For part one of this interview click here.
“If you want to see the ideal of the World Bank and the IMF, look at the Russian, Latvian and Estonian economies. They have shrunk as if there were a war on. And in a sense it is a war – a class war and simultaneously a war of American high finance against the rest of world. As in military wars, its devastating consequences threaten to include shortening life expectancy, lower health standards and depopulation, poverty and de-industrialization, rising debt arrears and defaults. You’re going to have many of the post-Soviet countries going the way of Iceland very quickly as their real estate debt collapses. Because crazy as it may seem, it was the real estate bubble that brought in the foreign exchange – in the form of mortgage loans denominated in foreign currencies – that financed their structural trade deficits. Now that the bubble has burst, there’s no way of keeping these neoliberal hothouse economic experiments afloat.”
I’m Bonnie Faulkner (BF): Today on Guns and Butter, Dr. Michael Hudson. Today’s show: “The Bailout’s New Financial Oligarchy.” Dr. Hudson is a Financial Economist and Historian. He is President of the Institute for the Study of Long-Term Economic Trend, a Wall Street Financial Analyst and Distinguished Research Professor of Economics at the University of Missouri, Kansas City. His 1972 book “Superimperialism: The Economic Strategy of American Empire” is a critique of how the United States exploited foreign economies through the IMF and World Bank. He is also author of “The Myth of Aid” and “Global Fracture: the New International Economic Order.”
Dr. Hudson has written several articles on the recent Wall Street meltdown and Secretary of the Treasury Hank Paulson’s Plan. These articles include, Financial Bailout: America’s Own Kleptocracy – the Largest Transformation of America’s Financial System since the Great Depression; The Paulson/Bernanke Bailout: Will the Cure Be Worst than the Disease?; Financial Fraud: Mr. Paulson and the New Yazoo Land Scandal; and Thinking the Unthinkable: a Debt Write Down and Jubilee Year Clean Slate. These articles are on CounterPunch and Global Research, and are picked up on Information Clearing House and other sites.
BF: Dr. Hudson, welcome again.
Michael Hudson (MH): Thank you, Bonnie.
BF: Last week the Dow Jones Industrial Average closed out its worst week ever, down 18%. On Thursday, October 9th, it touched 7999, down over 40% from its high around 14000. Then on Friday it had a 1000-point swing on record volume. I heard one woman on the floor of the New York Stock Exchange yelling that no one knows what anything is worth. What’s going on?
MH: During the first seven minutes on Thursday I watched the Dow sink 100 points per minute. That’s over 1% per minute. Then the average began to recover, pending a statement by President Bush. But when he didn’t say anything helpful, it continued its fall. Late in the day you could see the Plunge Protection Team come in and try to push up the financial stocks, but the attempt ran out of steam. The reason is that most investors – and voters too, by the way – have come to realize that Paulson’s plan is not going to help the “real” economy, only his cronies on Wall Street.
Let’s go over his two plans. Plan A, initially rejected by Congress (thanks mainly to Republican opposition) was to buy $700 billion of junk mortgages and other bad debts, including fraudulent loans. The aim was to bail out bad lenders and investors, but not their victims. This predator-oriented plan was a waste of money as far as helping the economy recover was concerned. Congress rejected it as a blatant giveaway, although Mr. Paulson says that he’s still going to spend hundreds of billions of dollars for this purpose and nobody looks ready to impeach him. Predatory finance has been able to protect its gains extracted from the economy at large by passing its losses onto the government sector.
Plan B calls for giving this money directly to the banks and leading insurance companies, on terms that let them continue paying high executive salaries and dividends to existing shareholders rather than wiping them out as normally happens when an enterprise has Negative Equity. The Treasury’s idea of “protecting the taxpayer” is to buy “preferred” stock. The word “preferred” is a legal term that means simply that the shares are non-voting and can be wiped out, because they are not technically creditor claims. In case of further trouble the government goes to the back of the collection line, not to the front. This gives the banks money to pay the big speculators on bad gambles, enabling the winners to collect from suddenly affluent debtor-banks and debtor insurance companies.
The pretense is that the banks are going to turn around and lend out this government money is going to help the economy at large. But the economy is too over-indebted and is shrinking too fast to take on more debt. Homeowners and consumers, real estate investors and corporations have pledged so much of their income to pay debt service that there is not much left to pay interest on yet more debt. The solution to today’s problem is less debt, not more.
The market plunge for mortgages and corporate bonds had the virtue of preparing the ground for renegotiations, write-downs and write-offs along these lines. But Mr. Paulson made it much more difficult sought to turn things around in this way. Higher valuations for mortgages and other debt claims have taken the pressure off creditors to agree to write-downs. It’s easier for them simply to swap their junk mortgages to the Treasury or Federal Reserve for full-value U.S. Treasury bonds, and make the government take the loss – and presumably levy taxes to cover the interest charges on the augmented debt!
There is no way that Mr. Paulson, in charge of as clever a company as Goldman Sachs, could honestly pretend that giving money to banks would persuade them to make bad loans that will lose even more.For recent confirmation see James Politi, “US banks tighten grip on lending,” Financial Times, November 4, 2008: “US banks have pulled back on lending to consumers and businesses in a big way over the past three months.” http://www.ft.com/cms/s/0/26a624c2-aa13-11dd-958b-0...8.html This assertion merely serves as a cover story for the Treasury giveaway. The money actually will be used to buy other banks, consolidating the U.S. banking sector into just a few giant nationwide banks, European-style.
Mr. Paulson is what Franklin Roosevelt called a “bankster.” Congress is not going to indict him for perjury, but I think people have seen his true colors and that he is not a “public servant” acting in the national interest. When an official follows a policy that fails, you can be pretty sure that somebody is benefiting by his blindness. Such people are called “useful idiots” to the vested interest, but I think we are dealing here not with idiots but by skilled double-talkers, masters of deception. The aim of these banksters is to take the bailout money and run – or as I said, to act as vulture investors buying other banks to strengthen their monopoly hold on the rest of the economy. So what we’re seeing is really the largest financial theft in American history. Wall Street has inserted its lobbyists into the government’s decision-making apparatus and crafted a cover story that they know to be false. The media are barely questioning it. Today’s New York Times front page (Oct. 15) does point out that the Treasury has given the banking system and its lobbies what they want – a program free of Treasury control over executive remuneration.
But neither the New York Times nor other popular media have acknowledged the basic problem: Today’s debt overhead is substantially in excess of the ability to pay, and hence of today’s market valuations. This means that a large part of the private sector’s bad mortgages and other bad debts are unpayable. But now are going to be carried, either by the banks or by the government if it takes ownership in exchange for the new Treasury bonds it is printing.
When you get down to the actual magnitude of this problem, the only real solution turns out to be “Plan C” – the Unthinkable Option from the creditors’ vantage point. That is to do what always has to be done in the end: to write down the unpayable debts to reflect the current market value of collateral pledged to back them, that is to the amount that can be paid under today’s conditions. And remember, these conditions are worsening. The economy will continue to shrink as long as these excessive debts are kept on the books.
Unfortunately, the Treasury plan does not require banks to renegotiate or otherwise write down the debts. The bailout plan passed by Congress is an anti-debtor plan. It won’t work over time, but a lot of speculators and creditors can get richer by leaving the government holding the bag for these bad debts. The Treasury is swapping its own bonds for bad IOUs. Interest charges on these newly minted Treasury bonds will be built into the federal budget as a transfer payment from taxpayers (that is, the lower income brackets, which pay the highest tax rates) to creditors and property owners (who have made themselves exempt from income taxation).
One twist to Mr. Paulson’s Plan is that banks do not have to mark their securities or other assets to actual market prices. Rather than telling prospective investors, depositors or others that they’re worth, banks can use Enron-style “mark-to-model” accounting to say that their stock’s book value is whatever in-house model-builders want to say they’re worth, on whatever blue-sky assumptions they choose. The only constraint now is the fact that foreigners and domestic investors have now realized the degree to which that the banking system, Wall Street and the rating agencies are run by men that used to be crooks, but now are euphemized simply as “creative accountants.”
BF: A lot of people, including yourself, have come out with good ideas about what ought to be done, but they’re not doing it. It seems that the people at the levers of power don’t really want to fix the economy.
MH: It’s worse than that, Bonnie. The interests of Mr. Paulson and his Wall Street banksters are antithetical to the economy. The “product” that the banks and Wall Street sell is interest-bearing debt. The banking system makes its money by extracting interest from the economy, and by lending it out. Its gain is the industrial economy’s loss if it does not finance new tangible capital formation but simply provide borrowers with the credit to bid up prices for housing, commercial buildings, stocks and other assets already in place. This forces prospective buyers of these assets to borrow yet more and pay yet more interest in a snowballing effect. The process doesn’t create new tangible property; it only inflates access prices, while the rising payment of debt service diverts income away from the “normal” or “Say’s Law” circular flow between producers and consumers.
To make matters worse, the financial sector lobbies politically to un-tax commercial real estate and other property so as to leave more rent and monopoly super profits available to be paid as interest. But interrupting this flow to siphon off interest and management fees is the basic business of financial institutions, in contrast to industry and public enterprises. So when Mr. Paulson’s plan leaves the economy poorer than before, it’s not a case of, “Oh, gee, we messed up. We didn’t expect downturn to continue.” The reality is that they’re trying their worst to take as much of the economy for themselves as they can. Their aim is to empty out the cupboards before the November 4th election.
It’s something like medieval populations fleeing from Genghis Khan: “Let’s take everything we can carry.” Except in this case, it’s Wall Street Republicans fleeing from the prospect of a Democratic election victory, fearing that somehow Obama may not end up appointing Robert Rubin or another Wall Street Treasury Secretary. They better steal everything they can while they can. And it looks like they may steal enough to shape the next century of American Wealth by creating a new set of ruling families and vested interests before our very eyes.
There goes the theory of the Invisible Hand! It turns out to be the hand of predators, not that of a beneficent deity. Acting covertly as insiders, they’ve created a deceptive rhetoric by weaving a cloak of invisibility around their actions. They do this first by depicting finance and rent-seeking privilege as part of the economy’s real wealth-creating process rather than as an extractive sector, and second, by, pretending that the financial problem is only a temporary liquidity problem, not a structural problem debt of debts that can’t be paid –unless the government makes up the gap at the non-financial sector’s expense.
The bottom line is that we have two economies. An extractive financial sector (Economy #2) has wrapped itself around the “real” economy of production, distribution and production (Economy #1). The academic and political strategy of Economy #2 is to conceal public recognition of this dichotomy, so that it can continue its extraction of interest and fees.
BF: There doesn’t seem to be much fight-back at all. Do you see anybody in any position of power pushing back against this?
MH: (laughing wryly) I don’t even see anybody “not” in a position of power pushing back. Hardly anyone is confronting the real issue – the fact that the only way to revive an over-indebted economy is to write down the bad debts. This should be so obvious that leaving it out of account shows the degree of control that Wall Street lobbyists have, not just over Congressional debate, but over the mass media and even academic economics departments.
BF: How significant is insider trading in the Dow’s huge daily price swings?
MH: There’s no way to know. It doesn’t seem to make sense that something worth one price in the morning can be worth either twice or half as much in the afternoon. Wall Street has killed the regulatory policemen. The Republicans say they’re in favor of putting more police on the streets, but they’ve fired or downsized the financial policemen on Wall Street.
BF: It seems from these huge swings that institutions and people with a lot of money know ahead of time what’s going to happen, and it’s all discounted in advance.
MH: It’s hard to know what’s going to happen, but they have a fallback position. Years ago, insurance companies who managed pension funds and other peoples’ money would do the usual array of trades each day. The good trades that made money would be registered in their own accounts. The bad trades would be put in the accounts of the clients whose funds they managed. This is the option that repeal of the Glass-Steagall Act has provided to banks and their money-management subsidiaries.
BF: On television they keep talking about interest-rate cuts. What will this do?
MH: The interest rate they’re talking about is not the rate on credit cards. It’s not the mortgage rate either. It’s not a kind of interest that people or companies pay, but the very low interest rate at which the government provides credit to the banking system and large financial speculators. The Treasury and Federal Reserve are saying: “We’re going to give you almost free credit. If you borrow enough, you can bid up the price of assets and make a capital gain. So we’re going to flood the economy with credit and let you make this gain. That will re-inflate the assets you hold to back what you owe your depositors.”
The problem is that the banks and the other investors who would like to make such a free lunch don’t want to buy assets that already are underwater. The problem is Negative Equity. So many mortgages, so many assets and so many banks themselves have negative equity – that is, they owe more debt than their assets are worth – that there is no point in buying assets right now. The government credit policy is called “pushing on a string.” You can lead a horse to water, but you can’t make it drink. You can provide credit, but in a shrinking economy you can’t make people borrow to buy assets they expect to keep falling in price.
BF: Financial commentators on television keep saying, “We’ve got to unfreeze credit. Banks are scared to lend money to each other.” They think the answer is for banks to lend short-term credit to each other. What about this?
MH: The reason banks aren’t lending isn’t that they don’t have enough capital reserves. It’s that Wall Street’s behavior has destroyed trust. The law that Congress passed made things worse, by giving banks the right to misrepresent their position by “marking to model” accounting. This lets banks take a package of sub-prime junk mortgages and say it’s worth anything they want. So their model-builders say, “If it’s paid off at the exploding interest rate we expect, if the current owner somehow is able to sell the house in a revived real-estate market, then the mortgage is worth such-and-such.” This turns financial markets into an exercise in science fiction that has little basis in reality.
Bank lobbyists have gotten their way in avoiding reality – and now the banks are suffering for their political victory of being able to keep financial reality secret. When Congress, backed by the President and a Wall Street Treasury Secretary, all give banks a license to lie, investors and money managers respond by saying, We don’t want any part of this.” The media are not reporting that as far as Europe is concerned, Wall Street is being run by crooks in much the same way that it used to be before the Reform Era and New Deal clean-ups. Instead of acknowledging crooked behavior and prosecuting these guys, government financial officials are rewarding them. And when investors refrain from providing new money to these banks and insurance companies, the government turns around and spends $125 billion to buy their stocks at a price way above current market value. So the worse Wall Street behaves, the worse the financial crisis gets and the more they are able to go to Washington and say, “You have to pay more money to save us, because what’s good for us is good for the economy.” The implicit message is, “We’ll wreck the economy if you don’t give us what we want!”
BF: Wasn’t this part of Paulson’s Plan – this change in accounting rules where they don’t have to mark to market?
MH: He hoped that promising that the government would give $700 billion to the banks would convince foreigners and sovereign wealth funds (maybe OPEC countries, Arab oil sheiks, maybe China and Japan) that the government could solve the problem. But the trick didn’t work, because the Bush Administration has lost credibility. Wall Street has made matters worse by the way Lehman Brothers emptied out its European offices of cash the day before it went bankrupt, paying off its closest U.S. cronies. The government followed up by making an illegal gift to American car manufacturers by saying “We’re going to break international law and only give subsidies to U.S. auto companies, not foreign-owned companies in the United States. Asian companies protested against this favoritism that discriminates against Japanese firms that have relocated in the United States to take advantage of a tariff and non-tariff trade barriers. They say, “We’re doing everything you’ve said, and now you’re screwing us.” So is it any surprise that foreigners view this administration as a gang? That’s why they’re bailing out of the economy.
Never before in my experience (which goes back fifty years on Wall Street), have I seen seven days of steady decline in the stock market. Every decline I’ve ever seen has normally been a zigzag: It goes down one, two, three maybe even four days, then it bounces up. There’s a brief squeeze on short sellers, pessimists who have oversold and have to buy shares to cover their positions. But then the market goes down again, bounces up, and then goes down further. A zigzag is how markets normally operate. But there’s been no zigzag. So you know it’s not a panic but a phase change. Foreign investors in particular – and even foreign officials now – are disgusted with how the Americans are mismanaging the economy and indeed, flagrantly stealing from the public domain.
BF: Yet I hear financial reporters on television railing about how we need foreign investment, and how we’re going to attract it.
MH: That era has ended. We are entering a new era of other countries treating the U.S. economy as a hot potato. They want to get rid of dollar-denominated assets. The German government has had to bail out German banks in Düsseldorf and in Saxony – banks that had faith in the packaged mortgage debt that U.S. financial institutions and money managers were selling them. It’s like the situation in Animal House, when one of the fraternity boys lent his friends his father’s expensive car and they wrecked it. He was crying, all upset: “You’ve wrecked my father’s car! What will I do?” One of the boys explained: “You screwed up. You trusted us.” That’s what America has said to banks in Germany and other countries: “You screwed up, you trusted our money managers.”
In other words, “We’ve made a mint off you, and we’re going to keep it.” These managers already have given themselves stock options, golden parachutes and high salaries. That’s the result of our failure to regulate. The banksters have got their money – that is, all the Treasury bonds that Mr. Paulson has been able to give them – and they’re running. Let the next administration clean up the mess and pay for this bailout and the vast new sums of public debt it’s created.
BF: So Paulson’s bailout is not going to fix the need for foreign capital.
MH: That’s one reason why the stock market has been going down. Foreigners are saying, “We don’t trust the U.S. economy anymore. We especially don’t trust the banks.” So they’re selling U.S. stocks and other investments. The balance-of-payments problem looks like it will be pushing down the dollar’s value against other currencies, so even if stocks go up in dollars, they may fall when denominated in euros.
The big picture is that America is running a heavy long-term structural trade deficit. It also is already running a heavy military deficit because of the wars in Afghanistan and Iraq. In the past these deficits have been financed by foreign central banks and private-sector foreign investors recycling these dollars back to the United States via the Treasury or Wall Street. But now there’s a net U.S. investment outflow as well. The result is a three-fold pressure on the U.S. dollar. Wall Street’s “free-market” planning has hollowed out the economy.
Dismantling public regulation has been supported by the economic theory taught in almost every university. This is the junk-economic theory that has been getting Nobel prizes for free trade and open capital markets for the last thirty-two years. It is as bankrupt as the banking system.
BF: You’re referring to Milton Friedman. Didn’t he get a Nobel Prize?
MH: Yes. The vast majority of these prizes have been given to Chicago School economists who are in effect shills for the financial sector. When these “useful idiots” use complex math to oppose a role for government planning, they overlooked what you and I have talked about on this show before: Every economy is planned by some party or other. Economies have been planned ever since the Neolithic. People have to look forward. That’s why the calendar was invented. If the government doesn’t do the key planning, if it withdraws as society’s long-term planner, then the role is left to Wall Street. The problem with this relinquishing of public authority is that the time frame of the financial sector’s credit allocation traditionally has been short-term. A hit-and-run mentality is the norm. Today, Wall Street managers have taken their golden parachutes and exercised their stock options, squirreled away their high salaries and put them into hard assets – land, real estate, anything they can get. They’ve made themselves safe, and now they’re letting the rest of the economy go under.
BF: In the show that you and I did entitled “America: host or parasite?” you explained how foreign investment has been supporting our economy.
MH: These days foreigners are pulling out their money. They’re also unwinding the cheap money they’ve borrowed via Japan’s carry trade. This has been pushing up the yen, and that money has been coming to the United States, pushing up the dollar temporarily. But when this unwinding is finished, we return to a situation in which foreign creditors to the United States have lost a bundle. German banks have gone broke from their U.S. investments, and English banks have gone broke on their own U.S.-style real estate pyramiding. The G7 meetings in Washington have failed because the U.S. Government has taken a belligerent nationalistic position. It is telling European and other governments to bail out the American bank branches in their countries. The message is, “We don’t care what it costs you. Just take care of us.”
The reaction by the European and other foreign bankers has been to conclude that there can’t really be an agreement. They’re now trying to figure out how to try and save themselves. At best this will put governments on a path to try to develop an alternative to the U.S. dollar-based system, that is, dollar hegemony that obliges other countries to hold their foreign exchange reserves in the form of loans to the U.S. Treasury. It’s become obvious that the money they’re lending will never be repaid. It never can be repaid, and in any event there is no desire in the United States to repay foreigners.
BF: Can we expect hyperinflation?
MH: Not yet. That occurs when a currency crashes against other currencies, usually by trying to pay debts that its trade balance can’t cover. I don’t think you’ll find hyperinflation of dollar prices until other economies create an alternative to the dollar. This will start by developing a vehicle for trade among themselves.
The first stage is to arrange barter deals, as was done with the Soviet Union in the 1960s. The moral is that over-indebtedness always leads to barter in the “final” stage. The Roman Empire remains civilization’s primary and most serious example. But as we move toward this position, the United States simply will not have much to exchange with foreign economies.
Once Europe, Asia and the post-Soviet economies can’t find many dollarized financial vehicles in which to invest, you can be sure that will try to develop an alternative to the dollar. Until they actually do that, there will not be inflation here. There will simply be a polarization of income between wealthy creditors – the top 10 percent of the population – and an increasingly indebted bottom 90 percent. This is basically a deflationary process – debt deflation as far as the distribution of income is concerned. The only inflationary impact will come as the dollar declines to reflect how much the debt overhead has hollowed out the U.S. economy.
What Congress’s vote to approve the Wall Street bailout accomplished was to polarize the economy to an unprecedented degree. The effect will be to reverse the American dream and make it much harder for people to get rich, except for the few who win the lottery. But most people who play the lottery are going to lose, of course. People will become more desperate. And the more desperate they get, the more money they’re going to lose and the faster the economy will polarize. That’s how polarization occurs. It’s an accelerating process, and Mr. Paulson and the Democrats have just pressed the financial accelerator.
BF: Even on American television, commentators were complaining that he’s not being specific and isn’t going far enough, that is, far enough to help debtors as well as Wall Street. What will be the effect of the G7 meeting and the communiqué from Hank Paulson?
MH: When a Treasury Secretary is not specific coming out of a meeting of finance ministers, this means they wouldn’t give him what he wanted. He tried to boss them and they wouldn’t say yes, so the United States has nothing to say. In other words, it made irrational demands. Short of dropping an atom bomb on Europe, I don’t see there’s any way of getting the U.S. demands met.
BF: The International Monetary Fund (IMF) and World Bank also are meeting this weekend. What role do these organizations play?
MH: Nothing positive. These institutions function as extensions of the U.S. Treasury. Most of their staff – and most finance ministers in general, for that matter – are brainwashed pro-creditor monetarists or they wouldn’t be in the World Bank or the IMF in the first place. The IMF has lost its Western clients, as Turkey left in May by paying off its remaining debt. And its prime minister says it doesn’t want to go back to it. Nobody wants to go near the IMF and World Bank, because of their knee-jerk policy demands: economic austerity and privatization sell-offs to insiders. The World Bank is equally dysfunctional, creditor-oriented and pro-American.
So when you hear calls for a “new Bretton Woods” from Europe, Asia and the Third World, this really means an anti-Bretton Woods, negotiated to protect the rest of the world from U.S. dollar hegemony rather than lock them into it as occurred in 1944. (This is the story I’ve told in Super Imperialism: The Economic Strategy of American Empire.) For the United States, on the other hand, a “new Bretton Woods” means a plan to wipe out the U.S. Treasury debt and replace it with “paper gold,” that is, IMF notes for foreign central banks to trade among themselves, to be exchanged for claims on the U.S. Treasury and hence on the U.S. economy. This pseudo-reserve IMF currency would be meaningless “trash for cash” from an economic point of view. I don’t see how any country except little England and maybe Tonga will go along with it.
BF: Both these organizations have played a destructive role in Third World countries, haven’t they?
MH: Yes, and also in Russia and the post-Soviet countries where they promoted kleptocracies and an anti-labor, anti-development “flat tax” while freeing real estate and finance from taxation. If you want to see the ideal of the World Bank and IMF, look at the Russian, Latvian, and Estonian economies. They have shrunk as if there’s a war on. It is a war – a neoliberal class war being waged by American finance against the rest of world. The effect is to “free” land rent and monopoly rent from privatized public enterprises to be paid to banks as interest, forcing taxes to be levied on labor and industry. So the government budget is limited to what it can extract from labor. The World Bank applauds this and puts Latvia and the Baltic states at the top of its list of business-friendly countries. These happen to be the countries whose economies are now falling apart the fastest. These are the most neoliberalized economies in the world, causing them to suffer from depopulation, de-industrialization, poverty, deteriorating health standards and rising industrial accident rates. They anti-labor policy and trade dependency are so extreme that about a sixth of men between the ages of 25 and 35 have told pollsters that they expect to emigrate in the next five years. In the past two years nearly 10 percent of Latvia’s workforce has emigrated – between 50,000 and 100,000 workers, about half to Ireland.
Many post-Soviet countries are going to go the way of Iceland as their real estate debt collapses. IMF and World Bank advice has led the Baltics to borrow primarily in foreign currency against their real estate. Over three-quarters of Latvian mortgage debt is denominated in foreign currencies. Once the domestic currency goes down, debt defaults will spread and the economy will fracture.
BF: To shift back to the U.S. economy, I just saw an on-line video clip from a television station in southern California, an area referred to as the “inland empire.” I think this covers Riverside and San Bernardino County where a lot of expensive housing recently has been built. They took a television-crew into some of these new developments. The houses are brand new, very spacious beautiful homes that people simply have walked away from. The video was very disturbing because people haven’t even taken anything with them. There was a business that does something that’s now referred to as “trash-outs.” They go into these big homes where all the furniture is still there, people’s clothing is hanging in the closets, there are computers, printers, flat-screen televisions, birth certificates, photographs – everything that you can imagine would be in a house is still there. They go in and they move these big dumpsters out in the front yard and start clearing everything out of the house to take to a landfill. The homeowners apparently don’t even have time to call a charity to come and pick it up, because they say the trucks don’t arrive on time. One man has a company that charges $200 to fix up lawns that have gone without any water. He spray-paints the lawns green so that the place has what he calls curb appeal.
Every other house in this neighborhood is either in foreclosure or on what is called a short sale. The interviewer asked the person in charge of this trash-out why people left their things and he said, “Well, I don’t know, maybe they couldn’t afford to hire a moving truck.”
MH: Under the bankruptcy law, if you’re a business, you’re not allowed to empty it out when you go bankrupt. You have to leave everything as it was or else the creditors can come after you for what you’ve taken. But for homeowners there wouldn’t seem to be any motivation for people to act so irrationally. Nobody really needs to hurry to get out of the house. I don’t understand why the creditors didn’t try to recover some of this material. It suggests that what’s left is going to be difficult to sell. California’s property tax laws don’t help – its Proposition 13 limiting how much the state can tax owners who bought in early. The state economy is going to shrink and suffer more bankruptcies as its economy becomes more stratified.
BF: Under the old bankruptcy law, before they changed it, I thought you could keep your house.
MH: You can renegotiate mortgages on as many houses as you want, except for the house you live in. Senator McCain said he has maybe seven houses. If he were to go bankrupt he could keep the second, third, forth, fifth, sixth and seventh house and the judge could reset the debts attached to them. But the new bankruptcy law prevents judges from renegotiating the mortgage on the house the defaulting debtor or bankrupt lives in. The aim evidently was to deer homeowners from threatening bankruptcy as a way to negotiate their mortgage debt downward, the way commercial investors such as Donald Trump have done. The effect is to cause abandonment. This is the law that Congress passed on behalf of the credit card companies and mortgage lenders.
BF: Regarding these mortgages in default, in terms of the junk paper that the Treasury Plan was designed originally to buy, I understand now that Fannie Mae and Freddie Mac are now buying this paper. Is that right?
MH: They were given $200 billion dollars to resume lending and to buy these mortgages. In today’s market not many people are able to get new mortgages. If they really wanted to fix things, they would simply write down existing mortgages to the current market value of houses. This would begin to liquefy the real estate market again without costing government money. Bad lenders would absorb the losses from their bad decisions. The reason why property can’t be sold is that their mortgages exceed the market price.
The government is now scheduled to absorb the loss of writing off this negative equity, this extra debt that’s been loaded onto them. This opens the door for cronyism. If I’m working for Fannie Mae and buy $2 billion worth of loans from Countrywide (now part of Bank of America), I may hope that when they break up Fannie Mae into a smaller agencies, I may get a nice vice-presidential job in Bank of America. There is no protection against this kind of conflict of interest.
BF: Could you say a bit about the demise of the investment bank Lehman Brothers. That seemed to go belly up overnight, and is had a devastating effect. Nobody is writing much about it.
MH: Lehman Brothers basically committed suicide. It was trashed by its CEO, Richard Fuld, Jr. The Koreans and other groups made offers to buy the company if he would have sold it at a reasonable price in a timely way. But he insisted on getting the reported book value according to his Enron-style accounting. He wanted to be paid what Lehman Brothers used to be worth. Prospective buyers offered to pay what the company was worth at the time. That would have been enough to keep it in business. But he preferred that the company go bankrupt rather than take one penny less than what it used to be worth. He didn’t want to take a loss. So the company went bankrupt. The employees lost their jobs. Employees in the London office were told to get out that night. All they had were the canteen credit cards on which they’d prepaid for a month up to a hundred pounds. The news reports said that employees were lining up before the canteens to buy coffee, gum or anything they could carry with them. The employees were furious at Mr. Fuld’s grandstanding. Having made hundreds of millions of dollars in bonuses and excess salary, he said in effect, “I don’t care if everybody’s losing their job and retirement accounts. I’ve got my money. If I can’t sell at the price I paid for Lehman’s assets, I don’t want to play in the game anymore. And if I don’t play, no other Lehman employees will either.”
The bankruptcy was contagious because Lehman had so many cross-trades on its books. Its executives had emptied out the company treasury by paying out much of its capital in bonuses, dividends and even for stock buybacks. So it lacked the money to cover its bad trades and insurance.
BF: Italian Prime Minister Sylvio Berlusconi said that governments may shut financial markets as the credit freeze pummels stocks and threatens global recession. He said that markets may be shut while policy makers “rewrite the rules of international finance.” How likely do you think this is?
MH: Even if you shut down formal markets, a shadow market will spring up somewhere in the world. It could be in the Cayman Islands, or even Russia or Beijing. These would be offshore trade in options, for settlement by securities held in American depositories. But officially, shares wouldn’t be transferred. So what does it really mean to shut down financial markets?
One meaning would be that when the markets reopen, banks would start from a near-zero position. Debts (except for current wages that employers owed their employees) would be wiped out, along with deposits over a basic working-balance amount. This happened with remarkable success in Germany with the Allied monetary and debt reform of 1947. Alternatively, the currency could be devalued. As in the post-Soviet economies, people would get possession of their homes free and clear. But this could not be done with commercial properties, or you would create an incredibly wealthy class. So the rental value would have to be collected by a tax policy simultaneous with the financial restructuring. Quite frankly, I don’t think any politician has thought through what restructuring really would mean, because there are so many variables and so many policies – and even inevitable future developments – are still in the “unthinkable” category.
Wiping out debts gets into the realm of rewriting the rules of international finance as well as domestic tax policy. I have no indication that Europeans have such an idea. There was a communiqué from the IMF yesterday saying that they were going to look at all possible options. But you know that when they say “all possible options,” it really is a pretty narrow range, designed to favor creditors and oppose labor’s interests. Richard W. Fischer of the Federal Reserve said that the Fed will do whatever is necessary to ease the strains on markets and the economy. But here again, when someone in his position refers to “whatever is necessary,” this does not even consider writing down debts to the ability to pay. Appointees vetted by Wall Street or European financial interests are not going to consider nationalizing the banks or insurance companies.
So the bottom line is that politicians are not going to go against these vested interests – their biggest campaign contributors, after all. They’re not willing to think what, to them, is politically unthinkable. Even when reality hits them in the face, few politicians understand enough economics to understand the constraints at work, especially now that the leeway for indebtedness has almost all been used up. That’s the real problem: The only solutions able to save the economy from depression are, to them, unthinkable. So politicians and public officials are most likely to keep on steering the economy over the cliff.
In such a situation, insiders normally take what they can, as fast as they can. This is what’s happening with the Paulson bailout today. It is the plan he worked out with the help of banking and Wall Street lobbyists, supported by the Democratic Congress.
BF: Do you think they want a Depression?
MH: No, they’d love to have a thriving economy in which they could continue to make money and siphon off a free lunch for themselves. This is their dream, the guiding fiction of the “miracle of compound interest.” The problem is that the financial sector doesn’t want to do anything that doesn’t serve its own short-term interest. That’s the inherent historical problem with finance. It’s time frame is short-term, based on quick in-and-out buying and selling. This is not a strategy of long-term growth. That is supposed to be the responsibility of governments. But for the last half century the financial sector has backed an ideology that sees governments only as part of the problem, not part of the solution. Taxes are supposed to be only deadweight, not the basis for funding infrastructure. Government planning is supposed to be inherently inefficient. The inference is that government should relinquish planning power and resource allocation to the private financial sector. But when you do this, when you shift planning out of the hands of government to the banks and money managers, their policies aim to make money in the easiest way possible – by inflating asset prices and engaging in financial engineering rather than industrial engineering.
BF: State and local governments tax revenue is declining. What effect will this have?
MH: Already in New York City, where I live, Mayor Bloomberg has said now that Wall Street is not going to be paying as much tax, so we’ll have to cut back capital spending such as the 2nd Avenue subway and raise fares for transportation and other public services. All over the country we’ve heard about infrastructure rotting away – bridges collapsing in Minnesota, roads in disrepair, levees breaking. But states and municipal taxes are being voted down and cut back, while federal revenue sharing also is down. So they’re not able to fix the roads. They’re not able to fix the bridges. They’re cutting back capital spending programs and downsizing the municipal labor force, so we’re going to suffer economic shrinkage.
To top matters, almost no states and municipalities have been funding their pension programs. So they’re heading for the kind of situation that San Diego is in. If you want to see where many localities are going, look at San Diego’s failure to put aside money to pay the pensions that it now has to fund on a current basis as tax revenues fall. This means huge cutbacks.
If the government really wants to help the American economy it would set up an insurance fund for states and municipalities, with regulatory power to insist on adequate financing rather than borrowing. It would do well to federalize the property tax, levied on land rent as the basic fiscal revenue, reversing the tax shift since the 1930s onto labor via income and sales taxes. But it has done nothing of the sort. The Treasury and Federal Reserve are only funding Wall Street, not the localities that are actually in need of revenue these days, and certainly not mortgage debtors. Now that real estate prices are falling, the banks and the real estate industry are clamoring for property tax cuts so that owners can pay more to the banks and therefore support higher mortgages and hence a return to higher property prices. But if cities and states lower their real estate taxes, their fiscal position will be squeezed even more.
Along with Ben Bernanke at the Federal Reserve, Mr. Paulson, is saying that we’ve got to reflate the real estate market. They depict the collapse in real estate prices as a tragedy. But what is this tragedy? It is that real estate prices are becoming more affordable. So restoring “wealth creation” by supplying more credit – that is, by running up yet more debt – is the same thing as saying, “We don’t want more affordable real estate prices. We want high enough real estate prices to keep the debt bubble fully inflated and growing once again.”
The problem from Mr. Paulson’s point of view seems to be that Americans are only paying 40 percent of their money for housing now. His plan calls for Americans to reflate the real estate market by paying up to 60 percent of their income on housing and financial charges, mainly in the form of mortgage debt. If this trend persists, how will families have enough to spend on goods and services at anywhere near present levels?
Today’s form of finance capitalism is turning out to be the antithesis of the industrial capitalism that most textbooks describe. Financial managers have increased stock prices for industrial companies not by investing more in capital formation, but by borrowing money to buy their own stocks or simply to pay out as dividends. This enables financial managers to cash out on their stock options at higher prices than they otherwise could have. But Wall Street has stripped corporate assets, hollowing out industrial capital by loading it down with debt.
So with regard to your question about state and municipal finance, today’s finance capitalism is committed to capitalizing the entire economic surplus into interest charges. Local payment of debt service is “crowding out” the use of tax revenue for direct spending. This threatens to de-urbanize the economy and dismantle the public infrastructure that has kept down the cost of living and doing business since the Progressive Era. In the public as well as the corporate sector, debt extraction is depleting the “wealth of nations.”
BF: What do you think things will look like in the near future? So far we haven’t been able to identify any pushback against this debt trend. What will our world look like after the next president takes office?
MH: For a foretaste you might to look at what happened in Russia after 1996 and other post-Soviet economies that Mr. Rubin had a free hand in designing. Labor unions were broken (or simply stillborn) and living standards fell. If that is any guide, suicide rates will go up, life expectancy will shorten. President Bush already has told people to go to the emergency wards of hospitals if they’re sick. They will be given an aspirin and maybe some baking soda to settle their stomachs. Jobs will be cut. Cities will be less pleasant places as people lose their jobs and mental problems rise. Transport will be cut back, as it’s already being cut back in New York, raising the cost of living in outlying areas. Public infrastructure will crumble until it’s sold off to foreigners to “solve” the local fiscal crisis. The new private owners will charge – or charge more – for what they used to give for free or at subsidized prices for roads and other basic services. People will be squeezed like never before in modern times. It may lead to emigration of skilled labor abroad just as there was a brain drain in the case of Russia.
BF: This could lead to complete social breakdown, couldn’t it?
MH: I’m not sure how far you want to go in defining the word “breakdown.” Today’s economic deterioration is financially driven to evolve into kleptocratic rentier economies with polarized wealth distribution and debtor-creditor strains. America may begin to look like Mexican and Latin American kleptocracies as politicians adopt essentially the economic plan the Chicago Boys who advised Gen. Pinochet in Chile, right down to trying to turn privatized Social Security into casino capitalism.
The problem is debt deflation. The solution must be political – by restructuring the institutional context within which market forces operate. Unfortunately, I don’t see much political pushback.
BF: Are we on the verge of a Great Depression?
MH: We seem to be – not a V-shaped downturn with a quick recovery, but a longer L-shaped one, limping along until the debt overhead is paid off. The problem is that if the debts are indeed paid, this must be at the expense of foregoing the purchase of goods and services. If you don’t buy goods and services then people will not be hired to produce them.
It doesn’t have to be this way. The financial sector and its neoliberal economists will try to convince people that going to say this is just a normal business cycle and will be cured automatically – if the government cuts taxes for the wealthy to let the financial sector lead the economy back up. So the cure is more trickle-down tax policy.
When stagnation continues, they’ll insist that not enough subsidies have been given fast enough to the banking and financial sector to restore normalcy. Their idea of “normal” leaves out of account the fact that this financial sector has gotten rich by loading down the economy with debt – debt that is beyond the ability to be paid, resulting in Negative Equity. The economy cannot “earn its way out of debt” of this magnitude. It would be much easier if the creditors and investors in junk mortgages and junk bonds took their losses, and if the $450 billion in derivative superstructure simply was let go. Instead, we are getting the worst of all possible worlds. The Treasury is taking responsibility for making bad lenders and bad investors whole, but leaving bad debts and even Negative Equity on the books and even putting the government in the position of “debt collector of last resort.” But instead of confronting the over-indebtedness problem, financial lobbyists –along with the staff at the Fed and Treasury, and the Congressional leadership – will say that a depression happens mathematically once a century, and recommend that one do nothing but give more money to the financial sector to loan out and create yet more debt. Without saying just what problem Mr. Greenspan created and Mr. Paulson aggravated, there is little likelihood of a real solution being proposed.
It was the Clinton Administration that really started the ball rolling. Now that you have Ms. Pelosi and Mr. Reid leading the pack for Wall Street, the Democrats have to take as much responsibility as the Republicans for the Bailout and hence for pushing us into Depression.
BF: People keep talking about injecting money directly into the banks. What will this achieve?
MH: They’re talking about the government buying special non-voting stock in the banks. This will enable the banks to report this equity as part of their capital structure under what’s called Basel II. This is the set of reserve requirements to have a certain amount of capital to back deposit liabilities. The government’s contribution will take the form of so-called preferred stock, which is counted as equity. As I mentioned above, it won’t be voting stock. Instead of the governments taking over the banks as in Europe, instead of steering their lending in the public interest, the Treasury is leaving control over to the same guys who have been mismanaging the credit system all along. So it’s a subsidy to mismanagement.
This is not merely a set of personal errors or “bad apples.” The error is systemic. It’s a mentality at work – one that blocks out an awareness of how serious the debt problem is. Just as culpable are the Congressional committee heads who act in effect as lobbyists to block appointment of officials or advisors who do understand the financial problem at hand. And at university economics departments, neoliberal economists have acted as censors to exclude from the curriculum any response to the debt problem that does not serve the short-term interests of the banks and Wall Street.
BF: In that vein, I understand that one of the parts of the Emergency Economic Stabilization Act says that banks no longer are required to maintain cash reserves to cover deposits. Is that true?
MH: What that means is that if the banks go under, the FDIC now will bail depositors out up to $250,000 per account. So why should the banks need to keep heavy cash reserves if the government is going to take responsibility? The pretense is that banks will be able to lend more. But all the government guarantee really does is to enable them to operate more profitably, by shifting the risk onto the government and leveraging their own capital more.
BF: What do you expect to see tomorrow morning when the stock markets reopen?
MH: I have no idea. Nobody I know has any idea on any given morning. Last week even Jim Cramer on CNBC, who euphemizes every decline as a “buying opportunity,” told viewers that if they are going to need their money in the next year or so, they don’t belong in this market. If even manic Jim Cramer says to sell out for the short term, what’s the point of holding onto stocks? If they are going to keep drifting down for another year or so before going back up, why should people hold onto them on the way down?
BF: You know, I actually heard Jim Cramer say that whatever money you need in the next FIVE years you should take off the table.
MH: It’s unprecedented. Suppose I need money in ten years. If I know the market is going down for five years, my interest would be to pull out now, put my money in cash or Treasuries, and buy back into stocks five years from now, or whenever the crisis has passed. The present gloom shows the demoralization at work. What people imagined to be reality turns out to have been a fictitious science-fiction world, a just-pretend happy world where stocks and real estate prices only go up and debts can be paid out of the financial free lunch of capital gains. The model that most people – including Congressional policy makers – carry around in their minds has not been reframed to grasp financial reality.
BF: So you think we haven’t hit the bottom yet?
MH: When congenitally optimistic Jim Cramer worries that we may be five years from the bottom, I think people should realize that a phase change has occurred. In terms of the actual economy, the real economy of people’s living standards, public services, the cost of living and the value of the dollar, all these things have a long way down to go.
BF: Before we close, could you say a bit more about the credit crunch. Is it still the case that people are not able to get loans?
MH: It’s hard to get a loan for property that’s worth less than the mortgage that already is on it. It’s hard to get an auto loan, because it used to be that lenders could resell the car at a given price after a year or two. But nobody is buying more cars these days, so lenders are not lending as high a proportion of the car’s price as they used to – or real estate for that matter, because prices for housing and office building are declining. When forecasters say that they expect prices to decline for another year or so, that means “as far as the eye can see.” Falling asset prices deter lending.
Banks are not going make any more mortgage loans with zero down-payment at 100% of the purchase price, to say nothing of 125% loans. Buyers actually have to put up some money of their own now. That hasn’t been done for a while, and it is changing the market. Most people don’t have enough money to make the higher down payments that the banks now require.
The problem isn’t only the banks. Suppose you want to buy a house. Why would you buy right now, when houses all over the neighborhood have “For Sale” signs? You know that as these houses are sold off at distress prices, you can buy it cheaper later on. Why would buyers want to borrow under these conditions – or banks lend to them? The economy is having to face the diverging relationship between the volume of debt and the falling market prices for whatever assets they own or are buying. The Negative Equity gap is killing the market and preventing new credit from being extended.
Many home owners are frozen into where they live, like feudal serfs tied to the land. If their employers shift them to another city, they can’t move without paying off their mortgage, and most don’t have the cash to do this. They would be wiped out, as the Treasury and Congress are only making lenders whole. The political system is thus as dysfunctional as the financial system. It has become the legislative mirror image of the trickle-down mentality of neoliberal “financialization.” It means the ending of America’s great traditions of upward mobility and geographic mobility.
BF: I’ve been reading that the lack of transparency in mortgage securities makes people uncertain, so they don’t want to buy them.
MH: Instead of “lack of transparency” I prefer the term “fraudulent Enron-style accounting.” There’s a good reason for the lack of trust. It’s not a “lack,” but a positive awareness of how the banks, insurance companies and money managers are trying to exploit their customers and counter-parties in any way possible. People prefer safe investments such as Treasury bonds because they realize that banks have lobbied to deprive victims of financial fraud of their rights. As I mentioned earlier, the Treasury gave bank lobbyists the right not to disclose the accurate market value of their reserves, so nobody really knows their net worth or degree of negative equity. Why should anyone be gullible enough to trust such people under these conditions?
BF: The media is referring to the lack of market confidence and say that we need to restore it. Do you think that’s possible?
MH: There’s certainly been is a “confidence game,” which the financial sector would like to lead to a trickle-down economic policy. A con man is someone who gets people confidence and then steals their money. The con will be: “You didn’t give us enough the first time. We need more. Otherwise, without our being “made whole, the economy won’t be able to function.” Implicit is the follow-up threat: “We’ll see to that.” So the banking system is holding the economy hostage, not only for itself but for the financial and insurance and brokerage affiliates that banks have taken over since Glass-Steagall was repealed in 1999.
The idea is to keep up confidence that the financial sector should continue to act as the economy’s planner and resource allocator via its control of the credit, payment and savings-management system. But confidence in this worldview will gone as people come to understand that deregulation has let a financial gang take over the banking system and vertically organize the financial sector into a giant trusts with only a few dominant capo banks. Remember what Zola said: “Behind every family fortune is a great theft,” Never has this been more true than under the Clinton and Bush Administrations. They’ve let Angelo Mozilo of Countrywide walk away with hundreds of millions of dollars instead of prosecuting him for fraud. They’re using the government’s bailing funding to reward executives who have wrecked the lives of millions of American families. These individuals are predators posing as philanthropists. That’s the con.
There is no “panic” in the market. Panic is a neurotic psychological response, often unrealistic. This is an intelligent, well-calculated economic response. It’s not panic when investors refrain from buying anything they don’t know the value of. And if sellers have shown repeatedly that they’re out for themselves and have been dishonest about what they’re selling, investors are not going to patronize them. When people see banks browbeating the bond rating agencies and accounting firms to whitewash the quality of what they’re pawning off on their customers, when they see bank lobbyists getting Washington to block state prosecutions of financial fraud so as to clear the way for more predatory lending and false packaging of the junk securities they’re selling and to win the right not to reveal their true financial position, there’s a good reason not to buy what’s in these black boxes. Not many intelligent people would take a chance on paying good money to so deceptive a sector.
BF: You mentioned at the beginning of the show that foreigners, sovereign investment funds and central banks are getting out.
MH: Foreign and U.S. investors. When the Secretary of the Treasury lets the banks act like crooks, depositors and other customers are going to expect them do just that. Only a crazy person would keep on making a mistake of trusting them – or trusting Congress again. Insanity is defined as doing the same thing and imagining that the result will be different this time. Until the financial system and the regulatory system and legal system are changed to put in place a reality-based economic ideology and corresponding system of checks and balances, the economy cannot recover. It will limp along and shrink slowly. Financial depression will stifle the “real” economy – while pretending to save it with an IMF-style austerity plan, something like an abusive parent beating a child and saying, “It’s for your own good.” It’s really not good at all, of course.
What the government wants people to do is indeed to panic. It’s succeeded in creating panic, in the hope that this will enable a radical giveaway “to restore the market.” The Treasury is spreading the panic by its deception. We’re in an economy of deception spread by the Treasury, promoted by the Bush administration and amplified by the Democratic Party’s Congressional leaders. I’m afraid that all you’re getting from Mr. Obama and Mr. McCain is further deception in support of a bailout act that should have been seen for what it is – a plan that will create precisely the anarchy that we’ve seen in the last eight trading days. What created this crisis was Congressional ratification of the Wall Street rip-off.
What is so discouraging is that there has been no real pressure by the media, the public, the pension funds, labor unions or other groups. There has been no serious discussion of the basic problem – the fact that the debts can’t be paid. No economy ever has repaid its debts, as Adam Smith noted already back in 1776. We’re now at that crisis point for the United States, but no one is discussing how we are going to not pay the debts. Are we going to resolve the problem of their non-payment by letting widespread foreclosures take place at the expense of debtors? Will this include the voluntary public bankruptcy of cities and states selling off their public enterprises, land and public domain to private buyers as an alternative to taxing property and wealth? Will voters be panicked into believing that this kind of IMF austerity plan is valid for the United States, not just for third world kleptocracies? Or, are we not going to pay the debts by writing them down to what can be paid, or writing off many bad debts altogether?
Mr. Paulson only wants to write down the debts of his cronies on Wall Street and major campaign contributors. That’s not going to help the economy. It means that the government will have to tax the industrial economy, labor and middle classes all the more. So when you were asking for the scenario, I should have said I expect taxes and user fees to go up sharply for most people, and the quality of public services to decline sharply. This is part of turning America into a Third World country. The only choice that voters are now being given is between two presidential candidates who have announced nearly identical economic programs as far as financial policy and favoritism to Wall Street is concerned.
BF: Can you elaborate on what you mean when you say the government wants people to panic?
MH: Panic is what gives politicians a free hand to serve special interests with policies that could not be enacted under normal circumstances. The Wall Street panic has been the financial sector’s 9/11. It created an emergency condition in which a government run by thieves can do whatever its backers want, by claiming that they’re doing what they’re acting to cure the panic. So they need to create a panic in order to say that they’re curing it. In reality, of course, what they’re doing is making the debt and tax problem much worse – so they can grab much more, in a vicious circle that they’ll try to keep going for as long as possible.
On the one hand the government wants to panic voters to buy into a program of saving creditors from having to take a loss on bad loans, and supporting anti-debtor policies. This is a radical U-turn in the direction in which Western civilization has been moving since the Enlightenment, and indeed since the fall of ancient Rome as a result of its debt strains that reduced its imperial economy to debt bondage.
On the other hand, the financial sector wants investors and asset holders to panic the market to sell stocks and real estate at such low distressed prices that vultures can pick up assets on the cheap to “clear the market.” But the market is not being cleared of its debt encumbrances, although the government may take many of these over. New buyers may come in to make a killing by buying assets for much less than they’re worth – from the government itself, if public agencies take ownership of real estate and other property being foreclosed on. This way of clearing market is to have the Treasury or Federal Reserve absorb the loss.
But we’re not yet near the lows. Stock market prices still have pretty high price-earnings ratios, especially in view of the fact that sales and earnings are expected to go way down as debt deflation depresses the economy.
BF: Do you want to summarize the points you’ve made?
MH: Paulson’s Giveaway Plans A and B – buying trash for cash (Plan A) and giving money to the banks by buying “preferred” stocks (Plan B) – are the financial equivalent of the Patriot Act that a panicked Congress passed quickly after 9/11. The Fed’s $850 billion purchase of loans on which Wall Street otherwise would take losses on is being made explicitly under “emergency” conditions. It’s not allowed to lend to non-banks under anything except emergencies.
But the real emergency affects mainly debtors – mortgage debtors with negative equity, companies loaded down with junk bonds (many of them taken to buy back corporate stock and increase dividend payouts to increase the price at which managers can cash out). Also facing emergency conditions are pension funds from their stock losses and bad-debt gambles. The government is likely to insist that if automakers and other companies get federal aid, they will have to avoid “rewarding labor unions” and replace defined benefit pension plans with “defined contribution” plans. The PBGC lacks the money to insure corporate pension-fund losses. Nobody has suggested helping it, because the savers are workers, not billionaires.
State and local budgets with falling tax receipts. In fact, real estate interests are demanding even further tax cuts, backed by financial lobbyists wanting to leave more revenue in the hands of property owners to pay their mortgages. This will aggravate the tax shift onto labor and industry. Homeowners will pay interest in place of property taxes – and will have to make up the tax shortfall as well! So debt deflation and fiscal deflation will go hand in hand.
All these parts of the U.S. economy are being plunged into a real economic emergency in order to benefit Wall Street. Yet its losses and gains are extraneous to the “real” economy, except that it uses its financial inflows to lend out and indebt the economy further. This financial wrap-around of the “real” economy is being saved, but not the contents – the work force and tangible means of production. This “flesh and bone” is being sacrificed in order to protect the “fat.” The result is a toxic form of financial and fiscal pollution – debt pollution and the tax policies to preserve the “magic of compound interest” as an exponential trend. It is stifling life and growth by shifting the economic surplus out of the real economy.
BF: Dr. Hudson, thank you very much.
MH: Thank you, Bonnie.
 For recent confirmation see James Politi, “US banks tighten grip on lending,” Financial Times, November 4, 2008: “US banks have pulled back on lending to consumers and businesses in a big way over the past three months.” http://www.ft.com/cms/s/0/26a624c2-aa13-11dd-958b-000077b07658.html