Two new books and an article in Wired are making more people aware of the doomsday system constructed by the Soviets during the 1980s, when they feared an American nuclear attack. Perimeter, nicknamed "the Dead Hand," went operational in 1986 and guaranteed that even if the leadership was killed and all command-and-control systems disrupted, the Soviets would still launch an all-out nuclear counter-attack. Like Skynet of the Terminator movies -- Linda Hamilton, call your office. And "the dead hand" is still operational, although Moscow officially won't discuss it. It's a good thing nothing ever goes wrong with complex systems.
As we observe a one-year anniversary nearly every day of some calamity from last year's Great Panic, I can't stop that feeling of grating ambivalence. Yes, Messers Bernanke, Paulson and Geithner averted a collapse of "the global financial system" and perhaps averted another Great Depression. That's the story line and even I buy it most of the time. But now the too-big-to-fail banks have gotten even bigger. The derivative boys are back at work. Promised re-regulation is being gutted. The pain has fallen on average Americans and the American taxpayer.
It's almost as if "the global financial system" built its own Dead Hand doomsday machine. So the question becomes: Did we avert apocalypse last fall and winter, fortunately shutting down this fearsome device. Or did we actually arm it by our actions. In other words, should we have called the bastards' bluffs in late 2008?
The conventional view is that Washington had to act aggressively as the subprime cancer moved into the overall financial system, exposing just how vulnerable it was to all the "innovations" and swindles cooked up during the deregulation years. The argument comes from the details: Should the Fed have acted faster? Did it exceed its authority on this or that specific detail (See David Wessel's In Fed We Trust for an excellent overview).
But that's not the only view. I remember hearing a veteran of the investment business say at the time: "Let 'em go down. If the average American is going to lose his house over that, then why should we save Wall Street?" This person is a politically moderate brainiac -- not a Ron Paul or Ralph Nader supporter, no seer of black helicopters. Still, I tended to discount it. Now I wonder if the view had real wisdom.
The policy moves that stopped the Great Panic have given "the financial services industry," "the global financial system," even more control over the American government and economy. Over our destiny. As Wessel makes clear, Bernanke was willing to do whatever it took to avoid what this Great Depression scholar saw as another looming depression. Unfortunately, that has meant setting precedents that Washington -- American tax dollars, and ultimately future living standards -- will stand behind this system.
That's disconcerting for a couple of reasons. In the 1930s, the FDIC guarantee was to depositors, not to banks. FDR mercilessly sorted out the bad banks and let them fail, taking their clueless or greedy shareholders with them. Then the Congress enacted the Glass-Steagall Act to regulate banking, prohibiting commercial banks from engaging in the kind of speculation that helped cause the crash of 1929. Investment banks were regulated by the new Securities and Exchange Commission. Now, we live in the aftermath of the repeal of Glass-Steagall, years of a lapdog SEC (and Fed), and one more enormous change. The "banking" system is hardly what most Americans think when they hear the term. It is highly complex, opaque even to the experts, with layers of unregulated players in the so-called shadow banking system, gambling with exotic, little-understood derivatives and dangerously interconnected. The bankers are highly compensated for making high-risk bets. This combination helped cause last year's panic and its fundamentals are little changed -- oh, there is the fact that speculation is now backed by the full faith and credit of the federal government. No wonder many experts say today's situation is more dangerous than before -- and we're on the hook for all this.
The second problem is how the panic exposed how much of the American economy had become 1) making money off of derivatives of structured investment vehicles of counter-party insured bundled other derivatives, sold and resold, repackaged again and again, that somewhere down the chain of fraud and swindles were once connected to a real asset or a real dollar. And, 2) spending money we don't have and aren't actually making -- because income inequality is at 1929 highs and most Americans have seen their pay stagnate for years -- through the magic of bubbles and credit. And, unfortunately for you Screwed Joe & Jill Sixpack -- that part of the deal is now over. And, by the way, you've been foreclosed and fired. Now you're one of six seeking every open job (a record). By the way, the banks are raising your fees.
And all we get is Bernie Madoff in the hoosegow? Bernie's a piker compared to the enablers of the great collapses last year that have cost us trillions and will be a dead-weight dragging us under for decades to come. Not one of them has gone to prison. Nor have the ones who deregulated banking in the 1990s been intellectually discredited. The "system" keeps functioning, going back to business, setting the table for the next collapse.
The time to have avoided this reckoning was years ago. Free-market capitalism only works when the market is kept healthy, honest and competitive through regulation. When checks and balances exist. No monopolies, cartels or highly consolidated industries. Dispersed power and pluralism, so workers and small companies get a fair shot. A progressive tax system. And trade deals where both sides play by the rules. Instead, we built crony capitalism and got the inevitable results.
But here's an interesting counterfactual history exercise: What if Wall Street, the big banks and all the shadowy "counterparties" had been forced to eat it? What if the trillions would have been deployed to ease the pain for the American people and then reconstruct a real economy? A real economy that made real things of productive value for the world, and one that provided middle-class jobs and security. Our Chinese creditors? They would have felt much better about the security of their Treasury bonds if they were backed by a solvent government and a productive economy. The capital markets would always be with us, but after a catharsis of actually having to pay the price for their swindles, they would have bounced back, chastened and sober -- and then faced a 21st century Glass-Steagall. What if?
But the people guiding American policy -- under both Presidents Bush and Obama -- are creatures of the "global financial system's" status quo. Yes, many members of both parties, especially the Republicans, are bought and paid for by the financial lobby. As bad, they are prisoners of the conventional wisdom. To them, it is vital to rescue "financial services" (and throw in GM and Chrysler because we can't lose Michigan next election). Meanwhile, China is trying to corner the world market in real things, from sustainable energy to rare earth metals. Europe makes high-speed trains and advanced solar energy equipment -- while maintaining a civilization with pensions and universal health care. We have our derivatives.
If you would have deliberately set out to construct a scenario that would bankrupt America and ensure our eclipse in the world, you couldn't have done better than this (and add a war or two).
The Dead Hand.
Yes, we should have called their bluff. It wouldn't be any worse than it is for the middle and lower classes.
And speaking of Doomsday, Maricopa Co. wants to double the amount of freeways at a cost of $60B to accommodate their projection of 10 million people living in the Valley. The Dead Hand still is around our throats.
Posted by: eclecticdog | September 28, 2009 at 08:08 AM
It's true we have a hollowed-out economy but that, paradoxically, makes the hollowers even more powerful. I'm not even sure there's a conspiracy in any of this beyond the ordinary persuasion factor of concentrated wealth. It's as if we're locked into a play whose ending is bad and whose script doesn't permit overwrites. This empire is imploding.
Posted by: soleri | September 28, 2009 at 11:20 AM
Judging to what extent the bailout was necessary, or at least prudent, and what was hyperbole in service of a hidden agenda or ulterior motive, requires more information than has been made available to the general public, so far as I know.
The Bush and Obama administration's advisers who counceled these actions have never reproduced their reasoning and the details behind it for the public, or even for specialists in the fields of economics and finance -- again, so far as I know.
The justification given by them paints, in very broad strokes, a story of interlinked financial institutions, and a domino theory involving companies like AIG, but what little detail has been revealed to date is far from strongly compelling.
There are several possibilities:
(1) The standard explanation is accurate.
(2) Essentially accurate, but the bailout was larded with special deals for favored parties that probably weren't necessary to maintain the integrity of the system as a whole.
(3) Essentially inaccurate, but nobody had a real understanding of what was going on, and the advice and decisions of all influential parties were well-intentioned.
(4) Essentially inaccurate, but a comparative handful of highly influential individuals were offering deliberately dishonest explanations and advice to the administrations and the public, for their own benefit.
(5) Essentially inaccurate, and this was widely known at the upper levels of the political and/or economic establishment.
Take your pick.
Posted by: Emil Pulsifer | September 28, 2009 at 01:17 PM
The media (television and radio especially, but also general readership newspapers) does a very poor job of explaining the workings of the system even when this involves aspects that have existed for many years and are well documented.
Part of this is the lack of specialist reporters, part is laziness, and part is the result of low standards in the media industry.
Too often, reporters do not bother to read through primary documents -- especially when these are large (such as the Budget of the United States Government) but instead rely on executive summaries and/or press releases. Balance in reporting is considered to be fulfilled if the leadership of both major parties is consulted; but when both parties have a reason for lying, the public is ill-served.
For example, today I saw an Associated Press article in the Arizona Republic titled "Job losses causing huge deficits for Social Security".
http://www.azcentral.com/arizonarepublic/news/articles/2009/09/28/20090928social-security0928.html
"Big job losses and a spike in early-retirement claims from laid-off seniors will force Social Security to pay out more in benefits than it collects in taxes the next two years - the first time that has happened since the 1980s.
"The deficits - $10 billion in 2010 and $9 billion in 2011 - will not affect payments to retirees because Social Security has accumulated surpluses from previous years totaling $2.5 trillion."
Well, no. This program is run on a cash basis and the so-called trust funds are a preposterous scam. The government actually admits this explicitly in its budget documents.
Social Security's monies come from the General Fund account of all monies collected by the Government: the government collects taxes and fees, and uses these (plus borrowing) to pay the obligations of all federal programs, including Social Security.
If there is a "deficit" it is with the general budget and not a specific program; and payments to beneficiaries are determined by the formulas contained in Social Security legislation, which can be changed (and has been numerous times).
"Without a new fix, the $2.5 trillion in Social Security's trust funds will be exhausted in 2037."
No. The "trust funds" are financially and legally irrelevant: they are not a source of funds, and never will be, and their contents do not determine who receives benefits or at what levels. They cannot be "exhausted" because there is nothing to exhaust.
"The Congressional Budget Office is projecting that Social Security will pay out more in benefits than collect in taxes next year and in 2011 - a first since the early 1980s, when Congress last overhauled Social Security."
True, except that Congress didn't "overhaul" the program: they deliberately raised payroll taxes above what was necessary to fund ongoing program expenditures, falsely representing this as saving toward the future for an aging population, then spent the excess funds on other things; and this was perfectly legal.
Amazingly, despite all of this, at the end of the article the author seems to acknowledge it:
"Those funds have actually been spent over the years on other government programs. They are now represented by government bonds, or IOUs, that will have to be repaid as Social Security draws down its trust fund."
The first sentence is true. The second is not, since the trust fund does not contain assets, and the IOUs were issued by the government not to the public, but to itself. There is nothing to draw down, nobody to repay except itself, and no way to raise program funds except the usual method of taxation, fees, and borrowing that fund federal programs in general.
Posted by: Emil Pulsifer | September 28, 2009 at 01:52 PM
It is way past time for heads on sticks.
Posted by: krazy bill | September 28, 2009 at 04:41 PM
I wrote:
[Social Security and Medicare are] "run on a cash basis and the so-called trust funds are a preposterous scam. The government actually admits this explicitly in its budget documents."
Fortunately, you don't have to take my word for this. It's interesting to observe how the government has become more sophisticated in obscuring the facts in its own budget documents. Back in FY 1996, despite putting the information in an obscure section of the budget and surrounding it with language designed to camouflage the facts, the language used was nonetheless relatively clear:
"The Federal budget meaning of the term 'trust' differs significantly from its private sector usage. In the private sector, the beneficiary of a trust owns the income generated by the trust and usually its assets. A trustee, acting as a fiduciary, manages the trust’s assets on behalf of the beneficiary. The trustee is required to follow the stipulations of the trust, which he cannot change unilaterally. In contrast, the Federal Government owns the assets and earnings of Federal trust funds, and it can raise or lower future trust fund collections and payments, or change the purpose for which the collections are used, by changing existing law." (p. 251)
"These balances are available to finance future benefit payments and other trust fund expenditures -- but only in a bookkeeping sense. Unlike the assets of private pension plans, they do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, reducing benefits or other expenditures, or borrowing from the public." (p.258)
"However, issuing debt to Government accounts does not have any of the economic effects of borrowing from the public. It is an internal transaction between two accounts, both within the Government itself. It does not represent either current transactions of the Government with the public or an estimated amount of future transactions with the public. For example, if the account records the transactions of a retirement program, the debt that it holds does not represent the actuarial present value of future benefits." (p.188)
http://www.gpoaccess.gov/usbudget/fy96/pdf/bud96p.pdf
In the current budget document, much of this language has been removed or altered, and the meaning is less clear, though substantial portions remain. See for example the same section in the FY 2010 budget:
http://www.whitehouse.gov/omb/budget/fy2010/assets/borrowing.pdf
Posted by: Emil Pulsifer | September 28, 2009 at 04:57 PM
Mr. Talton asked whether or not the bailout disarmed or enabled the "dead hand" of Big Finance. Clearly, without fundamental regulatory reforms, the bailout will only serve to increase "moral hazard" and encourage future profligacy and irresponsible risk-taking for private gain.
Robert Cyran of breakingnews.com had a great column buried in the Business section of today's New York Times which was headlined "Canadian Banks Missed A Chance".
The main point of the article, however, wasn't the Canadian banks' timidity, but the way that Canadian banking regulations, industry attitudes, and culture allowed the biggest Canadian banks to escape largely unscathed by the meltdown:
"None of the major banks in Canada failed in this financial crisis. In fact, they found themselves in stronger shape. The total market capitalization of the big five Canadian banks — Royal Bank of Canada, Toronto Dominion, Bank of Nova Scotia, Bank of Montreal and CIBC — has risen 8 percent since the start of 2007. By comparison, the five biggest American commercial banks lost almost 40 percent, vaporizing more than $350 billion of market value.
"There are many reasons that American banks got into trouble while the Canadians didn’t. Among them: 50 percent greater leverage among American banks, which amplified losses; less prudent underwriting and credit standards; a regulatory patchwork that allowed [American] banks to play one set of watchdogs off against another; American government officials’ belief that the private sector needed less oversight; and a larger reliance on short-term borrowing.
"These factors all played a role and fed upon each other. For example, Canadian regulations encourage banks to keep more loans on their books. While half of all United States mortgage loans were sold at the peak of the securitization bubble, the figure for Canada was about 25 percent. Since the banks had to eat more of their own cooking, so to speak, there was more incentive to make sure borrowers could repay.
"The Canadians also had a bit of luck. They weren’t forced to step in and provide liquidity to their off-balance-sheet vehicles at the height of the crisis because, unlike in the United States, the standard legal arrangements didn’t require that. More important, the American cultural mood latched onto the idea of buying houses and flipping them for hefty profits to a much greater extent. Canadians were more circumspect, limiting the housing bubble north of the border."
http://www.nytimes.com/2009/09/28/business/28views.html
Posted by: Emil Pulsifer | September 28, 2009 at 05:23 PM