Monthly Archives: April 2010


L. Randall Wray

In a startling turn of events, the SEC announced a civil fraud lawsuit against Goldman Sachs. I use the word startling because a) the SEC has done virtually nothing in the way of enforcement for years, managing to sleep through every bubble and bust in recent memory, and b) Government Sachs has been presumed to be above the law since it took over Washington during the Clinton years. Of course, there is nothing startling about bad behavior at Goldman—that is its business model. The only thing that separates Goldman on that score from all other Wall Street financial institutions is its audacity to claim that it channels God as it screws its customers. But when the government is your handmaiden, why not be audacious?

The details of the SEC’s case will be familiar to anyone who knows about Magnetar. This hedge fund sought the very worst subprime mortgage backed securities (MBS) to package as collateralized debt obligations (CDO). The firm nearly single-handedly kept the subprime market afloat after investors started to worry about Liar and NINJA loans, since Magnetar was offering to take the very worst tranches—making it possible to sell the higher-rated tranches to other more skittish buyers. And Magnetar was quite good at identifying trash: According to an analysis commissioned by ProPublica, 96% of the CDO deals arranged by Magnetar were in default by the end of 2008 (versus “only” 68% of comparable CDOs). The CDOs were then sold-on to investors, who ultimately lost big time. Meanwhile, Magnetar used credit default swaps (CDS) to bet that the garbage CDOs they were selling would go bad. Actually, that is not a bet. If you can manage to put together deals that go bad 96% of the time, betting on bad is as close to a sure thing as a financial market will ever find. So, in reality, it was just pick pocketing customers—in other words, a looting.

Well, Magnetar was a hedge fund, and as they say, the clients of hedge funds are “big boys” who are supposed to be sophisticated and sufficiently rich that they can afford to lose. Goldman Sachs, by contrast, is a 140 year old firm that operates a revolving door to keep the US Treasury and the NY Fed well-stocked with its alumni. As Matt Taibi has argued, Goldman has been behind virtually every financial crisis the US has experienced since the Civil War. In John Kenneth Galbraith’s “The Great Crash”, a chapter that documents Goldman’s contributions to the Great Depression is titled “In Goldman We Trust”. As the instigator of crises, it has truly earned its reputation. And it has been publicly traded since 1999—an unusual hedge fund, indeed. Furthermore, Treasury Secretary Geithner handed it a bank charter to ensure it would have cheap access to funds during the financial crisis. This gave it added respectability and profitability—one of the chosen few anointed by government to speculate with Treasury funds. So, why did Goldman use its venerable reputation to loot its customers?

Before 1999, Goldman (like the other investment banks) was a partnership—run by future Treasury Secretary Hank Paulson. The trouble with that arrangement is that it is impossible to directly benefit from a run-up of the stock market. Sure, Goldman could earn fees by arranging initial public offerings for Pets-Dot-Com start-ups, and it could trade stocks for others or for its own account. This did offer the opportunity to exploit inside information, or to monkey around with the timing of trades, or to push the dogs onto clients. But in the euphoric irrational exuberance of the late 1990s that looked like chump change. How could Goldman’s management get a bigger share of the action?
Flashback to the 1929 stock market boom, when Goldman faced the same dilemma. Since the famous firms like Goldman Sachs were partnerships, they did not issue stock; hence they put together investment trusts that would purport to hold valuable equities in other firms (often in other affiliates, which sometimes held no stocks other than those in Wall Street trusts) and then sell shares in these trusts to a gullible public. Effectively, trusts were an early form of mutual fund, with the “mother” investment house investing a small amount of capital in their offspring, highly leveraged using other people’s money. Goldman and others would then whip up a speculative fever in shares, reaping capital gains through the magic of leverage. However, trust investments amounted to little more than pyramid schemes—there was very little in the way of real production or income associated with all this trading in paper. Indeed, the “real” economy was already long past its peak—there were no “fundamentals” to drive the Wall Street boom. It was just a Charles Ponzi-Bernie Madoff scam. Inevitably, Goldman’s gambit collapsed and a “debt deflation” began as everyone tried to sell out of their positions in stocks—causing prices to collapse. Spending on the “real economy” suffered and we were off to the Great Depression. Sound familiar?

So in 1999 Goldman and the other partnerships went public to enjoy the advantages of stock issue in a boom. Top management was rewarded with stocks—leading to the same pump-and-dump incentives that drove the 1929 boom. To be sure, traders like Robert Rubin (another Treasury secretary) had already come to dominate firms like Goldman. Traders necessarily take a short view—you are only as good as your last trade. More importantly, traders take a zero-sum view of deals: there will be a winner and a loser, with Goldman pocketing fees for bringing the two sides together. Better yet, Goldman would take one of the two sides—the winning side, of course–and pocket the fees and collect the winnings. You might wonder why anyone would voluntarily become Goldman’s client, knowing that the deal was ultimately zero-sum and that Goldman would have the winning hand? No doubt there were some clients with an outsized view of their own competence or luck; but most customers were wrongly swayed by Goldman’s reputation that was being exploited by hired management. The purpose of a good reputation is to exploit it. That is what my colleague, Bill Black, calls control fraud.
Note that before it went public, only 28% of Goldman’s revenues came from trading and investing activities. That is now about 80% of revenue. While many think of Goldman as a bank, it is really just a huge hedge fund, albeit a very special one that happens to hold a Timmy Geithner-granted bank charter—giving it access to the Fed’s discount window and to FDIC insurance. That, in turn, lets it borrow at near-zero interest rates. Indeed, in 2009 it spent only a little over $5 billion to borrow, versus $26 billion in interest expenses in 2008—a $21 billion subsidy thanks to Goldman’s understudy, Treasury Secretary Geithner. It was (until Friday) also widely believed to be “backstopped” by the government—under no circumstances would it be allowed to fail, nor would it be restrained or prosecuted—keeping its stock price up. That is now somewhat in doubt, causing prices to plummet. Of course, the FDIC subsidy is only a small part of the funding provided by government—we also need to include the $12.9 billion it got from the AIG bail-out, and a government guarantee of $30 billion of its debt. Oh, and Goldman’s new $2 billion headquarters in Manhattan? Financed by $1.65 billion of tax free Liberty Bonds (interest savings of $175 million) plus $66 million of employment and energy subsidies. And it helps to have your people run three successive administrations, of course.
Unprecedented and unprecedentedly useful if one needs to maintain reputation in order to run a control fraud.
In the particular case prosecuted by the SEC, Goldman created synthetic CDOs that placed bets on toxic waste MBSs. A synthetic CDO does not actually hold any mortgage securities—it is simply a pure bet on a bunch of MBSs. The purchaser is betting that those MBSs will not go bad, but there is an embedded CDS that allows the other side to bet that the MBSs will fall in value, in which case the CDS “insurance” pays off. Note that the underlying mortgages do not need to go into default or even fall into delinquency. To make sure that those who “short” the CDO (those holding the CDS) get paid sooner rather than later, all that is required is a downgrade by credit rating agencies. The trick, then, is to find a bunch of MBSs that appear to be over-rated and place a bet they will be downgraded. Synergies abound! The propensity of credit raters to give high ratings to junk assets is well-known, indeed assured by paying them to do so. Since the underlying junk is actually, well, junk, downgrades are also assured. Betting against the worst junk you can find is a good deal—if you can find a sucker to take the bet.
The theory behind shorting is that it lets you hedge risky assets in your portfolio, and it aids in price discovery. The first requires that you’ve actually got the asset you are shorting, the second relies on the now thoroughly discredited belief in the efficacy of markets. In truth, these markets are highly manipulated by insiders, subject to speculative fever, and mostly over-the-counter. That means that initial prices are set by sellers. Even in the case of MBSs—that actually have mortgages as collateral—buyers usually do not have access to essential data on the loans that will provide income flows. Once we get to tranches of MBSs, to CDOs, squared and cubed, and on to synthetic CDOs we have leveraged and layered those underlying mortgages to a degree that it is pure fantasy to believe that markets can efficiently price them. Indeed, that was the reason for credit ratings, monoline insurance, and credit default swaps. CDSs that allow bets on synthetics that are themselves bets on MBSs held by others serve no social purpose whatsoever—they are neither hedges nor price discovery mechanisms.

The most famous shorter of MBSs is John Paulson, who approached Goldman to see if the firm could create some toxic synthetic CDOs that he could bet against. Of course, that would require that Goldman could find chump clients willing to buy junk CDOs—a task for which Goldman was well-placed. According to the SEC, Goldman allowed Paulson to increase the probability of success by allowing him to suggest particularly trashy securities to include in the CDOs. Goldman arranged 25 such deals, named Abacus, totaling about $11 billion. Out of 500 CDOs analyzed by UBS, only two did worse than Goldman’s Abacus. Just how toxic were these CDOs? Only 5 months after creating one of these Abacus CDOs, the ratings of 84% of the underlying mortgages had been downgraded. By betting against them, Goldman and Paulson won—Paulson pocketed $1 billion on the Abacus deals; he made a total of $5.7 billion shorting mortgage-based instruments in a span of two years. This is not genius work—84% to 96% of CDOs that are designed to fail will fail.
Paulson has not been accused of fraud—while he is accused of helping to select the toxic waste, he has not been accused of misleading investors in the CDOs he bet against. Goldman, on the other hand, never told investors that the firm was creating these CDOs specifically to meet the demands of Paulson for an instrument to allow him to bet them. The truly surprising thing is that Goldman’s patsies actually met with Paulson as the deals were assembled—but Goldman never informed them that Paulson was the shorter of the CDOs they were buying! The contempt that Goldman shows for clients truly knows no bounds. Goldman’s defense so far amounts to little more than the argument that a) these were big boys; and b) Goldman also lost money on the deals because it held a lot of the Abacus CDOs. In other words, Goldman is not only dishonest, but it is also incompetent. If that is not exploitation of reputation by Goldman’s management, I do not know what would qualify.

By the way, remember the AIG bail-out, of which $12.9 billion was passed-through to Goldman? AIG provided the CDSs that allowed Goldman and Paulson to short Abacus CDOs. So AIG was also duped, as was Uncle Sam—although that “sting” required the help of the New York Fed’s Timmy Geithner. I would not take Goldman’s claim that it lost money on these deals too seriously. It must be remembered that when Hank Paulson ran Goldman, it was bullish on real estate; through 2006 it was accumulating MBSs and CDOs—including early Abacus CDOs. It then slowly dawned on Goldman that it was horribly exposed to toxic waste. At that point it started shorting the market, including the Abacus CDOs it held and was still creating. Thus, while it might be true that Goldman could not completely hedge its positions so that it got caught holding junk, that was not for lack of trying to push all risks onto its clients. The market crashed before Goldman found a sufficient supply of suckers to allow it to short everything it held. Even vampire squids get caught holding garbage.
Some have argued that the SEC’s case is weak. It needs to show not only that Goldman misled investors, but also that this was materially significant in creating their losses. Would they have forgone the deals if they had known that Paulson was shorting their asset? We do not know—the SEC will have to make the case. Besides, Goldman does this to all its clients—so the SEC will have to make the case that clients could have been misled, whilst knowing that Goldman screws all its clients. After all, Goldman hid Greece’s debt, then bet against the debt—another fairly certain bet since debt ratings would fall if the hidden debt was ever discovered. Goldman took on US states as clients (including California and New Jersey and 9 other states), earning fees for placing their debts, and then encouraged other clients to bet against state debt—using its knowledge of the precariousness of state finances to market the instruments that facilitated the shorts. Did Goldman do anything illegal? We do not yet know. Reprehensible? Yes. Normal business practice.

To be fair, Goldman is not alone—all of this appears to be normal business procedure. In early spring 2010 a court-appointed investigator issued his report on the failure of Lehman. Lehman engaged in a variety of “actionable” practices (potentially prosecutable as crimes). Interestingly, it hid debt using practices similar to those employed by Goldman to hide Greek debt. The investigator also showed how the prices by Lehman on its assets were set—and subject to rather arbitrary procedures that could result in widely varying values. But most importantly, the top management as well as Lehman’s accounting firm (Ernst&Young) signed off on what the investigator said was “materially misleading” accounting. That is a go-to-jail crime if proven. The question is why would a top accounting firm as well as Lehman’s CEO, Richard Fuld, risk prison in the post-Enron era (similar accounting fraud brought down Enron’s accounting firm, and resulted in Sarbanes-Oxley legislation that requires a company’s CEO to sign off on company accounts)? There are two answers. First, it is possible that fraud is so wide-spread that no accounting firm could retain top clients without agreeing to overlook it. Second, fraud may be so pervasive and enforcement and prosecution thought to be so lax that CEOs and accounting firms have no fear. I think that both answers are correct.

To determine whether Goldman and other firms engaged in fraud will require close examination of the books, internal documents, and emails. Perhaps the SEC has finally fired the first shot at the Wall Street firms that aided and abetted the creation of the conditions that led up to the financial collapse. More importantly, that first shot might have driven a bit of fear into the financial institutions that have been trying to carry-on with business as usual. And, finally, perhaps the SEC might induce the Obama administration to stand-up to Goldman.

It is probably not too early for Goldman management and alumni to begin packing bags for extended stays in our nation’s finest penitentiaries. More than 1000 top management at thrifts served real jail time in the aftermath of the Savings and Loan fiasco. This current scandal is many orders of magnitude greater—probably tens of thousands of managers and traders and government officials were involved in fraud. We may need dozens of new prisons to contain them.

Meanwhile, the Obama administration should immediately revoke Goldman’s bank charter. Even if the firm is completely cleared of illegal activities, it is not a bank. There is no justification for provision of deposit insurance for a firm that specializes in betting against its clients. Its business model is at best based on deception, if not outright fraud. It serves no useful purpose; it does not do God’s work. Government should also relieve itself of all Goldman alumni—no administration that is full of Goldman’s people can retain the trust of the American public. President Obama should start his house cleaning with the Treasury department. Yes, Rubin and his hired hand Summers and protégé Geithner (and his hired hand Mark Patterson, Goldman’s lobbyist who became chief of staff of the Treasury) and Hank Paulson must be banned from Washington; and Rattner (former NYTimes reporter who tried to bribe pensions funds when he worked for the Quadrangle Group—who served as Obama’s “car czar” and is now likely to face lawsuits), and Lewis Sachs (senior advisor to Treasury, who helped Tricadia to make bets identical to those made by Magnetar and Goldman), and Stephen Friedman (Goldman senior partner who served as chairman of the NYFed), and NY Fed president Dudley (former chief US economist at Goldman) must all be sent home. Actually, anyone who ever worked for a financial institution must be banned from Washington until we can reform and downsize and drive a stake through the heart of Wall Street’s vampires.

And why not use the powers of eminent domain to take back Goldman’s shiny new government-subsidized headquarters to serve as the offices for 6000 newly hired federal government white collar criminologists tasked with the mission to pursue Wall Street’s fraud from the Manhattan citadel of the mighty vampire squid? If Obama is serious about reform, that would be a first step.

What is Responsible Fiscal Policy?

By Pavlina R. Tcherneva

I can’t fault the taxpayer for being upset with the deficit. I blame my profession, which has been spewing nonsense about government spending for decades. Economics is long-overdue for a renaissance. The deficit phobia, not the deficit itself, should be made public enemy #1. Taxpayers are decidedly working against their own interests when they demand that the government reduce or eliminate its deficit. Here is why:
Government deficits create non-government surpluses. It is a simple mathematical proposition; it is neither high theory, nor rocket science. If one sector spends more than it earns, another, by the rules of double-entry bookeeping, earns more than it spends. And so it is with the government—if it spends more than it collects in taxes, it runs a deficit, which is exactly equal to the surplus accumulated by the non-government sector. Deficits create income and profits for the private sector in excess of the taxes the private sector pays to the government. My fellow bloggers have explained this clearly many times before (e.g. here, here and here).

“My alternative proposal on trade with China”

By Warren Mosler*

We can have BOTH low priced imports AND good jobs for all Americans

Attorney General Richard Blumenthal has urged US Treasury Secretary Geithner to take legal action to force China to let its currency appreciate. As stated by Blumenthal: “By stifling its currency, China is stifling our economy and stealing our jobs. Connecticut manufacturers have bled business and jobs over recent years because of China’s unconscionable currency manipulation and unfair market practices.”

The Attorney General is proposing to create jobs by lowering the value of the dollar vs. the yuan (China’s currency) to make China’s products a lot more expensive for US consumers, who are already struggling to survive. Those higher prices then cause us to instead buy products made elsewhere, which will presumably means more American products get produced and sold. The trade off is most likely to be a few more jobs in return for higher prices (also called inflation), and a lower standard of living from the higher prices.

Fortunately there is an alternative that allows the US consumer to enjoy the enormous benefits of low cost imports and also makes good jobs available for all Americans willing and able to work. That alternative is to keep Federal taxes low enough so Americans have enough take home pay to buy all the goods and services we can produce at full employment levels AND everything the world wants to sell to us. This in fact is exactly what happened in 2000 when unemployment was under 4%, while net imports were $380 billion. We had what most considered a ‘red hot’ labor market with jobs for all, as well as the benefit of consuming $380 billion more in imports than we exported, along with very low inflation and a high standard of living due in part to the low cost imports.

The reason we had such a good economy in 2000 was because private sector debt grew at a record 7% of GDP, supplying the spending power we needed to keep us fully employed and also able to buy all of those imports. But as soon as private sector debt expansion reached its limits and that source of spending power faded, the right Federal policy response would have been to cut Federal taxes to sustain American spending power. That wasn’t done until 2003- two long years after the recession had taken hold. The economy again improved, and unemployment came down even as imports increased. However, when private sector debt again collapsed in 2008, the Federal government again failed to cut taxes or increase spending to sustain the US consumer’s spending power. The stimulus package that was passed almost a year later in 2009 was far too small and spread out over too many years. Consequently, unemployment continued to rise, reaching an unthinkable high of 16.9% (people looking for full time work who can’t find it) in March 2010.

The problem is we are conducting Federal policy on the mistaken belief that the Federal government must get the dollars it spends through taxes, and what it doesn’t get from taxes it must borrow in the market place, and leave the debts for our children to pay back. It is this errant belief that has resulted in a policy of enormous, self imposed fiscal drag that has devastated our economy.

My three proposals for removing this drag on our economy are:

1. A full payroll tax (FICA) holiday for employees and employers. This increases the take home pay for people earning $50,000 a year by over $300 per month. It also cuts costs for businesses, which means lower prices as well as new investment.

2. A $500 per capita distribution to State governments with no strings attached. This means $1.75 billion of Federal revenue sharing to the State of Connecticut to help sustain essential public services and reduce debt.

3. An $8/hr national service job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment as the pickup in sales from my first two proposals quickly translates into millions of new private sector jobs.

Because the right level of taxation to sustain full employment and price stability will vary over time, it’s the Federal government’s job to use taxation like a thermostat- lowering taxes when the economy is too cold, and considering tax increases only should the economy ‘over heat’ and get ‘too good’ (which is something I’ve never seen in my 40 years).

For policy makers to pursue this policy, they first need to understand what all insiders in the Fed (Federal Reserve Bank) have known for a very long time- the Federal government (not State and local government, corporations, and all of us) never actually has nor doesn’t have any US dollars. It taxes by simply changing numbers down in our bank accounts and doesn’t actually get anything, and it spends simply by changing numbers up in our bank accounts and doesn’t actually use anything up. As Federal Reserve Chairman Bernanke explained in to Scott Pelley on ’60 minutes’ in May 2009:

(PELLEY) Is that tax money that the Fed is spending?
(BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Therefore, payroll tax cuts do NOT mean the Federal government will go broke and run out of money if it doesn’t cut Social Security and Medicare payments. As the Fed Chairman correctly explained, operationally, spending is not revenue constrained.

We know why the Federal government taxes- to regulate the economy- but what about Federal borrowing? As you might suspect, our well advertised dependence on foreigners to buy US Treasury securities to fund the Federal government is just another myth holding us back from realizing our economic potential.

Operationally, foreign governments have ‘checking accounts’ at the Fed called ‘reserve accounts,’ and US Treasury securities are nothing more than savings accounts at the same Fed. So when a nation like China sells things to us, we pay them with dollars that go into their checking account at the Fed. And when they buy US Treasury securities the Fed simply transfers their dollars from their Fed checking account to their Fed savings account. And paying back US Treasury securities is nothing more than transferring the balance in China’s savings account at the Fed to their checking account at the Fed. This is not a ‘burden’ for us nor will it be for our children and grand children. Nor is the US Treasury spending operationally constrained by whether China has their dollars in their checking account or their savings accounts. Any and all constraints on US government spending are necessarily self imposed. There can be no external constraints.

In conclusion, it is a failure to understand basic monetary operations and Fed reserve accounting that caused the Democratic Congress and Administration to cut Medicare in the latest health care law, and that same failure of understanding is now driving well intentioned Americans like Atty General Blumenthal to push China to revalue its currency. This weak dollar policy is a misguided effort to create jobs by causing import prices to go up for struggling US consumers to the point where we buy fewer Chinese products. The far better option is to cut taxes as I’ve proposed, to ensure we have enough take home pay to be able to buy all that we can produce domestically at full employment, plus whatever imports we want to buy from foreigners at the lowest possible prices, and return America to the economic prosperity we once enjoyed.

*This article first appeared on

The Coming European Debt Wars

By Michael Hudson
(Portions of this essay appeared in today’s Financial Times)

Government debt in Greece is just the first in a series of European debt bombs that are set to explode. The mortgage debts in post-Soviet economies and Iceland are more explosive.  Although these countries are not in the Eurozone, most of their debts are denominated in euros. Some 87% of Latvia’s debts are in euros or other foreign currencies, and are owed mainly to Swedish banks, while Hungary and Romania owe euro-debts mainly to Austrian banks. So their government borrowing by non-euro members has been to support exchange rates to pay these private sector debts to foreign banks, not to finance a domestic budget deficit as in Greece.

All these debts are unpayably high because most of these countries are running deepening trade deficits and are sinking into depression. Now that real estate prices are plunging, trade deficits are no longer financed by an inflow of foreign-currency mortgage lending and property buyouts. There is no visible means of support to stabilize currencies (e.g., healthy economies). For the past year these countries have supported their exchange rates by borrowing from the EU and IMF. The terms of this borrowing are politically unsustainable: sharp public sector budget cuts, higher tax rates on already over-taxed labor, and austerity plans that shrink economies and drive more labor to emigrate.

Bankers in Sweden and Austria, Germany and Britain are about to discover that extending credit to nations that can’t (or won’t) pay may be their problem, not that of their debtors. No one wants to accept the fact that debts that can’t be paid, won’t be. Someone must bear the cost as debts go into default or are written down, to be paid in sharply depreciated currencies, but many legal experts find debt agreements calling for repayment in euros unenforceable. Every sovereign nation has the right to legislate its own debt terms, and the coming currency re-alignments and debt write-downs will be much more than mere “haircuts.”
There is no point in devaluing, unless “to excess” – that is, by enough to actually change trade and production patterns. That is why Franklin Roosevelt devalued the US dollar by 41% against gold in 1933, raising its official price from $20 to $35 an ounce. And to avoid raising the U.S. debt burden proportionally, he annulled the “gold clause” indexing payment of bank loans to the price of gold. This is where the political fight will occur today – over the payment of debt in currencies that are devalued.
Another byproduct of the Great Depression in the United States and Canada was to free mortgage debtors from personal liability, making it possible to recover from bankruptcy. Foreclosing banks can take possession of collateral real estate, but do not have any further claim on the mortgagees. This practice – grounded in common law – shows how North America has freed itself from the legacy of feudal-style creditor power and the debtors’ prisons that made earlier European debt laws so harsh.
The question is, who will bear the loss? Keeping debts denominated in euros would bankrupt much local business and real estate. Conversely, re-denominating these debts in local depreciated currency will wipe out the capital of many euro-based banks. But these banks are foreigners, after all – and in the end, governments must represent their own home electorates. Foreign banks do not vote.
Foreign dollar holders have lost 29/30th of the gold value of their holdings since the United States stopped settling its balance-of-payments deficits in gold in 1971. They now receive less than a thirtieth of this, as the price has risen to $1,100 an ounce. If the world can take that, why shouldn’t it take the coming European debt write-downs in stride?
There is growing recognition that the post-Soviet economies were structured from the start to benefit foreign interests, not local economies. For example, Latvian labor is taxed at over 50% (labor, employer, and social tax) – so high as to make it noncompetitive, while property taxes are less than 1%, providing an incentive toward rampant speculation. This skewed tax philosophy made the “Baltic Tigers” and central Europe prime loan markets for Swedish and Austrian banks, but their labor could not find well-paying work at home. Nothing like this (or their abysmal workplace protection laws) is found in the Western European, North American or Asian economies.
It seems unreasonable and unrealistic to expect that large sectors of the New European population can be made subject to salary garnishment throughout their lives, reducing them to a lifetime of debt peonage. Future relations between Old and New Europe will depend on the Eurozone’s willingness to re-design the post-Soviet economies on more solvent lines – with more productive credit and a less rentier-biased tax system that promotes employment rather than asset-price inflation that drives labor to emigrate. In addition to currency realignments to deal with unaffordable debt, the indicated line of solution for these countries is a major shift of taxes off labor onto land, making them more like Western Europe. There is no just alternative. Otherwise, the age-old conflict-of-interest between creditors and debtors threatens to split Europe into opposing political camps, with Iceland the dress rehearsal.
Until this debt problem is resolved – and the only way to resolve it is to negotiate a debt write-off – European expansion (the absorption of New Europe into Old Europe) seems over. But the transition to this future solution will not be easy. Financial interests still wield dominant power over the EU, and will resist the inevitable. Gordon Brown already has shown his colors in his threats against Iceland to illegally and improperly use the IMF as a collection agent for debts that Iceland doesn’t legally owe, and to blackball Icelandic membership in the EU.
Confronted with Mr. Brown’s bullying – and that of Britain’s Dutch poodles – 97% of Icelandic voters opposed the debt settlement that Britain and the Netherlands sought to force down the throat of Althing members last month. This high a vote has not been seen in the world since the old Stalinist era. It is only a foretaste. The choice that Europe ends up making will likely drive millions into the streets. Political and economic alliances will shift, currencies will crumble and governments will fall. The European Union and indeed, the international financial system will change in ways yet to be seen. This will be especially the case if nations adopt the Argentina model and refuse to make payment until steep discounts are made.
Paying in euros – for real estate and personal income streams in negative equity, where the debts exceed the current value of income flows available to pay mortgages or for that matter, personal debts – is impossible for nations that hope to maintain a modicum of civil society. “Austerity plans” IMF and EU style is an antiseptic, technocratic jargon for life-shortening and killing impact of gutting income, social services, spending on health on hospitals, education and other basic needs, and selling off public infrastructure for buyers to turn nations into “tollbooth economies” where everyone is obliged to pay access prices for roads, education, medical care and other costs of living and doing business that have long been subsidized by progressive taxation in North America and Western Europe.
The battle lines are being drawn regarding how private and public debts are to be repaid. For nations that balk at repayment in euros, the creditor nations have their “muscle” waiting in the wings: the credit rating agencies. At the first sign a nation is balking in paying in hard currency, or even at the first hint of it questioning a foreign debt as improper, the agencies will move in to reduce a nation’s credit rating. This will increase the cost of borrowing and threaten to paralyze the economy by starving it for credit.
The most recent shot was fired n April 6 when Moody’s downgraded Iceland’s debt from stable to negative. “Moody’s acknowledged that Iceland might still achieve a better deal in renewed negotiations, but said the current uncertainty was hurting the country’s short-term economic and financial prospects.”

The fight is on. It should be an interesting decade.

*Prof. Hudson is Chief Economic Advisor to the Reform Task Force Latvia (RTFL). His website is