Bubble Economy 2.0:
The Financial Recovery Plan from Hell
by Michael Hudson
Global Research, February 11, 2009
Martin Wolf started off his Financial Times column today (February 11)
with the bold question: “Has Barack Obama’s presidency already
failed?”[1] The stock market had a similar opinion, plunging 382 points.
Having promised “change,” Mr. Obama is giving us more Clinton-Bush via
Robert Rubin’s protégé, Tim Geithner. Tuesday’s $2.5 trillion Financial
Stabilization Plan to re-inflate the Bubble Economy is basically an
extension of the Bush-Paulson giveaway – yet more Rubinomics for
financial insiders in the emerging Wall Street trusts. The financial
system is to be concentrated into a cartel of just a few giant
conglomerates to act as the economy’s central planners and resource
allocators. This makes banks the big winners in the game of “chicken”
they’ve been playing with Washington, a shakedown holding the economy
hostage. “Give us what we want or we’ll plunge the economy into
financial crisis.” Washington has given them $9 trillion so far, with
promises now of another $2 trillion– and still counting.
A true reform – one designed to undo the systemic market distortions
that led to the real estate bubble – would have set out to reverse the
Clinton-Rubin repeal of the Glass-Steagall Act so as to prevent the
corrupting conflicts of interest that have resulted in vertical trusts
such as Citibank and Bank of America/Countrywide/Merrill Lynch. By
unleashing these conglomerate grupos (to use the term popularized under
Pinochet with Chicago Boy direction – a dress rehearsal of the mass
financial bankruptcies they caused in Chile by the end of the 1970s) The
Clinton administration enabled banks to merge with junk mortgage
companies, junk-money managers, fictitious property appraisal companies,
and law-evasion firms all designed to package debts to investors who
trusted them enough to let them rake off enough commissions and capital
gains to make their managers the world’s highest-paid economic planners.
Today’s economic collapse is the direct result of their planning
philosophy. It actually was taught as “wealth creation” and still is, as
supposedly more productive than the public regulation and oversight so
detested by Wall Street and its Chicago School aficionados. The
financial powerhouses created by this “free market” philosophy span the
entire FIRE sector – finance, insurance and real estate,
“financializing” housing and commercial property markets in ways
guaranteed to make money by creating and selling debt. Mr. Obama’s
advisors are precisely those of the Clinton Administration who supported
trustification of the FIRE sector. This is the broad deregulatory medium
in which today’s bad-debt disaster has been able to spread so much more
rapidly than at any time since the 1920s.
The commercial banks have used their credit-creating power not to expand
the production of goods and services or raise living standards but
simply to inflate prices for real estate (making fortunes for their
brokerage, property appraisal and insurance affiliates), stocks and
bonds (making more fortunes for their investment bank subsidiaries),
fine arts (whose demand is now essentially for trophies, degrading the
idea of art accordingly) and other assets already in place.
The resulting dot.com and real estate bubbles were not inevitable, not
economically necessary. They were financially engineered by the
political deregulatory power acquired by banks corrupting Congress
through campaign contributions and public relations “think tanks” (more
in the character of Orwellian doublethink tanks) to promote the perverse
fiction that Wall Street can be and indeed is automatically
self-regulating. This is a travesty of Adam Smith’s “Invisible Hand.”
This hand is better thought of as covert. The myth of “free markets” is
now supposed to consist of governments withdrawing from planning and
taxing wealth, so as to leave resource allocation and the economic
surplus to bankers rather than elected public representatives. This is
what classically is called oligarchy, not democracy.
This centralization of planning, debt creation and revenue-extracting
power is defended as the alternative to Hayek’s road to serfdom. But it
is itself the road to debt peonage, a.k.a. the post-industrial economy
or “Information Economy.” The latter term is another euphemistic
travesty in view of the kind of information the banking system has
promoted in the junk accounting crafted by their accounting firms and
tax lawyers (off-balance-sheet entities registered on offshore
tax-avoidance islands), the AAA applause provided as “information” to
investors by the bond-rating cartel, and indeed the national income and
product accounts that depict the FIRE sector as being part of the “real”
economy, not as an institutional wrapping of special interests and
government-sanctioned privilege acting in an extractive rather than a
productive way.
“Thanks for the bonuses,” bankers in the United States and England
testified this week before Congress and Parliament. “We’ll keep the
money, but rest assured that we are truly sorry for having to ask you
for another few trillion dollars. At least you should remember our theme
song: We are still better managers than the government, and the bulwark
against government bureaucratic resource allocation.” This is the
ideological Big Lie sold by the Chicago School “free market” celebration
of dismantling government power over finance, all defended by complex
math rivaling that of nuclear physics that the financial sector is part
of the “real” economy automatically producing a fair and equitable
equilibrium.
This is not bad news for stockholders of more local and relatively
healthy banks (healthy in the sense of avoiding negative equity). Their
stocks soared and were by far the major gainers on Tuesday’s stock
market, while Wall Street’s large Bad Banks plunged to new lows. Solvent
local banks are the sort that were normal prior to repeal of Glass
Steagall. They are to be bought by the large “troubled” banks, whose
“toxic loans” reflect a basically toxic operating philosophy. In other
words, small banks who have made loans carefully will be sucked into
Citibank, Bank of America, JP Morgan Chase and Wells Fargo – the Big
Four or Five where the junk mortgages, junk CDOs and junk derivatives
are concentrated, and have used Treasury money from the past bailout to
buy out smaller banks that were not infected with such reckless
financial opportunism. Even the Wall Street Journal editorialized
regarding the Obama Treasury’s new “Public-Private Investment Fund” to
pump a trillion dollars into this mess: “Mr. Geithner would be wise to
put someone strong land independent in charge of this fund – someone who
can say no to Congress and has no ties to Citigroup, Robert Rubin or
Wall Street.”[2]
None of this can solve today’s financial problem. The debt overhead far
exceeds the economy’s ability to pay. If the banks would indeed do what
Pres. Obama’s appointees are begging them to do and lend more, the debt
burden would become even heavier and buying access to housing even more
costly. When the banks look back fondly on what Alan Greenspan called
“wealth creation,” we can see today that the less euphemistic
terminology would be “debt creation.” This is the objective of the new
bank giveaway. It threatens to spread the distortions that the large
banks have introduced until the entire system presumably looks like
Citibank, long the number-one offender of “stretching the envelope,” its
euphemism for breaking the law bit by bit and daring government
regulators and prosecutors to try and stop it and thereby plunging the
U.S. financial system into crisis. This is the shakedown that is being
played out this week. And the Obama administration blinked – as these
same regulators did when they were in charge of the Clinton
administration’s bank policy.. So much for the promised change!
The three-pronged Treasury program seems to be only Stage One of a
two-stage “dream recovery plan” for Wall Street. Enough hints have
trickled out for the past three months in Wall Street Journal op-eds to
tip the hand for what may be in store. Watch for the magic phrase
“equity kicker,” first heard in the S&L mortgage crisis of the 1980s. It
refers to the banker’s share of capital gains, that is, asset price
inflation in Bubble #2 that the Recovery Program hopes to sponsor.
The first question to ask about any Recovery Program is, “Recovery for
whom?” The answer given on Tuesday is, “For the people who design the
Program and their constituency” – in this case, the bank lobby. The
second question is, “Just what is it they want to ‘recover’?” The answer
is, the Bubble Economy. For the financial sector it was a golden age.
Having enjoyed the Greenspan Bubble that made them so rich, its managers
would love to create yet more wealth for themselves by indebting the
“real” economy yet further while inflating prices all over again to make
new capital gains.
The problem for today’s financial elites is that it is not possible to
inflate another bubble from today’s debt levels, widespread negative
equity, and still-high level of real estate, stock and bond prices. No
amount of new capital will induce banks to provide credit to real estate
already over-mortgaged or to individuals and corporations already
over-indebted. Moody’s and other leading professional observers have
forecast property prices to keep on plunging for at least the next year,
which is as far as the eye can see in today’s unstable conditions. So
the smartest money is still waiting like vultures in the wings – waiting
for government guarantees that toxic loans will pay off. Another no-risk
private profit to be subsidized by public-sector losses.
While the Obama administration’s financial planners wring their hands in
public and say “We feel your pain” to debtors at large, they know that
the past ten years have been a golden age for the banking system and the
rest of Wall Street. Like feudal lord claiming the economic surplus for
themselves while administering austerity for the population at large,
the wealthiest 1% of the population has raised their appropriation of
the nationwide returns to wealth – dividends, interest, rent and capital
gains – from 37% of the total ten years ago to 57% five years ago and it
seems nearly 70% today. This is the highest proportion since records
have been kept. We are approaching Russian kleptocratic levels.
The officials drawn from Wall Street who now control of the Treasury and
Federal Reserve repeat the right-wing Big Lie: Poor “subprime families”
have brought the system down, exploiting the rich by trying to ape their
betters and live beyond their means. Taking out subprime loans and not
revealing their actual ability to pay, the NINJA poor (no income, no
job, no audit) signed up to obtain “liars’ loans” as no-documentation
Alt-A loans are called in the financial junk-paper trade.
I learned the reality a few years ago in London, talking to a commercial
banker. “We’ve had an intellectual breakthrough,” he said. “It’s changed
our credit philosophy.”
“What is it?” I asked, imagining that he was about to come out with yet
a new magical mathematics formula?
“The poor are honest,” he said, accompanying his words with his jaw
dropping open as if to say, “Who would have guessed?”
The meaning was clear enough. The poor pay their debts as a matter of
honor, even at great personal sacrifice and what today’s neoliberal
Chicago School language would call uneconomic behavior. Unlike Donald
Trump, they are less likely to walk away from their homes when market
prices sink below the mortgage level. This sociological gullibility does
not make economic sense, but reflects a group morality that has made
them rich pickings for predatory lenders such as Countrywide, Wachovia
and Citibank. So it’s not the “lying poor..” It’s the banksters’ fault
after all!
For this elite the Bubble Economy was a deliberate policy they would
love to recover. The problem is how to start a new bubble to make yet
another fortune? The alternative is not so bad – to keep the bonuses,
capital gains and golden parachutes they have given themselves, and run.
But perhaps they can improve in Bubble Economy #2.
The Treasury’s newest Financial Stability Plan (Bailout 2.0) is only the
first step. It aims at putting in place enough new bank-lending capacity
to start inflating prices on credit all over again. But a new bubble
can’t be started from today’s asset-price levels. How can the $10 to $20
trillion capital-gain run-up of the Greenspan years been repeated in an
economy that is “all loaned up”?
One thing Wall Street knows is that in order to make money, asset prices
not only need to rise, they have to go down again. Without going down,
after all, how can they rise up? Without a crucifixion for the economy,
how can there be a resurrection? The more frenetic the price
fibrillation, the easier it is for computerized buy-and-sell programs to
make money on options and derivatives.
So here’s the situation as I see it. The first objective is to preserve
the wealth of the creditor class – Wall Street, the banks and the other
financial vehicles that enrich the wealthiest 1% and, to be fair within
America’s emerging new financial oligarchy, the richest 10% of the
population. Stage One involves buying out their bad loans at a price
that saves them from taking a loss. The money will be depicted to voters
as a “loan,” to be repaid by banks extracting enough new debt charges in
the new rigged game the Treasury is setting up. The current loss will be
shifted the onto “taxpayers” and made up by new debtors – in both cases
labor, onto whose shoulders the tax burden has been shifted steadily,
step by step since 1980.
An “aggregator” bank (sounds like “alligator,” from the swamps of toxic
waste) will buy the bad debts and put them in a public agency. The
government calls this the “bad” bank. (This is Geithner’s first point.)
But it does good for Wall Street – by buying loans that have gone bad,
along with loans and derivative guarantees and swaps that never were
good in the first place. If the private sector refuses to buy these bad
loans at prices the banks are asking for, why should the government
pretend that these debt claims are worth more. Vulture funds are said to
be offering about what they were when Lehman Brothers went bankrupt:
about 22 cents on the dollar. The banks are asking for 75 cents on the
dollar. What will the government offer?
Perhaps the worst alternative is that is now being promoted by the banks
and vulture investors in tandem: the government will guarantee the price
at which private investors buy toxic financial waste from the banks. A
vulture fund would be happy enough to pay 75 cents on the dollar for
worthless junk if the government were to provide a guarantee. The
Treasury and Federal Reserve pretend that they simply would be
“providing liquidity” to “frozen markets.” But the problem is not
liquidity and it is not subjective “market psychology.” It is
“solvency,” that is, a realistic awareness that toxic waste and bad
derivatives gambles are junk. Mr. Geithner has not been able to come to
terms with how to value this – without bringing the Obama administration
down in a wave of populist protest – any more than Mr. Paulson was able
to carry out his original Tarp proposal along these lines.
The hardest task for today’s banksters is to revive opportunities for
creditors to make a new killing. (It’s the economy that’s being killed,
of course.) This seems to be the aim of the Public/Private investment
company that Mr. Geithner is establishing as the second element in his
plan. The easiest free lunch is to ride the wave of a new bubble – a
fresh wave of asset-price inflation to be introduced to “cure” the
problem of debt deflation.
Here’s how I imagine the ploy might work. Suppose a hapless family has
bought a home for $500,000, with a full 100% $500,000 adjustable-rate
mortgage scheduled to reset this year at 8%. Suppose too that the
current market price will fall to $250,000, a loss of 50% by yearend
2009. Sometime in mid 2010 would seem to be long enough for prices to
decline by enough to make “recovery” possible – Bubble Economy 2.0.
Without such a plunge, there will be no economy to “rescue,” no
opportunity for Tim Geithner and Laurence Summers to “feel your pain”
and pull out of their pocket the following package – a variant on the
“cash for trash” swap, a public agency to acquire the $500,000 mortgage
that is going bad, heading toward only a $250,000 market price.
The “bad bank” was not quite ready to be created this week, but the
embryo is there. It will take the form of a public/private partnership
(PPP) of the sort that Tony Blair made so notorious in Britain. And
speaking of Mr. Blair, I am writing this from England, where almost
every America-watcher I talk to has expressed amazement at Obama’s
performance last week idealizing England’s counterpart to George Bush
when it comes to unpopularity contests. Blair’s tenure in office was a
horror story, not something to be congratulated for. He privatized the
railroads and entering into the disastrous public/private partnership
that doubled, tripled or quadrupled the cost of public projects by
adding on a heavy financial overhead If Obama does not realize how he
shocked Britain and much of Europe with his praise, then he is in danger
of foisting a similar public/private financialized “partnership” on the
United States
The new public/private institution will be financed with private funds –
in fact, with the money now being given to re-capitalize America’s banks
(headed by the Wall St. bank’s that have done so bad). Banks will use
the Treasury money they have received by “borrowing” against their junk
mortgages at or near par to buy shares in a new $5 trillion institution
created along the lines of the unfortunate Fanny Mae and Freddie Mac.
Its bonds will be guaranteed. (That’s the “public” part – “socializing”
the risk.) The PPP institution will have the power to buy and
renegotiate the mortgages that have passed into the hands of the
government and other holders. This “Homeowner Rescue Trust” will use its
private funding for the “socially responsible” purpose of “saving the
taxpayer” and middle class homeowners by renegotiating the mortgage down
from its original $500,000 to the new $250,000 market price.
Here’s the patter talk you can expect, with the usual Orwellian
euphemisms. The Homeowners Rescue PPP will appear as a veritable Savior
Bank resurrected from the wreckage of Bubble #1. Its clients will be
families strapped by their mortgage debt and feeling more and more
desperate as the price of their major asset plummets more deeply into
Negative Equity territory. To them, the new PPP will say: “We’ve got a
deal to save you. We’ll renegotiate your mortgage down to the current
market price, $250,000, and we’ll also lower your interest rate to just
5.50%, the new rate. This will cut your monthly debt charges by nearly
two thirds. Not only can you afford to stay in your home, you will
escape from your negative equity.”
The family probably will say, “Great.” But they will have to make a
concession. That’s where the new public/private partnership makes its
killing. Funded with private money that will take the “risk” (and also
reap the rewards), the Savior Bank will say to the family that agrees to
renegotiate its mortgage: “Now that the government has absorbed a loss
(in today’s travesty of “socializing” the financial system) while
letting let you stay in your home, we need to recover the money that’s
been lost. If we make you whole, we want to be made whole too. So when
the time comes for you to sell your home or renegotiate your mortgage,
our Homeowners Rescue PPP will receive the capital gain up to the
original amount written off.”
In other words, if the homeowner sells the property for $400,000, the
Homeowners Rescue PPP will get $150,000 of the capital gain. If the home
sells for $500,000, the bank will get $250,000. And if it sells for
more, thanks to some new clone of Alan Greenspan acting as
bubblemeister, the capital gain will be split in some way. If the split
is 50/50 and the home sells for $600,000, the owner will split the
$100,000 further capital gain with the Homeowners Rescue PPP. It thus
will make much more through its appropriation of capital gains (the new
debt-fueled asset-price inflation being put in place) than it extracts
in interest!
This would make Bubble 2.0 even richer for Wall Street than the
Greenspan bubble! Last time around, it was the middle class that got the
gains – even if new buyers had to enter a lifetime of debt peonage to
buy higher-priced homes. It really was the bank that got the gains, of
course, because mortgage interest charges absorbed the entire rental
value and even the hoped-for price gain. But homeowners at least had a
chance at the free ride, if they didn’t squander their money in
refinancing their mortgages to “cash out” on their equity to support
their living standards in a generation whose wage levels had stagnated
since 1979. As Mr. Greenspan observed in testimony before Congress, a
major reason why wages have not risen is that workers are afraid to
strike or even to complain about being worked harder and harder for
longer and longer hours (“raising productivity”), because they are one
paycheck away from missing their mortgage payment – or, if renters, one
paycheck or two away from homelessness.
This is the happy condition of normalcy that Wall Street’s financial
planners would like to recover. This time around, they may not be
obliged to make their gains in a way that also makes middle class
homeowners rich. In the wake of Bubble Economy #1, today’s debt-strapped
homeowners are willing to settle merely for a plan that leaves them in
their homes! The Homeowners Rescue PPP can appropriate for its
stockholder banks and other large investors the capital gains that have
been the driving force of U.S. “wealth creation,” bubble-style. That is
what the term “equity kicker” means.
This situation confronts the economy with a dilemma. The only policies
deemed politically correct these days are those that make the situation
worse: yet more government money in the hope that banks will create yet
more credit/debt to raise house prices and make them even more
unaffordable; credit/debt to inflate a new Bubble Economy #2.
Lobbyists for Wall Street’s enormous Bad Bank conglomerates are
screaming that all real solutions to today’s debt problem and tax shift
onto labor are politically incorrect, above all the time-honored debt
write-downs to bring the debt burden within the ability to pay. That is
what the market is supposed to do, after all, by bankruptcy in an
anarchic collapse if not by more deliberate and targeted government
policy. The Bad Banks, having demanded “free markets” all these years,
fear a really free market when it threatens their bonuses and other
takings. For Wall Street, free markets are “free” of public regulation
against predatory lending; “free” of taxing the wealthy so as to shift
the burden onto labor; “free” for the financial sector to wrap itself
around the “real” economy like parasitic ivy around a tree to extract
the surplus.
This is a travesty of freedom. As the putative neoliberal Adam Smith
explained, “The government of an exclusive company of merchants, is,
perhaps, the worst of all governments.” But worst of all is the
“freedom” of today’s economic discussion from the wisdom of classical
political economy and from historical experience regarding how societies
through the ages have coped with the debt overhead.
How to save the economy from Wall Street
There is an alternative to ward all this off, and it is the classic
definition of freedom from debt peonage and predatory credit. The only
real solution to today’s debt overhang is a debt write-down. Until this
occurs, debt service will crowd out spending on goods and services and
there will be no recovery. Debt deflation will drag the economy down
while assets are transferred further into the hands of the wealthiest 10
percent of the population, operating via the financial sector.
If Obama means what he says, he would use his office as a bully pulpit
to urge repeal the present harsh creditor-oriented bankruptcy law
sponsored by the banks and credit-card companies. He would campaign to
restore the long-term trend of laws favoring debtors rather than
creditors, and introduce legislation to restore the practice of writing
down debts to reflect the debtor’s ability to pay, imposing market
reality to debts that are far in excess of realistic valuations.
A second policy would be to restore the power of state attorneys general
to bring financial fraud charges against the most egregious mortgage
lenders – the prosecutions that the Bush Administration got thrown out
of court by claiming that under an 1864 National Bank Act clause, the
federal government had the right to override state prosecutions of
national banks – and then appointing a non-prosecutor to this
enforcement position.
On the basis of reinstated fraud charges, the government might claw back
the bank bonuses, salaries and bank earnings that represented the
profits from America’s greatest financial and real estate fraud in
history. And to prevent repetition of the past decade’s experience, the
Obama Administration might help popularize a new psychology of debt. The
government could encourage “the poor” to act as “economically” as Donald
Trumps or Angelo Mozilo’s would do, making it clear that debt
write-downs are a right.
Also to ward off repetition of the Bubble Economy, the Treasury could
impose the “Tobin tax” of 1% on purchases and options for stocks, bonds
and foreign currency. Critics of this tax point out that it can be
evaded by speculators trading offshore in the rights to securities held
in U.S. accounts. But the government could simply refuse to provide
deposit insurance and other support to institutions trading offshore, or
simply could announce that trades in such “deposit receipts” for shares
would not have legal standing. As for trades in derivatives, depository
institutions – including conglomerates owning such banks – can simply be
banned as inherently unsafe. If foreigners wish to speculate on
financial horse races, let them.
Financial policy ultimately rests on tax policy. It is the ability to
levy taxes, after all, that gives value to Treasury money (just as it is
the inability to collect on debts that has depreciated the value of
commercial bank deposits). It is easy enough for fiscal policy to
prevent a new real estate bubble. Simply shift the tax system back to
where it originally was, on the land’s site-rental value. The “free
lunch” (what John Stuart Mill called the “unearned increment” of rising
land prices, a gain that landlords made “in their sleep”) would serve as
the tax base instead of burdening labor and industry with income taxes
and sales taxes. This would achieve the kind of free market that Adam
Smith, John Stuart Mill and Alfred Marshall described, and which the
Progressive Era aimed to achieve with America’s first income tax in
1913. It would be a market free of the free lunch that Chicago Boys
insist does not exist. But the recent Bubble Economy and today’s Bailout
Sequel have been all about getting a free lunch.
A land tax would prevent housing prices from rising again. It is the
most hated tax in America today, largely because of the disinformation
campaign that has been mounted by the real estate interests and
amplified by the banks that stand behind them. The reality is that
taxing land appreciation rather than wages or corporate profits would
save homeowners from having to take on so much debt in order to obtain
housing. It would save the economy from seeing “wealth creation” take
the form of the “unearned increment” being capitalized into higher bank
loans with their associated carrying charges (interest and amortization).
The wealth tax originally fell mainly on real estate. The most immediate
and politically feasible priority of the Obama Administration thus
should be to repeal the Bush Administration’s drastic tax cuts for the
top brackets and its moratorium on the estate tax. The aim should be to
bring down the polarization between creditors and debtors that has
concentrated over two-thirds of the returns to wealth in the richest 1%
of the population.
If alternatives to the Bubble Economy such as these are not promoted, we
will know that promises of change were mere rhetoric, Tony Blair style.
[1] Martin Wolf, “Why Obama’s new Tarp will fail to rescue the banks,”
Financial Times, Feb. 11, 2009.
[2] “Geithner at the Improv,” Wall Street Journal editorial, February
11, 2009.
Michael Hudson is a frequent contributor to Global Research. Global
Research Articles by Michael Hudson
Michael Hudson is a former Wall Street economist specializing in the
balance of payments and real estate at the Chase Manhattan Bank (now
JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson
Institute (no relation). In 1990 he helped established the world’s first
sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis
Kucinich’s Chief Economic Advisor in the recent Democratic primary
presidential campaign, and has advised the U.S., Canadian, Mexican and
Latvian governments, as well as the United Nations Institute for
Training and Research (UNITAR). A Distinguished Research Professor at
University of Missouri, Kansas City (UMKC), he is the author of many
books, including Super Imperialism: The Economic Strategy of American
Empire (new ed., Pluto Press, 2002) He can be reached via his website,
www.michael-hudson.com and his email mhmichael-hudson.com .
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