE BUSINESS MODEL

Imagine what would happen if you filed an insurance claim on your $20,000 car after you sold it. Most of us don't do this because it's against the law. Specifically, most of us don't do it because it's morally and ethically wrong. We have a conscience. Not so with our nation's biggest banks. They not only file claims like these, but they do it often. Here's how it works.

The nation’s five largest mortgage companies have been accused of defrauding taxpayers by using defective and faulty documents to file federal reimbursement claims on home mortgages that are backed by the federal government (VA or FHA mortgages, for example). The problem is that these claims are being filed on homes the banks foreclosed on AFTER they sold it for less than the outstanding loan balance.

If it were a car, what the banks are accused of doing with foreclosed homes is akin to filing an insurance claim on a car the bank repossessed AFTER they sold it for less than what the previous owner owed. Instead of taking a hit for making bad loan decisions they're forcing the federal government the American taxpayer to take it on the chin.

Five separate investigations conducted by the Department of Housing and Urban Development examined the activities of Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and Ally. To pursue the case the feds are using the False Claims Act, a Civil War-era law crafted after numerous firms swindled the U.S. government by selling it (and Union soldiers) sub par and defective food, uniforms, and weapons. 

So, why is all of this important? Three reasons.

First, if the banks knew they were going to get their claims paid out by filing false claims to the federal government then the banks had a financial incentive not to hire people to help distressed homeowners modify their loans (not hiring more staff also saved the industry $40 billion).

Second (and worse), the banks also would have had a financial incentive to file and speed up foreclosures on distressed home owners whose homes were backed by the government. Taxpayer guarantees are easy pickings. Bank of America, it appears, has mastered this practice.

Finally, the key to making all of this market magic work was to find a way to kick people out of their homes en masse, and quickly. Hello, Robo Signing mills ...

There's a reason why the banks want to pay fines for doing all of the above, instead of being forced to negotiate with distressed homeowners. They've made a ton of money, and fines are viewed more as a nuisance tax. With the federal government making guaranteed payouts, and with nifty tools like "net present value" to undermine homeowner interests, foreclosure has become a lucrative business.

Why isn't any of this surprising?

- Mark

THE FALSE PROMISE OF UNBRIDLED CAPITALISM

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While good reviews and course adoptions of my book are heart warming, I'm particularly excited when I learn that other academics who have read my book are writing aggressive op-ed pieces that strengthen or build on the arguments I made in The Myth of the Free Market. The article below - "False Promise of Unbridled Capitalism" - is one of those pieces. It was written by R. Matthew Poteat, Assistant Professor of History, at Central Virginia Community College. It's excellent, and deserves to be circulated widely. Enjoy.
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False promise of unbridled capitalism
Written by R. Matthew Poteat


GOP presidential hopeful Tim Pawlenty is finding out that the road to his party's nomination runs to the right. The far right. Take for example Pawlenty's view on capitalism:

"I'm a market person, but there are certain circumstances where you've got to have government put up the guardrails or bust up entrenched interests before they become too powerful."

This view, however, is no longer acceptable to many GOP voters. These voters believe not only that unbridled capitalism will fix the debt/ deficit crisis, create jobs, and protect American freedoms, it will also fix our schools and hospitals, too. They believe the government should "get out of the way," deregulate the marketplace, slash taxes and spending, and let independent market forces do their job.

The problem is, market objectivity is an illusion. There is no such thing as a truly free market. In a truly free market there would be one-page trade agreements. Trade in child labor, drugs, sex, and weapons would be open. Environmental regulations would not exist. Foreign capital and foreign workers would flow freely across borders.

All markets, therefore, are political and require government intervention. Every market has rules and boundaries that restrict freedom of choice. Yet, faith in free market fundamentalism is today a GOP litmus test. Moreover, to give this view historical weight, its supporters allege that by accepting this orthodoxy America is merely returning to its founding principles.

It may sound good to some, but it's not true.

Take for example the Gilded Age. From about 1877 to 1892, the U.S. economy grew at the fastest rate in its history. Industry boomed and mass transportation and communication networks were built. By the 20th century, U.S. per capita income and industrial production led the world.

Strict free-marketeers point to this period as the golden age of free market American capitalism. Yet, what they ignore is the 50 percent protectionist tariff rate and foreign investment prohibitions that allowed American industry to grow.

As Republican president William McKinley said, "free foreign trade gives our money, our manufactures, and our markets to other nations to the injury of our labor, our tradespeople, and our farmers. Protection keeps money, markets, and manufactures at home for the benefit of our own people." (Alexander Hamilton had suggested this decades earlier).

There are numerous examples of why unbridled free market capitalism doesn't work as well as advertised — especially for developing nations — but let's use a local example: the wild turkey.

By the 20th century, wild turkeys and many other wildlife species were hunted to near extinction. That is until concerned Americans lobbied their government for market regulation. In 1937 Congress passed the Federal Aid in Wildlife Restoration Act, which taxed firearms and other hunting equipment. The revenue was used for conservation programs. From fewer than 30,000 wild turkeys in the 1930s, the population today is over 7 million.

This law, and other regulations like bag limits, hunting seasons, and wildlife refuge areas, has contributed to an enormous growth in the outdoor industry.

According to the Virginia Department of Game and Inland Fisheries "each year in Virginia, hunters spend more than $480 million in trip-related and equipment expenditures and generate $128 million in state and local taxes supporting more than 24,000 jobs in the commonwealth. Hunters also contribute to the Virginia economy in the form of food, lodging, gasoline, dog food, kennel supplies, veterinarian care for hunting dogs,and equipment purchases. Hunting attracts visitors from out-of-state and those visitors spend a lot of money here in that pursuit."

None of that would have been possible without state intervention in the marketplace.

Capitalism is the best and most just economic system invented, but Adam Smith and our founders understood that the invisible hand of the market required state regulation to check greed and corruption. Indeed, a just market cannot operate in a state of nature. Article I sec. 8 of the Constitution, Federalist Papers 10 and 42, and the recent Great Recession make this clear.

The utopia promised by rigid free market capitalism is a myth, and politicians and radio talk show hosts who think otherwise aren't being honest or historically accurate.

R. Matthew Poteat is an assistant professor of history in the Virginia Community College System. Email him at rmpoteat@gmail.com
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Click on the link here if you want to read the "Comment" section. As you'll see, Professor Poteat hit a nerve with a few of his neighbors.

- Mark

WHAT MAKES THE MAGIC OF THE MARKET WORK ...

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From time to time I post snippets from my lectures to help students understand certain concepts. When I explain how "free markets" actually work I often start by telling students about my experience with my kids at Disneyland about six years ago. Below I discuss how free markets come to life, and use Aladdin as the reference point. Entrepreneurialism, as I point out, is but one aspect of our "free market" system.
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About six years ago, after a long day of rides at Disneyland, we made our way to the Disney play about Aladdin. At the time my daughter was seven. My son was five. We were seated in the second set of seats, higher up than we originally wanted. But when the scene with magic carpet ride began I realized that we had the best seats in the house.

Aladdin and Jasmine floated above the stage on a "magic carpet" ride that was made more real by music and a magnificent lighting system that was meant to keep your eyes on the events unfolding before you. As I looked at my daughter I could see that she was both mesmerized and enchanted. For my daughter the carpet ride was real. There was magic in the world.

Now, you and I understand that while the carpet ride was real, the magic was not. A good deal of unseen preparation and background work is what allowed the magic to happen.

I use this story as a metaphor in class to help students understand the magic of the market, especially because of how it's explained to us by pundits and politicians. We're told that the magic of the market is real, and that it will soar to new heights on its own, but only if we allow market players to work their magic. Everything, as the story goes, will fall into place after that. A harmony of interests will prevail.

This approach to understanding markets, like with our Disney magic carpet ride, rests on you and I either ignoring the background work, overlooking the smoke & mirrors, or suspending our capacity to reason. If we do these things we can live in a world governed by Disney's magic. Unfortunately, most of us can't do this. We understand that we live in a world governed more by the dynamics of a Mad Max movie.

Let's be real. The harmony of interests that our free market marketeers believe happen on their own is not only simplistic, but injects a degree of probity and innocence on to market players and society that simply isn't there.

We all know that people don't do the right thing. To be sure, we would all like to believe that people will act civil if we put a pile of money in front of them, but history tells us otherwise. The capacity to do the right thing when no one is looking is often absent when the prospect of making a killing in the market is made available. People cheat one another. People get greedy and stupid. This is not some great insight on my part. Again, history shows this to be true.

That this even needs to be said bewilders me.

Still, this is why we create the cables of life that guide and nudge everyone in the right direction. We want everyone to get a shot at the promises liberty and freedom offer. Broadly speaking, we started with a revolution, suffered through a civil war, made women jump through hoops for their rights, and had a civil rights movement to help make the promises of America real. In the process we've learned that with hard work, and a little luck, many of today's market elites don't have to look like 19th century robber barons.

And this is no accident. More specifically, among the cables that we've created to help make the magic of the market work for everyone include security networks, public universities and public schools, public infrastructures, affirmative action (which started with the GI Bill), legal infrastructures to settle market disputes, public health standards, etc.

Whether it's vaccines that helped keep us safe as children - and help prevent pandemics that can ruin every one's day - or simple regulations that keep brothels and bars out of residential areas, we've worked to expand the background "cables" of our life (often unseen) to make sure everyone gets a shot at that magic carpet ride.

And while many free marketeers might want to pick nits over public programs, they need to take a look at their multi-billion dollar subsidies, million dollar write-offs, generous deductions, legal protections, favorable legislation, trillion dollar bailouts, and other "cable" strings that have kept their magic carpet ride afloat.

But many of our free marketers ignore these cables of life. They would rather that you live with a sense of wonderment over "their" accomplishments, and the majesty behind their market magic. 

They don't want you to notice their cables and other supports, so they tell you to ignore yours.

The interesting thing here is that while my daughter was enchanted by Aladdin's magic carpet ride, my then 5-year old son grabbed at my shirt, pointed upward, and said, "Look Dad, they have strings [cables] holding the carpet ... it's not real."

He was proud of what he had discovered. I was too. Still, thinking of the world my daughter was experiencing I told him to be quiet.

The point is, it's time for our free marketeers to take a look at the world as it is - strings and all - and not how they wish it to be. To the extent that the magic of the market exists, it's been made possible by our modern liberal state.

To be sure, people work hard. Entrepreneurialism is alive and well. But people have worked hard throughout history (real entrepreneurs don't wait for a 5% drop in the capital gains tax). What's made the difference are the type of states we've fought to create around the world since the American Revolution.

The modern state creates the conditions under which the great wealth of our time has been created.

If my then 5-year old son can notice the cables in a Disney theater, it's about time that our pampered free marketeers acknowledge the strings that have made the magic of their market world come to life.

- Mark