"This sucker could go down"
Peter COSTANTINI
Likening the financial system to a casino, the author describes what
took place that led to the current financial crisis especially in the US
and a number of European countries with reverberating effects to the
rest of the world.
Crises seem to awaken the inner poet of the commentariat, and the
Crash of 2008 is no exception.
In the effort to wrap the mind around a phenomenon as expansive and
convoluted as this one, literal description falls short. And so, the
metaphor mills have been grinding at full capacity.
"It's like living through an extended earthquake," explained
television commentator David Brancaccio, "only we don't know yet if it's
the big one or a foreshock of a big one to come."
The New York Times offered "a landslide changing the financial
landscape". Others likened the events to Hurricane Katrina or an
eruption of Mount Vesuvius.
Even President George W. Bush reportedly chimed in at an emergency
meeting with what sounded vaguely like a haiku: "If money isn't loosened
up, this sucker could go down."
But perhaps the most popular, and most apt, comparison has been to a
casino. Commentators have identified the culprit as "casino capitalism"
or a "casino economy", and more than one has proposed a small tax on
securities transactions to slow down the betting.
The financial system, however, is an odd sort of casino. In most
gambling houses, management runs the gaming so that the house always
makes a profit. Card counters are thrown out by the bouncers.
In this casino, on the contrary, no one seems to be running the show.
Players get to make up their own games and chain them together in ways
so complicated that even the creators don't always seem to understand
them.
Normally, when a player loses, the house takes his or her money.
Here, if a player loses a large enough sum, the house intervenes and
assumes the player's debts.
Nobody knows exactly how much some clients have won or lost.
Apparently, the house has lost control.
Breakdown
"What happens in Vegas stays in Vegas" is the motto of the
archetypical gaming destination. In this case, however, what happened
did not stay on Wall Street: it spread to banks and real economies
around the world.
A big part of the problem is that this house is a disjointed
collection of government and quasi-public agencies led by financial
industry insiders.
Many have attenuated power and little will to trim the wings of
high-fliers like investment banks and hedge funds.
Nobel-laureate economist Joseph Stiglitz traced the roots of the
breakdown to "the spirit of excessive deregulation that the [George W.]
Bush administration so promoted."
In 2004, for example, the Securities and Exchange Commission, the
fairy godmother of financial markets, granted a wish heavily lobbied for
by the major investment banks: it loosened a key rule limiting the ratio
of debt to equity for these firms.
This freed up many billions of reserves for investment, the
equivalent of the casino offering unlimited free drinks to gamblers. At
Bear Stearns, the first of the big five to fail, the ratio reached 33
borrowed dollars for every dollar of the firm's own money.
Some of that spirit, though, predates the Bush years. During the
previous administration, legislation demolished regulations on
investment banks and the New Deal-era firewall between commercial banks
and investment and insurance businesses.
Senator Phil Gramm, John McCain's economic adviser, was a lead
Republican protagonist, but President Bill Clinton and his Secretary of
the Treasury, Robert Rubin, also supported the laws. Rubin, like current
Secretary Henry Paulson, was formerly CEO of Goldman Sachs.
How does this metastasizing Monte Carlo actually work?
If government regulators and Wall Street CEOs had known the answer,
the crisis might have been averted. Surveying the ruins, though, it
appears that the structure consisted of several floors offering a
dazzling variety of games for those with enough capital and nerve.
From higher levels, players can make bets on events lower down. And,
like Bear Stearns, they can borrow massive amounts of money to play
with, which is known as leveraging. When their bet wins, leverage
multiplies their winnings; likewise their losses when they lose. The
ground floor hosted a straightforward game played by millions of
homeowners: home-equity hold 'em. Through the 1990s and into this
decade, increases in US home prices far outpaced overall inflation.
Many families took out loans against the equity in their homes or
refinanced them to pay for other needs: mainly things like medical
emergencies and higher education, but in some cases less essential
purchases. Pressures to tap into home equity were exacerbated by the
DotCom crash and wage stagnation for many US workers.
The great majority of these mortgages were sound at the time. But
when home prices crashed, many homeowners were left holding loans larger
than the value of their houses. The Fed and Treasury failed to warn
citizens or to take action to deflate the bubble gradually before it
popped.
Perched precariously on top of the bubble, the second floor offered
games like refi roulette. Lenders thrust adjustable-rate mortgages and
"creative" financing schemes on overstretched home buyers, some of whom
didn't understand the potential downside and borrowed beyond their
means.
When low initial interest rates went up and home prices declined,
mounting numbers of borrowers both prime and sub-prime began to default
on their loans.
Foreclosures, the US procedure for dispossessing delinquent home
buyers, grew rapidly.
Derivatives
The third floor of the casino was a Wall Street theme park where
mathematicians, physicists and economists could act out their wildest
fantasies. Mortgage lenders sold their loans to intermediaries, such as
Fannie Mae and Freddie Mac, who aggregated the mortgages into pools.
These collections obscured the identity and value of the sub-prime loans
they contained.
Based on these camouflaged values, alchemists at investment banks and
hedge funds created byzantine unregulated securities like "collateralised
debt obligations". They also marketed derivatives that placed wagers and
counter-wagers on the risks lurking in the murky loan slurry.
Large volumes of these infected securities and derivatives found
their way into portfolios around the globe. As the extent of sub-prime
loan defaults became clear, the securities based on them began to
putrefy. Widening circles of financial institutions, often unaware how
much they were exposed to the contagion, began to rot from within, then
suddenly bled from the orifices and collapsed.
The fourth floor of the casino was a gigantic confidence game, but
also in a sense the foundation of the whole edifice: the interbank
payment system.
Banks need to loan and borrow short-term money from each other
constantly in order to provide credit and cash to businesses and
individuals. Without liquidity - accessible money and easily convertible
assets - to grease the gears of commerce, the machine grinds to a halt,
as in the Great Depression of the 1930s.
Playing on this floor requires trust and cooperation between players.
But the plague of degraded mortgage-based securities and derivatives,
and lack of transparency into who owned how much of them, led to a
breakdown of confidence. Nobody knew whom they could trust.
As a result, banks began to raise the rate of interest they charged
each other for short-term loans. On September 17, interbank credit
seemed on the verge of freezing. Had this happened, cash machine
withdrawals, credit card interactions, and short-term business loans
might soon have been imperiled.
Now, the high rollers have headed to Washington to try to salvage the
casino. Meanwhile, the fear and greed that broke the house continue to
reverberate around the world.
- Third World Network Features/IPS |