Broken Bones and AIG

The uproar about bonuses awarded to AIG employees would be hilarious were it not so troubling and pathetic.  It is almost emblematic of the refusal of virtually all, government, politicians, pundits, citizens, all, to see what is staring them in the face.

The solution to all this, at least for the short run (the next few years or so) is simple.   A long-term solution is far more difficult. If AIG, GM, CitiGroup, Goldman Sachs, etc. are too big to fail, then make them smaller and limit their power and authorityOnce upon a time, there was legislative protection against the sort of predatory practices that led to the current financial woes.  Way back in 1933 Congress passed the Glass-Steagall Act, forbidding commercial banks from engaging in investment bank activities.  In the years leading up to the Crash of ’29 commercial banks, legally, were very heavily involved in taking equity positions in the stock market.  Not surprisingly, many placed a large share of the blame for the crash on this sort of pursuit.  Glass-Steagall was intended to put an end to this practice.

Before the Great Depression commercial banks engaged in highly speculative investments of their assets (that is, their shareholders assets); they purchased various assets and then sold them to unsuspecting individuals.  Worse, they made loans to the companies they owned or partly owned, often shaky loans at that.  In a total conflict of interest, they then sold stock in those companies, reaping huge profits.  Minus the conflicts of interest, at least in theory, this stuff is normally the province of investment banks.  Sound familiar yet?  It should.

Glass-Steagall was supposed to formally and legally separate commercial and investment banks.  Another innovation of the Act was to allow insurance of bank deposits for the first time, at least in the U.S.A.  The Act created the Federal Deposit Insurance Corporation for this purpose.  With some exceptions, the Act did create such a separation, at least formally.  The Federal Reserve Board was the supposed regulatory body which would enforce Glass-Steagall.

The Federal Reserve Board, as so often happened, confused its regulatory duties with assisting the banks.  In 1956 Congress passed the Bank Holding Company Act, intended to stop banks from underwriting insurance.

It should be clear that, at least up to 1956, and for a time thereafter, Congress understood to a degree the perils of leaving financial institutions to their own devices.  The intent of Congress seemed to be to let commercial banks be commercial banks, let investment banks be investment banks, and let insurance companies be insurance companies.  The nation had not yet descended to the moral and ethical pits of reducing faith in the “free market” to religious principle.

With the election of Ronald Reagan the dismantling of government regulation proceeded in earnest.  Concomitantly, despite the ideological declarations of Reagan and his acolytes, most of the “principles” of the so-called conservatism espoused by Reagan actually fell by the wayside.  Government grew as never before.  The Federal deficit exploded.  The only thing that diminished was the scale of regulation.  The two-decades long process of placing political power, and by extension financial power, in the hands of those with the wherewithall to purchase it was underway.  Why did government grow so rapidly?  Why did the deficit balloon, seemingly out of control?  Well, in concrete terms, there was a hidden agenda.

Government grew so as to make it less useful to the average citizen.  Federal deficits grew so as to transfer wealth from you and me to those who were already wealthy beyond any dreams of avarice.  All apologists for the so-called free market are captives of their own fantasies, but they are useful to those who surreptitiously pick our pockets.

Under Reagan, the maximum income tax rate was reduced from 70 percent to 28 percent.   Meantime, the regressive Social Security and Medicare payments were increased, placing a burden on those with lower incomes.  The rich pay a negligible part of their incomes on Social Security and Medicare.  FICA collections for Social Security are capped, making the tax regressive.  Effectively the tax policy of the Reagan Administration lowered taxes on the rich and raised them for the poor and middle class.  Lowering taxes on the rich supposedly increases tax revenues because cutting taxes for the rich is alleged to be an economic stimulus.   Succeeding Presidents have largely adhered to this “trickle-down” theory.

Corporations, not to be outdone by individuals, have their own finagling perks.  Although the maximum tax rate for corporations is 35 percent, there are so many exclusions and deductions, not to mention direct payments by the federal government, virtually all large and many smaller corporations do not pay anything like the maximum rate.  Some pay no tax at all.  They are materially assisted in reducing their taxes to zero by enormous federal subsidies to various industries.  These subsidies are paid for by ordinary citizens in the form of higher prices, higher taxes in the lower brackets, and now most commonly by government borrowing, which moves the burden of payment to our descendents.

With the advent of economic globalization, domestic manufacturing has  declined significantly.  Capitalism, despite the claims of unbounded benefits by ideologues, is amoral at best, and will always seek to pay the lowest wages possible, and that means blue collar jobs have gone elsewhere.   As a result, industrial capitalism no longer drives the economy.  Supposedly the United States is now a service economy.  But just what is being served?  Economic mayhem.

The FIRE sector is now the driving force of America.  Finance, Insurance, and Real Estate.  But before the FIRE sector could bubble to the top, obstacles had to be removed.  Regulatory obstacles.  Although some relaxations of Glass-Steagall had been implemented, with minor exceptions it was still formally forbidden for commercial banks, investment banks, and insurance companies to operate as a single entity.

In 1998 Travelers, an insurance company, purchased Citibank, a bank holding company.  Technically this was illegal, but Travelers and Citibank knew something the rest of us did not.  Many have characterized this merger as a big gamble, but it actually provided the perfect excuse to remove almost all restrictions on financial capitalism.  In 1999 Congress passed the Gramm-Leach-Bliley Financial Services Modernization Act.  Gramm-Leach-Bliley made it possible for a single giant corporation to carry out commercial banking, investment banking, merchant banking, securities underwriting, dealing in, holding, and underwriting municipal bonds, and to both underwrite and trade in insurance.  The Act specifically allowed Bank Holding Companies to become Financial Holding Companies.  The latter may engage in any financial activity, or incidental to financial activity, or complimentary to financial activity.  That would seem to cover pretty much everything.  Passage was bipartisan with the Senate approving by 90-8 and the House voting 362-57.  President Clinton, ever the free market cheerleader, signed the bill into law.

With this single Act, the establishment of the corporate state was complete.  All the old rules were gone, and virtually anything was permitted.  Freed of any restraints, finance capitalism set out to fleece the nation.  Corporations no longer actually made much of anything within the confines of the United States.  It was much cheaper to pay what amounts to slave wages in other countries, with possibly some assembly operations still done domestically.

Many, many nefarious activities came to be regarded as benevolent contributors to the progress of the nation.  Two in particular became dominant drivers of the economy: housing and creative finance.  A ruling by the Federal Reserve and the Treasury Department permitted Financial Holding Companies to engage in real estate brokerage.  Banks no longer were restricted by meaningful rules about how to construct mortgages.  Banks could now grant mortgages to just about anyone who was still breathing.  No down payment required.  No proof of income required.  It didn’t matter if the borrower understood word one of the mortgage contract.  Balloon and adjustable rate mortgages became common.  The success of either depends on the willingness of the mortgage writer to refinance, usually after 5 to 7 years.  Many borrowers, too many it turns out, could not pay the balloon payment or the new adjusted rate, and banks became increasingly unwilling and in fact unable to refinance, as they were far too highly leveraged due to the devastation of the derivatives markets.

There’s a catch.  A whole bunch of catches, in fact.  One is that with requirements for creditworthyness removed, many mortgages are so-called subprime.  Subprime lending also occurs in the auto loan market, and in credit card transactions.  Defaults and foreclosures on subprime loans occur at a much higher rate than on prime loans.

Another catch is that virtually all such loans, and mortgage loans in general, are securitized.  They are packaged into a kind of asset based security known as Collateralized Debt Obligations.  Essentially no one knows the fate of any particular loan, so it became easy to assign risk categories, or tranches fraudulently.  Also as mark-to-market practices became increasingly adopted by corporations, fraud was inevitable when mark-to-market values were assigned to securities for which no meaningful value could be determined.

Sundry rationalizations were invented designed to assure investors, borrowers, and regulatory agencies that these instruments were safe.  So safe in fact that the rationalizers convinced themselves they could make lots more money by selling insurance on CDOs and similar doomed derivatives.  Thus Credit Default Swaps were invented.

All of this was a house of cards, as the housing and credit card markets were financed by debt assigned to those who could not honor it.  The government simply looked the other way, basing its indifference on the declarations of Federal Reserve Chairman Alan Greenspan that the financial capitalism industry could be relied upon to regulate itself.  It turns out that the only thing the Wall Street Masters of the Universe could be relied upon was to cheat.

The result of all this basically criminal activity was the financial meltdown of 2008, leading to the recession of 2009.  Here’s the problem:  The Federal government went deeply into debt in order to “bail-out” Wall Street.  Trillions of dollars have been given to institutions that are fundamentally corrupt.  Even though we should now be painfully aware that the giant financial entities created after passage of Gramm-Leach-Bliley are not just unworkable but lead inexorably to corruption and criminal acts, the government wants to return to the situation obtaining before things fell apart, with of course a few new regulations thrown in to keep all those crooks honest.  How is this paid for?  By selling Treasury notes to mostly to foreign governments and by printing money.

The only thing we citizens are going to reap from all this rescue stuff is more of the same.  The short term solution is to repeal Gramm-Leach-Bliley, restore Glass-Steagall in a modern version, and force regulatory agencies to do their job.  Repeal of Gramm-Leach-Bliley would force the breakup of Financial Holding Companies, and proper separation of economic activities would be assured.

The financial integrity of the economy, such as it was, can be restored, but not for long.  The whole scheme is predicated on the idea of getting the economy growing again.  Unfortunately this will only be possible over the short term.  Capitalism, with its fixation on perpetual growth, is fundamentally unsustainable.  Ultimately, we must turn away from the religion of growth and turn instead to a way of life that depends on community not competition, compassion not amorality, and restraint rather than greed.

1 comment to Broken Bones and AIG

  • Appreciating the time and energy you put into your site and detailed information you present. It’s nice to come across a blog every once in a while that isn’t the same out of date rehashed material. Fantastic read! I’ve saved your site and I’m adding your RSS feeds to my Google account.

Leave a Reply




You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>