Market Meltdown: Thoughts on Shadows, Secrets, and Shells
After reading Francine Hardaway, Dave Winer and Steve Gillmor today, it occurs to me that we are not under any obligation to accept the Bush Administration’s claim that their way is the only way out, or hand off incredible power to the Secretary of the Treasury with absolutely no understanding of how that power is to be used or how it will cure the problem.
Further, many have pointed out that the proposed bailout plan does not put a cure on the underlying disease that brought us to this place — out of control credit and lending practices locked inside an invisible, or shadow, banking system. As many other smarter people than I have pointed out, there is no instant cure for our financial market mess; there are too many players, too many vines branching out, and too many unknowns. But let’s start with mortgages as a place to dig our feet in.
The mortgages that are rocking the financial industry are still secured by real estate. The homes are, for the most part, still worth something, and when the market rebounds (which it will, just like it has many times in the past), they will regain their value. At the moment, many of these foreclosed homes (and office buildings, and parking lots and whatever else…) are vacant and waiting for someone to buy them. So we have a bunch of unoccupied homes that are bank-owned and worth less than what was loaned by the bank to purchase them.
Then, thanks to the repeal of Glass-Steagall and subsequent removal of the firewall between investment companies and banks, we have these mortgages bundled into funds by the banks’ subsidiary broker-dealer (wholly owned by the bank holding company, of course), and sold to individual investors as “prudent investments”, intended to spread the risk among many. In theory, it’s great, because evidently no one foresaw the entire industry turning belly up at once and leave those investors holding the bag. As Morgan Stanley and Goldman Sachs become full-fledged bank holding companies tomorrow by decree of the Federal Reserve, the Glass-Steagall firewal evaporates forever.
What we have isn’t a meltdown of the traditional banking system. It’s a meltdown of the shadow banking system, the behind the mask, unnamed industry that relies on short-term credit to reap big profits which are plowed back into investments in commercial paper.
In 2007, the founder and CIO of PIMCO wrote the following:
Financial institutions fell for the ruse, and now we all suffer the consequences. Defaults are rising, the dollar’s sinking, and — good Lord! — even Google’s (Charts, Fortune 500) stock price is going down. Something must really be wrong.
It is. What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.
My Pimco colleague Paul McCulley has labeled it the “shadow banking system” because it has lain hidden for years, untouched by regulation, yet free to magically and mystically create and then package subprime loans into a host of three-letter conduits that only Wall Street wizards could explain.
And in March, there was this excellent description of the shadow banking system:
On Wall Street, of course, what you do not see can hurt you. In the past decade, there has been an explosion in complex derivative instruments, like collateralized debt obligations and credit default swaps, that were intended primarily to transfer risk.
These products are virtually hidden from investors, analysts and regulators, even though they have emerged as being among Wall Street’s most outsized profit engines. They do not trade openly on public exchanges, and financial services firms disclose few details about them.
Used judiciously, derivatives can limit the damage from financial miscues and uncertainty, greasing the wheels of commerce. Used unwisely – when greed and the urge to gamble with borrowed money overtake sensible risk-taking – derivatives can become Wall Street’s version of nitroglycerin.
Bear Stearns’s vast portfolio of these instruments was among the main reasons for the bank’s collapse, but derivatives are buried in the accounts of just about every Wall Street company, as well as those of major commercial banks like Citigroup and JPMorgan Chase. What is more, these exotic investments have been exported all over the globe, causing losses in places as distant from Wall Street as a small Norwegian town north of the Arctic Circle.
For years, this has been the shell game fueling Wall Street while ordinary folks just try to get through the day and pay their bills. Credit has been the currency driving the markets, and as it proved lucrative for US investors, so too did it prove lucrative for foreign investors. As I understand it, 41% of US Treasury bonds are owned by foreign investors. Call me naive, but it seems to me that the addiction to credit isn’t just on Wall Street, it’s in Washington, too.
As I wrote last Sunday, our war in Iraq is being fueled by issuance and purchase of US Bonds. Only US citizens aren’t the only ones buying them. As more debt is piled on more debt, we run the serious risk of having our margins called by the likes of China, Saudi Arabia, and others. In the meantime, the UK markets grow shakier by the minute, and we are all placed at risk of losing what little savings we’ve managed to accumulate, while Lehman executives share 2.5 billion in bonuses, courtesy of Barclays Bank, who skimmed the cream off the soured milk that was a respected investment bank.
Glenn Greenwald echoes my own thoughts on this:
What is more intrinsically corrupt than allowing people to engage in high-reward/no-risk capitalism — where they reap tens of millions of dollars and more every year while their reckless gambles are paying off only to then have the Government shift their losses to the citizenry at large once their schemes collapse? We’ve retroactively created a win-only system where the wealthiest corporations and their shareholders are free to gamble for as long as they win and then force others who have no upside to pay for their losses. Watching Wall St. erupt with an orgy of celebration on Friday after it became clear the Government (i.e., you) would pay for their disaster was literally nauseating, as the very people who wreaked this havoc are now being rewarded.
More amazingly, they’re free to walk away without having to disgorge their gains; at worst, they’re just “forced” to walk away without any further stake in the gamble. How can these bailouts not at least be categorically conditioned on the disgorgement of ill-gotten gains from those who are responsible? The mere fact that shareholders might lose their stake going forward doesn’t resolve that concern; why should those who so fantastically profited from these schemes they couldn’t support walk away with their gains? This is “redistribution of wealth” and “government takeover of industry” on the grandest scale imaginable — the buzzphrases that have been thrown around for decades to represent all that is evil and bad in the world. That’s all this is; it’s not an “investment” by the Government in any real sense but just a magical transfer of losses away from those who are responsible for these losses to those who aren’t.
Which brings me to my point, such as it is. If a bailout of Wall Street is inevitable for our own protection, I want it on my terms. If I have to finance it, I want to do it in a way that’s going to benefit ME, the taxpayer. I want a return on my investment, not more taxes to service the debt owed to China.
Let’s start by making a citizen’s margin call. We actually do have clout, because it’s our 401(k) and pension money fueling the new investments that keep the pyramid on track as we move forward. Let’s tell the government we will make our investments in US bonds which may only be owned by US citizens, earmarked only for the purpose of retiring debt to foreign investors.
Let’s also insist that we don’t act with haste on any bailout of Wall Street. Any emergency measures taken at this time should be just that — emergency measures, for a very short period of time (3-6 months, maximum), while a longer-term plan which includes full disclosure, appropriate sanctions, and full recovery efforts of whatever assets and profits are left to recover.
Finally, there can be no — I repeat, NO — blank check granted for this bailout. No power without oversight, no action without proper accountability and recourse. None. Because it’s worth remembering this important fact, again courtesy of Glenn Greenwald:
What’s most vital to underscore is that the beneficiaries of this week’s extraordinary Government schemes aren’t just the coincidental recipients of largesse due to some random stroke of good luck. The people on whose behalf these schemes are being implemented — the true beneficiaries — are the very same people who have been running and owning our Government — both parties — for decades, which is why they have been able to do what they’ve been doing without interference. They were able to gamble without limit because they control the Government, and now they’re having others bear the brunt of their collapse for the same reason — because the Government is largely run for their benefit.
Lest you doubt, let me remind you that Jeb Bush served as a financial consultant to Lehman from 2007 on. Here’s an added bonus:
Sitting behind McCain was former Gov. Jeb Bush, who was hired a year ago by Lehman Brothers as a financial consultant. As governor, Bush served on the three-member State Board of Administration that agreed to let the state’s retirement fund buy a series of mortgage-backed securities from Lehman Brothers that turned out to be troubled. The subsequent steep drop in value prompted a $9 billion run on the fund last December by local governments who had invested their money in the SBA managed fund. Lehman also manages two funds for the SBA, which is also heavily invested in some Lehman securities.
All I can say to that is that the good people of Florida should really think hard before electing someone Jeb and George endorse, if they hope to keep what little retirement savings they have left.
Sphere: Related ContentStunning Coup Attempt of 2008: Right Here, Right Now
When I wrote about the bailout bill this morning two things happened. First, I was focused on the staggering, mind-numbing numbers. And second, even though intuition told me there would be something about this plan as insidious as the Patriot Act, I didn’t imagine it to be quite as bold and brazen as it was.
Fortunately, others did. It’s stunning in its audacity and simplicity.
In essence, the bailout as proposed represents the largest transfer of Congressional power to the executive branch in United States History, as well as the shift of public funds into corporate hands. Worse yet, there’s this:
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
Read that a couple of times. Let it sink in. The Treasury Secretary has been elevated above the rule of law. In essence, we are being asked to fork up 700 billion dollars to give to the Treasury Secretary with no accountability and no recourse. Imagine that. Then go read all of Larisa Alexandrovna’s article on Huffington Post.
If ever the words “fierce urgency of now” had any meaning, they must have meaning here. They must. Alexandrovna is absolutely right when she calls for us all to stand against this in unison, regardless of party:
You are no longer Republicans, Democrats, or any shade of voter. You do not live in a swing state or a solid colored state. You are simply this: an American. That is the only side that matters. So call your members of Congress and demand, no, declare that unless they do their duty to the Constitution and to us, we will move to the streets – not because we want to, but because our founding fathers demanded this duty of each and every citizen in the face of such a domestic enemy. Demand – as is your right – that this bill be voted against and demand – as is your right – that the people plotting this treachery be held to account. We are either a nation of laws or we are no longer a democracy. Pick a side, because there won’t be another time, another moment, another chance to be a patriot.
She’s right. There is no crisis more urgent, more in need of our attention, than this. Because if we, the people, do not stop this end run around the rule of law and balance of powers, we will live in the dictatorship we deserve.
This is the bookend to the Patriot Act, make no mistake. It’s time to say no.
Sphere: Related ContentOffshore Drilling: Summary of Talking Points
I wrote these yesterday for someone who was about to have a conversation with the #dontgo folks. Seems like they belong here, with the photos of untainted oceans too.
- The entire #dontgo movement is nothing more than political grandstanding, given that the absence of action (see this post for more details) unblocks offshore leases.
- There is no obligation on the part of the oil companies who hold drilling rights on these leases to: a) drill at all; and b) keep the oil drilled inside domestic markets. In fact, with a commodity such as oil, it’s far more likely that the oil would be sold on the open market.
- Even if the oil companies drill offshore and bring more oil out of the ground, it will have no impact on the prices at the pump, nor is there any guarantee of any impact for a minimum of five to ten years.
- Refinery output is the bottleneck. We are not able to process what we can drill at this time, and there are no plans on the table to build more refineries.
- Oil companies own patents to some of the best alternative fuel options, but are not doing anything with them. If they opt to drill offshore and exercise those grants, they should be forced to put the patents in the public domain.
- If they were truly committed to lower gas prices at the pump, there would be unanimous consent to close the Enron loophole which allows for unbridled price inflation because of unchecked speculation.
Feel free to add to the list in the comments.
Sphere: Related ContentThe Play Behind the Politics
This will bring my series of images protesting offshore drilling back to even — one for each day this month.
So that we’re clear here, the entire offshore drilling debate including the smoky #dontgo and #drillheredrillnow initiative is all about heat with very little light.
All of the smoke blown by the Republicans is simply the business of politics. It’s always about taking known advantages and making sure they cast the opponent in the worst light. This is no different.
We all know President Bush lifted the executive order on offshore drilling. What I didn’t know until today was that even if he hadn’t, the bans have to be renewed each year before they expire on September 30th. Traditionally, they’re renewed as a rider to the appropriations bill.
What Bush signalled with the lifting of the bans is that non-renewal would pass through his hands with a nod and a smile. The Democrats don’t have a strong enough majority in the House or the Senate to force attachment of a rider, nor a veto-proof majority when Bush vetoes it.
In other words, releasing those leases was a done deal with no further action from Congress on September 30th.
Do they REALLY wonder why they have such a low approval rating there on Capitol Hill? This should give you a clue. The Republicans are all out there shouting about how Democrats won’t allow a vote, yada yada.
The truth is, no vote is necessary. No action necessary at all. Score one for the bad guys.
Still, for the rest of this month I’ll offer you visual reasons to at least morally, if not politically, oppose offshore drilling.
And I will do everything I can to knock my own Representative, Elton Gallegly, out of office for this and many other ineffective, greedy actions.
Update: GOP spinner ericjodom agrees with my analysis while lifting a quote from this post and altering it to appear as though I’m applauding by moving the quote and changing the word “bad” to “good”, as though that somehow justifies things. As I said in response to him, how utterly Rovian.
Just remember when you hear the new spin that Pelosi and the Democrats are ‘caving in’, that what is really going on is an effort to make something out of a Bush-GOP created situation which has absolutely no bearing on our gas prices or the current oil prices. Exxon John will benefit from the spin, unless educated readers choose to speak out and stop him.
Sphere: Related ContentEven Big Oil Doesn’t Want to Drill Offshore
In fact, the Energy Information Agency acknowledges that offshore drilling presents no solution to the high price of oil.
“Because oil prices are determined on the international market, however, any impact on average wellhead prices is expected to be insignificant.” But, “the average field size in the Pacific and Atlantic regions tends to be smaller than the average in the Gulf of Mexico, implying that a significant portion of the additional resource would not be economically attractive to develop at the reference case prices.” In other words, oil companies might not even drill there if they could. The EIA estimates that it takes about five years, after the regions became open for drilling, before any oil production would commence.
David Fiderer has clearly laid out the dupe the media and Republicans are selling with their #dontgo campaign and their clarion call for offshore drilling. Be sure to read the whole article and click through to the links. It’s well-documented, and I particularly liked his conclusion:
Sphere: Related ContentIt’s all straight from Dr. Goebbels’ playbook. If you think the historic analogy is overstated, check out this hysterical call to arms from Jeff Mazzella, head of a right wing advocacy group oxymoronically called The Center for Individual Freedom. The idea: subvert any attempt at constructive compromise among lawmakers.
No Offshore Drilling #16
Apologies for being behind on posting these. It’s been a somewhat hectic and brutal time.
I took this last night while alone on the beach with no one in sight. Pelicans skimmed the waves looking for their last fish before the sun set, while the moon rose behind me.
Offshore drilling changes the landscape. Not just physically. It changes the ecology, the balance, the creation. It changes nights like these.
If some problem were really solved, then it might be worth the discussion. But the only problem solved with offshore drilling is that it gives a fatter bottom line to the oil companies by adding those leases as assets. It doesn’t address the question of increased refinery output, which is really more critical than the oil we have, and there are no guarantees that oil drilled here would remain here. Public companies are in bondage to the bottom line. Selling domestic oil at market prices will be their first priority, no matter who the buyer is. Expect China to lead on the buying market, meaning that oil companies will be richer, but oil prices won’t drop significantly, nor will your prices at the pump.
This is a critical issue. Far too many Americans believe that offshore drilling is the instant panacea to high gas and oil prices. In fact, the weak dollar is a far higher cause of inflated oil prices. A better and more effective strategy for easing prices at the pump is to leave the shoreline alone, and focus on shoring up the dollar.
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