Why the Wall Street bail out plan is bad-3: More doubts

I have described before how the subprime mortgage debacle lies at the root of this mess. But how did it come about that mortgage lending, once the most conservative and transparent and regulated of banking practices, became the basis of a massive shadow economy in which trillions of dollars flowed around, free from any oversight? And what is the government bailout meant to do?

The foundations of the mess lies with the neoliberal deregulation policies that began under the Carter administration and was enthusiastically followed by every subsequent administration of both parties. The driving idea behind all this loosening was that the banking and investment sector was being shackled by too many regulations and too much oversight. The protective firewalls that had been put up between banks and investment houses following the excesses that led to the Great Depression were targeted. It was argued that if the banks were freed from these onerous restrictions, capitalism would bloom.
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Why the Wall Street bail out plan is bad-2: Manufactured crisis?

I have been getting increasingly suspicious that this so-called financial crisis may be a bogus one to enrich this administration’s base of Wall Street cronies before Bush leaves office. While I am not an economist and do not have the inside knowledge that Henry Paulson (Treasury Secretary) and Ben Bernanke (head of the Federal Reserve) have, there is something about this mad rush to pass major legislation that strikes me as very suspicious. It reminds me too much of the way the administration flat-out lied about the danger that Iraq posed in order to get Congressional authorization for the invasion.

People like Paulson and Bernanke lied when they said they had the situation under control earlier when they bailed out Bear Stearns, Fannie Mae, Freddie Mac, and AIG. How do we know that they are not lying again now in order to push a covert agenda? While I accept that the financial sector is in trouble, what I want to know is what evidence has been produced that we need to act immediately. The stock market might go down if no immediate action is taken but that is not sufficient reason because they are betting on a bailout and their potential disappointment is not a reason for throwing more money into their trough.
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Why the Wall Street bail out plan is bad-1

I wrote last Friday of the reasons behind the current financial mess. Over the weekend, as everyone is aware by now, the US government issued a plan to put up a huge amount of money (initially about $700 billion but likely to grow to well over a trillion) to bail Wall Street out of the financial difficulties caused by its own greed and recklessness.

The public and the Congress are being stampeded with ‘the sky is falling’ rhetoric into giving the Treasury Secretary Henry Paulson a blank check, with no oversight and almost no reforms, to dole out money to his cronies in the financial sector so that they can continue the reckless practices that have led to the present situation. We should not forget that Paulson spent almost his entire career (over three decades) at Goldman Sachs, one of the investment banks at the center of the current mess.
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Unbalanced coverage-1

I follow news on two levels. The first level is trying to get actual information about what happened. The second meta-level is observing how events are covered and what and whose agenda is being served by the news media.

I cannot remember when I first started following the news in this dualistic way but I do know that by 1989 I had already fallen into this habit. Two things happened simultaneously in December of that year that drove home to me forcefully the need to do this.

With the disintegration of the Soviet Union, there was a revolt in Romania against its despotic leader Nikolai Ceausescu that began around December 17, 1989 that resulted in the government firing on demonstrators. This increased the protests and eventually led to the overthrow of the government and the later execution of Ceausescu.

Meanwhile on December 20, the US invaded Panama to overthrow its leader Manuel Noriega, massively bombing whole areas of the capital city, in the process destroying the densely populated El Chorrillo neighborhood in downtown Panama, which contained mostly poor people.

In those pre-internet days I had no recourse other than US TV to keep up with breaking news and I recall watching the news coverage as it switched back and forth between events in these two countries.

When it came to Romania, the US TV news reporters expressed deep skepticism about the Romanian government’s official claims about everything being fine and actually went to investigate the reported killings of civilians by the forces loyal to Ceausescu. They relayed stories of the dead and displaced that contradicted the official accounts. They acted as journalists should, being skeptical of official claims and seeking independent verification of the facts by going to the scene of the events and talking with eyewitnesses.

When the news switched to coverage of the events in Panama, however, it was quite different. The US reporters exhibited a remarkable lack of curiosity about civilian casualties caused by the US bombing and showed a cheerful willingness to accept at face value the official US government and military version of events. Once in a while the network news anchor would ask the reporter if he had heard of any civilian casualties as a result of the US invasion and the answer was always the same, that the US government and the military had ‘no information’ about the number of civilian dead. That was it. There was no attempt at all to independently find out the truth as they had done in Romania, although they had far more reporters on the ground in Panama. The news media acted as pure propaganda agents, passing on the US government and military story.

Those who think the media are better now are deceiving themselves. This kind of unbalanced reporting is still alive and well in the way that the media covers civilian casualties in the current conflicts around the world. How it is reported depends on whether the civilians are killed by ‘us’ and ‘our’ friends or by ‘them’, where the categories of ‘us’ and ‘them’ are defined by the US government.

Consider the conflict currently going on in Afghanistan.

On August 26, 2008 the BBC reported deaths by US bombing of about 90 people, 60 of them children, in the village of Azizabad in Afghanistan. But in the US such reports are treated as merely rumors not worth sending a reporter to, unless confirmed by the US military. And in order to prevent US reporters going there, the US authority has a standard procedure it follows whenever such a tragedy happens: first deny that any civilians died at all and assert that all the people killed were the enemy (which on its face is highly unlikely in any guerilla war), then when the prima facie case becomes too strong (as in this case when even UN observers confirm the deaths) say that they will themselves investigate, and ask the reporters to hold off on any judgment until the investigation is completed at some indefinite date.

Pentagon officials say they are concerned about the conflicting reports and are continuing their own investigation. Spokesman Bryan Whitman said he did not know when the investigation would end and its results released.

All this is stalling for time, with the military either staying silent and hoping people will forget the incident or conceding at a much later time that a very small number of civilians were killed in the midst of a large number of enemy, thus becoming ‘collateral damage’ and thus supposedly excusable.

The US media is happy to play along in this game. The blog left I on the news describes the reporting by the New York Times of this particular incident, and follows up with a description of the classic non-denial denial by a US government spokesperson when the evidence gets too strong.

It now turns out that there is credible evidence that the original report of large numbers of civilian deaths (including the huge number of children) is correct. But this report in a major US newspaper came on September 7, about two weeks later, and is still being denied and stonewalled by the US military, who still claim that they were responding to Taliban attacks. Meanwhile, to pacify the furious Afghan people, the Defense Secretary Robert Gates offered a vague and general apology for any civilian casualties, without acknowledging specific culpability in this case, and promised to take more care in the future.

This pattern is then repeated the next time civilians are killed. The US military has still not acknowledged civilian deaths.

Glenn Greenwald follows up the story, providing more details of the original incident as well as the attempted cover-up.

Next: Other examples of unbalanced coverage

POST SCRIPT: The elitists

An odd feature of this campaign is the attempt by the McCain campaign to try and paint Obama as an ‘elitist’. But Newsweek ran a story that looked into how many cars each candidate owns. The scorecard? The McCains: 13, the Obamas: 1, and that too a modest Ford Escape Hybrid.

The current financial mess

In a past series of posts, I looked at the financial crisis created by the collapse of the subprime housing crisis.

In the wake this week of the massive federal bailouts of Fannie Mae and Freddie Mac and AIG (American International Group), the collapse of the venerable Lehman Brothers investment bank, and the sale of another giant Merrill Lynch to Bank of America that staved off its own bankruptcy, it may be good to see how all these are linked.

This crisis is the inevitable result that follows ‘bubble’ economics’, the runaway (and unrealistic) growth in the price of a commodity due to the belief of investors that the price of that commodity will either always increase or that they can sell out before it drops. In this case, the commodity is real estate. At every stage of the process, the firm belief that the value of homes would increase, coupled with little or no oversight to ensure that minimum caution was exercised in lending money, resulted in this runaway train that is now crashing and causing massive damage.

The foundations of this bubble lies with the providing of mortgages to large numbers of people who simply could not afford the homes they sought to buy. How was this done? One culprit was the creation of mortgages that had very low introductory rates that enabled people to pay the mortgage premiums, at least initially. Of course, such an artificially low rate could not be sustained so the premiums would suddenly rise after a few years, to a level the buyer could not afford. This seems like an unbelievably stupid plan for both the home buyer and the people providing the mortgage. And it is, unless you believe that the price of the home would increase in value, because then the homebuyer could sell the home before the mortgage went up, repay the money to the mortgage lender, and still make a profit. Everyone wins. There seemed to be a free lunch, just for the taking.

As a result, all kinds of shady practices arose. Mortgage brokers working on commission actively sought out even ineligible buyers for properties, inflated their income to meet the minimal requirements for eligibility, and sold them properties. The banks providing the money did not bother to really check on the credit worthiness of the buyers because they immediately sold off most of their mortgages to investment banks. These investment banks then ‘securitized’ their collections of mortgages, bundling them into huge packages of thousands of mortgages, then dividing them up into smaller pieces, and selling the pieces like other securities such as bonds.

Since investors believed that home prices would always go up, there seemed to be little or no risk. But as a result of this bundling and slicing and dicing and no strict accounting or transparency requirements, no one knows exactly which mortgage is in which bundle, even now. But who cares? The idea was that by this bundling, even if a mortgage here or there went into default, it would be a small part of the whole package, hardly noticeable. Wholesale defaults would not happen since home prices always go up, don’t they?

The investment banks then bought and sold these securities, their huge commissions adding to the price. They were aided in this by the credit ratings agencies (like Moody’s) that gave these securities the highest ratings of AAA, which made them seem to be very safe investments. Why would the credit rating agencies give high ratings to securities whose origins were so murky and about which they seemed to know so little? Because it is a little known fact that these rating agencies are paid by the very companies they rate and so have a vested interest in pleasing their clients. Of course, they also felt there was little risk in giving these high ratings because, as we all know, home prices always go up, don’t they?

What about those cautious investors who were still a little nervous about buying these securities despite their high ratings? No problem. Along comes AIG, a huge insurance conglomerate. They created a new division that sold things called Credit Default Swaps (CDS). These things act like insurance in that they guarantee to reimburse the investor if their securities should lose value, thus reassuring them that these mortgage-based securitized investments were a safe bet. Although the CDS were sold like insurance, they are not actually called insurance because insurance is a regulated industry monitored by the states and as soon as something is called insurance it comes under that regulatory umbrella. But no one really paid much attention to such petty details since home prices are sure to go up, aren’t they? Thus no one was likely to lose money. So AIG was raking in huge amounts as ‘insurance’ premiums, while feeling it ran little or no risk of having to pay out any money.

And as long as home prices went up, they were all making money and no one was paying close attention, except for a few worrywarts who didn’t like to see trillions of dollars moving around in an unregulated and opaque manner. And for awhile home prices did go up, as was inevitable as more and more people were being encouraged and enabled to buy homes they really could not afford on the expectation that prices would go up yet higher. Thus were created the classic bubble conditions.

But all bubbles are inherently unstable and eventually collapse. And when it does, who gets hurt the most depends on who ends up holding the worthless investments. In this case, it is the US taxpayer.

Home prices started to drop. As homebuyers realized they could not pay the suddenly increased mortgage payments and could not sell the houses for a price that covered the amount they owed, they defaulted. As those defaults spread rapidly and became well known, investors started getting nervous about the value of the mortgage-based securities they were holding and started to sell them, rapidly lowering their value. This meant that banks and other investment houses that had these things as assets suddenly found their value drop precipitously and had to announce huge write-offs. Furthermore, those companies could no longer use those worthless securities as collateral to raise money and thus could not pay their own debts, making them risks for default and bankruptcy. This decreased investor confidence in those institutions and their share prices dropped dramatically.

This is what happened to Bear Stearns, Lehman Brothers, and Merrill Lynch. But they are just the most highly visible institutions. Huge numbers of banks are owners of similar mortgage-based assets and are nervously trying to figure out how much (or little) they are worth and what impact the revelations of their true value will do to their viability to survive. Eyes are now looking nervously at other banks like Washington Mutual and Wachovia and the two remaining large investment banks Goldman Sachs and Morgan Stanley.

British comedians John Bird and John Fortune back in August 2007 explained how subprime mortgage crisis came about. I have shown this before but it remains one of the clearest explanations.

Fannie Mae and Freddie Mac got hammered because they were the ultimate purchaser, the backstop if you will, of these mortgage-based securities. By buying them from the investment banks, they pumped money back into the mortgage system, enabling further cycles of dubious homes sales. As a result, these two giants ended up holding trillions of dollars of such worthless assets. They were able to buy these securities because they were easily able to borrow money since, although they were private companies, their incorporation charter gave them a quasi-government status, encouraging investors (especially foreign governments like China and oil-rich states with a lot of money to invest) to loan them money, since it was widely believed that the US government would not let these two institutions collapse. This is what the government did last weekend, essentially nationalizing those companies.

The US government desperately needs these foreign governments to invest in the US because that is the chief way they finance the deficits caused by the tax cuts for the rich and the two wars that are currently being fought. So essentially the US cannot do anything that will discourage future investments by these foreign governments. By taking over Fannie Mae and Freddie Mac, the US government is reassuring the foreign governments that they will get their money back since now the US government is directly responsible for paying back the money.

Meanwhile AIG, which had been eager to ‘insure’ these securities because of their safety (since home prices always go up, don’t they?) had to pay out huge amounts of money when the value of the securities collapsed and was on the verge of financial collapse itself. Although their regular insurance business was sound, the action of its little known CDS division was threatening to bring down the entire company. Since many other large institutions (mutual funds, pensions funds etc.) had large investments in AIG, the collapse of AIG was believed to be potentially disastrous over the entire financial sector. So on Wednesday the government essentially nationalized that too.

But as a result, the taxpayers are now suddenly the owners of these three shaky companies with all their dubious assets. Furthermore, the trillions of dollars in debt owned by these companies now become part of the national debt, effectively doubling it. So while these companies made a lot of money for their executives and investors while the going was good, the taxpayers are now stuck with the bill for their recklessness. This is what capitalism has become, privatizing profits while socializing losses. Capitalism in the US has become socialism for the rich.

John Bird and John Fortune discuss how the belief in markets always going up usually end up as government bailouts.

How will the US government (i.e., us) pay back all the money it now suddenly owes as a result of the unregulated greed that ran rampant over the last decade and that enriched a few at the expense of the many? How much bad debt still lurks in the financial sector and how many firms are still hiding the true extent of their liabilities?

I would hope that all those people who were gung-ho for privatizing social security, like George Bush and John McCain, would now realize what a bad idea that is.

The next president is going to have a lot to deal with.

POST SCRIPT: Explaining the current crisis

On April 3, 2008, Michael Greenberger, in an interview with Terry Gross on Fresh Air provided a very lucid explanation of what was roiling the financial markets.

He paid a return visit two days ago (September 17, 2008) to explain what was behind the most recent developments.

Both interviews are well worth listening to.

The Palin choice-12: The strange appeal of Sarah Palin