By Michael Hudson
When the financial bubble burst in September 2008, U.S. and European governments responded by shifting bank losses onto their own balance sheets. The pretense is that real growth cannot resume until the banks and speculators are “made whole.” To cover the cost of bailing out the banks, governments now are trying to run budget surpluses. This adds fiscal deflation to the debt deflation left in the bubble’s wake, shrinking the economy at large. Governments are raise taxes (or simply print new debt to swap for the financial sector’s bad loans and gambles) to reimburse financial institutions whose lending and outright gambling (not to mention the excursion into financial fraud) caused the crisis.
This financial and fiscal austerity is unnecessary – and counter-productive. The aim is to save the financial sector, not the economy. The working assumption is that bank lending must revive growth by clearing balance sheets for the next debt bubble. As TARP Special Inspector General Neil Barofsky has described, “saving the banks” has been a euphemism for saving Wall Street from losses, not to mention criminal prosecution.
Federal Deposit Insurance Corporation regulator Sheila Bair has described how depositors at Citibank and Bank of America could have been saved without keeping the banks’ speculative web of gambles and junk mortgage loans on the books. The FDIC could have treated these megabanks like it did Washington Mutual and other failed institutions, wiping out their stockholders and counterparty claims for their bad trades and liars’ loans. This would have annulled the overgrowth of speculative gambles and high-risk deposits that had no connection with retail banking. Taking over Citicorp as majority stockholder would have enabled the FDIC to renegotiate its mortgages downward for borrowers in negative equity. As a public ward, the bank could have fired its bad officers rather than letting them give themselves bonuses. None of this was done. The idea of a public option in banking was anathema.
Likewise, Barofsky’s Bailout memoir explains how the $182 billion loan to the insurance giant AIG could have been done as a takeover – on terms that segregated its British derivatives gambling unit (operating under Gordon Brown’s notoriously “light touch” at the Financial Services Authority) from the parent company’s basic “bread and butter” insurance operations. This would have saved the Treasury from having to pay Goldman Sachs and other counterparties, including French banks.
Neither the Treasury nor AIG protested against paying these counterparties. The ideological compact between winners and losers was that the gambling contracts were sacred. If losers could not pay, the government would lend them the money to do so. Wall Street’s Las Vegas was deemed essential. This was the logical conclusion of repealing Glass-Steagall and intermixing investment banking and CDO derivatives with the financial system’s basic deposit and lending functions.
By saving high finance (and much of low finance) and pushing the loss onto the economy at large, government’s policy preserved the financial system’s dominance – on the pretense that this was necessary to revive the economy, not bury it under a mountain of debt.
Tim Geithner a symptom of Wall Street’s regulatory capture of the Fed and Treasury
Barofsky is especially scathing when it comes to Tim Geithner’s claim that it was not possible to oblige AIG’s counterparties to “take a haircut” on its loans because French law did not permit banks to lose money.
Geithner’s team undercut any chance of getting relief for the taxpayer by deciding that no one concession would be accepted unless all of the banks agreed to the exact same percentage reduction. The New York Fed officials told us that for this reason, after the regulator overseeing AIG’s French bank counterparties told them that it would be against French law to accept less than full value for the bonds, the negotiations effectively ended. (Bailout, pp. 184-87.)
This deception was put forth in a panic atmosphere to bamboozle Congress into letting Geithner (then head of the New York Federal Reserve) and Treasury Secretary Hank Paulson pay Goldman Sachs (Paulson’s alma mater) and other Wall Street’s heavy winners. But there was no truth to the claim that French law prevented banks from taking a loss, or that the U.S. Government had to apply the same giveaway offer to Wall Street. When Barofsky subsequently called the French regulator, she emphasized that she had not ‘slammed the door’ on negotiations and had been more than ready to engage in them with the Fed as long as they were at a high level and universal. But she told us that the Fed officials had never seriously pursued that option, commenting that she had been surprised when the Fed officials had never called back. When I asked her about the Fed’s assertion that it would be illegal under French law to agree to a discount, she said that the French government could have waived that restriction.
The effect was to funnel “tens of billions of dollars of government money … directly to the banks. We therefore labeled the deal what it was, a ‘backdoor bailout of the banks.’” This inspired AIG’s head, Maurice R. Greenberg, to sue the U.S. Government, claiming that it “used billions of dollars from A.I.G. to settle credit-default swaps the insurer had with banks like Goldman Sachs, which received $12.9 billion in winning bets against AIG on CDOs (collateralized debt obligations). The deal, according to the lawsuit, empowered the government to carry out a ‘backdoor bailout’ of Wall Street.” (Ben Protess and Michael J. De La Merced, “Rescued by a Bailout, A.I.G. May Sue Its Savior,” The New York Times, January 8, 2013.)
It seems ironic that the main protest against the giveaway by the Federal Reserve Board and Treasury has been mounted not by U.S. voters but by the Mr. Greenberg arguing that the Treasury used AIG simply as a throughput vehicle to reward Wall Street with its casino winnings. True, as Barofsky explains (pp. 180f.):
The deal was a gross distortion of the normal functions of the market. In a bailout-free world, instead of being saved by the government, AIG would have been unable to make its cash collateral payments to the banks and gone into bankruptcy. As a result, the banks would have been left with the CDOs and stuck with their continued declines in value. Those losses would have punished the banks for what had been bad and risky bets – i.e., assuming that AIG would be able to meet all of its obligations. In market parlance, each of the banks would have borne the ‘counterparty risk’ of doing business with AIG and suffered the consequences of betting on the wrong counterparty. Instead they were paid out in full. In that respect, Geithner’s opening of the spigot of taxpayer cash for AIG was more of a bailout of the banks than it was for AIG itself.
It didn’t have to be this way. But AIG took the loan rather than seeing the company go bankrupt. One can only wish that Congress had been assertive as the corporate raider Carl Icahn was when he wrote in a New York Times op-ed (“We’re Not the Boss of A.I.G.,” The New York Times, March 29, 2009): “What the government should have gotten was board representation in return for its large investment in A.I.G.” It could have involved wiping out AIG stockholders and upper management – a fact that prompted The New York Times to characterize Mr. Greenberg’s suit as “an audacious display of ingratitude.” Shouldn’t he (or at least his fellow AIG stockholders, who have refrained from joining his suit) have been grateful to the government for lending AIG enough to pay the Wall Street giants?
The government certainly had good reason not to take public liability for AIG’s bad gambles. But it could have taken over the “bread and butter” business of the sorts regulated by state insurance agencies. Instead, Treasury fought against state regulators who sought to take over local AIG business. From the vantage point of what was best for the economy west of Wall Street, everything was done upside down. After the ratings agency downgraded the CDO’s that AIG had guaranteed by treating insurance premiums “as free money,” AIG’s goose was cooked.
Perhaps the most notorious example of how accommodating Geithner was after becoming Treasury Secretary was his approval of paying AIG’s reckless London office $180 million in bonuses. Barofsky accuses Treasury officials of doing little “to oversee the taxpayers’ $40 billion investment. For example, they could have forced AIG to renegotiate the terms of the contracts as a condition of the additional $30 billion in TARP funds that they had announced several days after learning about the imminent bonus payments.” Instead of alerting Congress and the public to the options available, “Treasury and Geithner stood behind the ‘sanctity’ of the executives’ contracts.”
The Clinton Administration refused to regulate CDO gambles, adopting the deregulatory Rubinomics ideology of Larry Summers, Ayn Rand disciple Alan Greenspan and Wall Street campaign contributors. So AIG was under no obligation to hold any reserves for losses against its bets. Little has changed under President Obama. The moral is that fictitious economic theory as public relations for the financial sector has heavy real-world costs (which academics call “externalities,” not included in free-market balance sheet of costs in benefits).
Why pay anything at all? That is the real question that needs to be discussed. Why didn’t the Treasury simply take over AIG’s insurance operations, letting its counterparties and creditors fight over the London gambles that caused its insolvency? Wiping out its stockholders would have made the U.S. Government 100% owner rather than merely 80%. It would not have had to let Goldman collect on its $13.8 billion bet. Goldman and other CDO speculators would have found themselves in a position akin to bettors at a Las Vegas casino whose bank had been broken, standing in line to divvy up their winnings from what was left. Wouldn’t this have been a good thing for the government’s fiscal position and hence for U.S. taxpayers?
Barofsky calculates $23.8 trillion in overall underwriting aimed to “get the banks lending again,” producing more debt. Including the $5.3 trillion for the mortgage financing agencies Fannie Mae and Freddie Mac, the overall Wall Street bailout added some $13 trillion to U.S. Government debt. This was a policy choice. The bailout was the largest government giveaway in American history since the railroad land grants of the mid-19th century. The choice was based on a fictitious image of reality – but is having disastrous real-world consequences.
There is no reason why the financial system would collapse and people lose their retail deposits or ATMs would run out of money if the gambling arms of the banks that lost couldn’t pay the gamblers on the winning end. Gamblers can afford to lose – or, if they cannot, their activity is decoupled from that of the “real” economy. They have run off the track, and that is that. The problem could be cured by doing what Glass-Steagall used to do before President Clinton repealed it in 1999: segregate the “good bank” from the “bad bank” departments at Citibank and other Too Big To Fail institutions.
The bailout’s great increase in government debt is largely responsible for the Obama Administration’s demands for austerity to “make taxpayers pay.” The deepening post-bubble austerity proposes to tax consumers and wage earners to provide governments with enough revenue to pay banks for their financial losses and misdeeds. So matters are brought back to the classic political issue of Who/Whom: Who will absorb the losses – and at whose expense? Will government rule on behalf of the economy, or its creditors?
The U.S. and European governments assume that the solution to clean up the financial wreckage is for economies to “borrow their way out of debt,” by creating yet a new bubble. The new article of faith is that high finance cannot lose; only the economy can be made to suffer losses, regardless of responsibility.
There is an alternative, of course. It requires overcoming today’s tunnel vision to undo the economy’s tragic detour that led to the bubble, the bailout, austerity, and economic polarization between creditors (the 1%) and the 99% in debt to them. The bank lobbyists’ narrative underlying the claim that governments need to bail out the banks at the expense of the “real” economy is that austerity will enable debts to be paid down by enough so that people can begin to borrow again. A new bubble will rescue us – and this time it will be better managed.
The counter-narrative is to recognize the financial sector comprises the Liabilities side of the economy’s balance sheet of assets and debts. As such, it has become a separate and indeed a perverse mirror image of the “real” production and consumption economy. A new debt bubble cannot succeed as a solution based on the economy “borrowing its way out of debt” in an attempt to re-inflate real estate and other asset prices. More bank lending will only impoverish the economy more, indebting the bottom 99% further to the 1%.
The dream is that borrowing can become part of increase the Magic of Compound Interest, continuing to enrich a financial overclass. But this cannot go on for long. It is a fantasy for governments to accept the financial lobbyist’s dream that the way to pull the economy out of austerity and debt deflation is to create a new bubble – to restore real estate as a speculative activity, to “create wealth” by re-inflating asset prices. It cannot be done honestly.
So let’s hope that Mr. Greenberg’s lawsuit will expose the Treasury’s dirty laundry as a catalyst to reopening alternatives to the false hope of inflating a new bubble.
 Yves Smith, http://www.nakedcapitalism.com/2013/01/schadenfreude-alert-with-or-without-aigs-help-hank-greenberg-plans-to-torture-treasury-and-geithner.html
The bail out of the banks and Wall Street firms, who miraculously changed their legal status overnight from brokers and dealers into banks and the insurance company AIG, by the US Treasury was wholly unnecessary.
The problem was a banking problem and the Federal Reserve could have easily taken care of it, without the involvement of the US government. The Federal Reserve should have stepped up to the plate and loaned these banking entities the necessary funds to ensure their survival.
Secretary of the Treasury Paulson perpetrated a huge fraud on Congress and was able to do so because most of its members are unaware of how the monetary system works, and if they are, they will either be so interested from it’s profits or so dependent on it’s favors that there was no opposition from them.
Don’t forget the role Texas regulators played in bringing the AIG fiasco to a head.
They insisted on acting on behalf of Texas citizens whose life insurance policies written by AIG subsidiaries had become worthless by consficating assets.
Mike another great post. Just reinforces “privatize the profits, socialize the losses”.
Have you read – http://www.govtrack.us/congress/bills/112/hr2990/text?
I’d like to know your experienced opinion.
oh yeah, i’m no economist, but i knew when they repealed glass-steagal it was going to be trouble. less than 10yrs to bring the system to it’s knees and require bailout.
Trying to re-inflate the economy by injecting cash into banks to encourage lending (supply side economics again) is like trying to push a string; especially since corporations are sitting on piles of cash right now and refusing to invest for lack of demand. Pull on the string (create demand) and everything will fall into place.
Disclaimer: I am not an expert on anything, just another seeker who wandered in here a few years ago and picked up on some of the concepts. I think this about Dennis Kucinich and his bill:
First, the man is a lion for the working class and always has been. I know of few Americans remotely as progressive, and none who have managed to profess this, in full public view, throughout the whole length of the period we all hope will prove to have been nothing but a reactionary, neo-liberal interregnum between the first era of Keynesian prosperity and the permanent, post-Keynesian one that we are trying to bring about. But, as much as I love this guy, I am very much afraid that the Congressman’s current bill is a muddle and a diversion.
If there is anything MMT has proved, it is that our existing institutional framework, exactly as it is now constituted, provides all of the policy space and organizational tools that an enlightened American government would need to end the recession, fix the economy, restore full employment, and even imprison and otherwise punish those who have broken the law. To suggest that anything is fundamentally lacking except the political will itself is, in my opinion, just adding to the confusion. And most of what we hear about fractional reserve banking, debt-based money and the evils of the 1913 Federal Reserve Act just sound like noise to me anyway.
From what I can make of it, this entire intellectual superstructure is erected upon the fallacy that private banks create our money. The terminology can get very confusing, but point number one is this: dollar-denominated bank credit is not the same kind of “money” (monetary-base money, a.k.a. “high-powered” money, a.k.a. “vertical” money) that the government creates when it directly spends. Bank deposits created by bank credit look the same and spend the same as other dollars, but all private credit contracts necessarily (axiomatically, definitionally) net to zero. No amount of this activity can add one dollar’s worth of *net* financial assets to the economy as a whole.
Lots of other pieces of the debt-money-bad meme (if that’s the right word) don’t hold up very well to scrutiny either. The complaint that fractional reserve banking is to blame for our problems recapitulates most of what’s most erroneous in the ‘mainstream’ theories about how bank lending works. It looks like a loanable-funds framework of some kind, but inverted into a demand that lending really *be* limited to ‘loanable’ deposits. None of this sounds anything like MMT’s (Warren Mosler’s, Bill Mitchells’s, Randall Wray’s) version of what banks lend – or why, or what it means for everyone else. I don’t see how this bill is anything except a muddled prescription to an even more muddled diagnosis of what ails us.
I have to go, and, again, don’t take my word for anything. But I feel forced to conclude that a very great man in many other respects has, in this case, listened to the wrong economists.
If there is anything MMT has proved, it is that our existing institutional framework, exactly as it is now constituted, provides all of the policy space and organizational tools… To suggest that anything is fundamentally lacking except the political will itself is, in my opinion, just adding to the confusion.
And most of what we hear about fractional reserve banking, debt-based money and the evils of the 1913 Federal Reserve Act just sound like noise to me anyway.
Because they are noise. It doesn’t make sense. It is an effort to make something simple complicated. The one point where MMTers can err is where they depart from great, truly philosophical thought best articulated by Mitchell-Innes, reiterated by Keynes & by Galbraith. Nobody cannot understand it. The problem is that it is all so simple! – that the mind is repelled (Galbraith’s gloss).
And something spectacularly forgotten in the 20th century, very especially the last third, which we are still basically mired in, was that simple, trivial DOES NOT mean obvious. “Advanced” work, “advanced” math, real philosophy, real worldly philosophy (= economics) is not more complicated and complex, it is simpler, easier, more trivial. Just not easier to discover, and if badly organized, written and communicated, as usual, not easier to learn!
The terminology can get very confusing
Yes. Yes. Yes.
Lots of other pieces of the debt-money-bad meme (if that’s the right word) don’t hold up very well to scrutiny either. Yes, because it is pure gibberish. Money is debt. Money is a kind of debt, a way of looking at debt. “Debt-free money” is like saying “rectangle-free square”. “Debt-based money” is like saying a one square or rectangle is “based on” another one. Phrases that mean nothing.
None of this sounds anything like MMT’s (Warren Mosler’s, Bill Mitchells’s, Randall Wray’s) version of what banks lend Which was basically the mainstream view, as one can learn from Schumpeter, from about 1920 to 1950, when he died and his history dates from, and so to sometime after. A history that needs to be written is just how astrology-economics displaced astronomy-economics in the demise of the Keynesian era.
If Kucinich is listening to any economist, it’s probably Mr. Hudson – he was his economic adviser when he ran for president.
Dale, thanks for the perspective. i too have wandered here to learn and seek thoughts on better alternatives to what we have now. from the mmt info, i now know more than i did, but still have to grasp some stuff. the gist to HR 2990 as i understand it, essentially seeks to end the necessity of the govt having to issue debt to spend it’s own money. i must admit, i don’t understand the frac reserve pro/con piece.
while the contention is that, under current instituional arrangements, the fed is “effectively” part of the govt. if this is so, then there should be no reason to not make it so, officially, and eliminate that noise. which is what HR 2990 seeks to do.
Everything about MMT i’ve read so far make a lot of sense…..except that in order to spend, the govt must issue interest bearing debt. And just as gold, due to it’s limited supply, became a problem when our money was based on it, basing money on debt is now the problem, although not due supply (because we can obviously create an unlimited amount of debt if desired) but because of the political will to accept ridiculous levels of debt. if there were no other way, i’d accept continously increasing the debt. when presented with a structural option such as HR2990, that breaks the dogma of debt based money, call me crazy but i find that background noise appealing.
So, you have the left who likes the govt spending for the societal benefits and the right who hate watching the govt debt + interest snow ball along. In my mind, the HR2990 gives both sides a what they are looking for and gets the govt back to being a solution than a hinderance.
As the late Congressman Wright Patman, Chairman of the House Committee on Banking and Currency for over 16 years, said, “I have never yet had anyone who could, through the use of logic and reason, justify the Federal Government borrowing the use of its own money….I believe the time will come when people will demand that this be changed. …………..and with the TDC we are getting closer.
If i am a fed res member bank, i can borrow $1B from thin air at .25% from fed, turn around and by $1B in treasurys that pay 2.75%. That’s $25m/yr profit for being a “privelaged” middleman of the govt borrowing it’s own money. That’s pretty good work……..if you can get it! rgds
@ Dale Pierce:
Very good comments and I agree with all your points. I think I am at a similar stage of understanding as you. I have not studied Kucinich’s proposal in any detail, but have read some of the money-as-debt articles some time ago on my way to MMT. I do not see how changing the bank reserve requirement to a new level, even 100%, would affect much of anything. It would affect only banks’ cost of business, as a larger proportion of their deposits would generate only the limited interest income that the Fed pays on reserves. But, more importantly, I do not see how it would change the fact that a new loan to a customer would create a new deposit and thus new bank money. I think you have nailed the issue very precisely. The Bill would be an ineffective cure to a miss-diagnosed problem. As you say, the tools to regulate and control the existing institutions and economy already exist. What is required is the understanding of the existing tools and the will to use them to “promote the general Welfare” as the Preamble to the US Constitution prescribes and as all our lawmakers have sworn an Oath to uphold.
@Jack, Dale, and Jim:
From the bill: “SEC. 102. UNLAWFUL FOR PERSONS TO CREATE MONEY.
Any person who creates or originates United States money by lending against deposits, through so-called fractional reserve banking, or by any other means, after the effective date shall be fined under title 18, United States Code, imprisoned for not more than 5 years, or both.”
I don’t think Kucinich knows how banking works. He better keep his fine book handy.
Dennis Kucinich well understands the way the banking system works in the US. His proposed bill does not flout the law, but seeks to change it in a wholly legitimate way. Right now, banks have the exclusive right to manufacture money out of thin air as a multiple of their deposits, which according to the Basel agreements is times 14.
Kucinich’s Bill seeks to redress this private monopoly by having the US Treasury create money debt free.
Here’s some of the points the bill addresses……they all sound good to me, and doable if you can change the structure.
SEC. 501. DIRECT FUNDING OF INFRASTRUCTURE IMPROVEMENTS.
SEC. 502. INTEREST RATE CEILINGS. Limit on annual percentage rate applicable to any loan of money may not exceed 8 percent on unpaid balances, inclusive of all charges.
SEC. 503. AUTHORITY OF FDIC.
SEC. 504. MONETARY GRANTS TO STATES.
SEC. 505. EDUCATION FUNDING PROGRAM.
SEC. 506. SOCIAL SECURITY TRUST FUNDS.
SEC. 507. INITIAL MONETARY DIVIDEND TO CITIZENS.
SEC. 508. UNIVERSAL HEALTH CARE FUNDING.
SEC. 509. RESOLVING THE MORTGAGE CRISIS.
SEC. 510. INTEREST FREE LENDING TO LOCAL GOVERNMENTAL BODIES.
that is one section that takes away the fraction reserve money from thin air option for banks, but it has counter proposals. again, don’t grasp it fully yet, which is why i’m looking for perspectives.
other section says:
(e) United States Money as Source of Loans- After the effective date, all lending by depository institutions may be accomplished only by the lending of actual United States Money that is–
(1) owned by the depository institution from earnings and or capital contributions by investors;
(2) borrowed at interest from the Federal Government; or
(3) borrowed at interest through the issuance of bonds or other interest-bearing securities by the lending bank, to the extent that such bonds or securities are structured in a manner consistent with the purposes of this Act.
in re saving the banks not the economy, tonight on marketplace i heard felix salmon say “unemployment hasn’t gone down but the crisis is over” that is totally the problem, the banker’s tail is wagging the economic dob (or is that the wanker’s tail is bagging the economic dog….)