Erstellt am: 25.09.2008 Autor: Edward Roby Status: Senior
Wall Street on welfare, dollar on Skid Row
Has the third week of September worked an historic wonder, shocking even haughty dollar stewards back to reality by showing them a sudden glimpse of the abyss? The existential danger of running endless twin deficits swelled by expensive wars of choice had long ago raised all sorts of red flags – to no avail. But market failure now speaks louder than cautionary words.
After a wasted year of piecemeal patches and repairs, the imminent collapse of U.S. money-market funds finally clinched the case for massive overhaul of the seizing financial engine. Suddenly the stakes were exponentially higher than the mere default of another noble Wall Street brokerage house. “To listen to the language of last evening, we may be days away from a complete meltdown of our financial system,” U.S. Senate Banking Committee Chairman Chris Dodd was quoted as saying in an AFP wire dispatch.
Chastened by what he called “one of the rare moments,” the veteran senator was still weighing the words of embattled U.S. Treasury Secretary Henry Paulson late Thursday, Sept. 18. The nationalization of mortgage loan recyclers Fannie Mae and Freddie Mac and that of credit-risk insurer AIG were not enough. This time upwards of $3 trillion in money-market funds, loaded with commercial paper that refinances credit-card debt and car loans, was on the skids because institutional investors were selling en masse. That could have wiped out the life savings of millions of ordinary Americans, who assumed that their money-market fund investments were as safe as bank deposits. Only a massive guarantee of public funds could arrest this slide toward oblivion.
In little more than one week, the map the U.S. financial world was redrawn. For starters, the Treasury planned to give the banks $700 billion of taxpayer money in exchange for disreputable debt securities, now spurned by the shrinking credit market – an arrangement aptly labeled by Princeton economist Paul Krugman as “cash for trash.” Some $50 billion was immediately earmarked to shore up the money funds. Five foreign central banks pitched in with new swap lines of $180 billion for dollar liquidity, which had been priced out of reach in the seizing interbank money market. Terrified by the fate of Lehman Bros., the remaining giants of Wall Street investment banking abandoned their free-wheeling business model or sought mergers with regulated commercial banks. Listed banks were placed under federal protection from short-selling. And the federal debt ceiling was set to be jacked up to $11.3 trillion to cover the government’s direct intervention. Up from $10.6 trillion, the new red number roughly matches a year’s gross domestic product.
“I believe we’re talking about a trillion dollars,” Rep. Richard Shelby of the House Banking Committee told a television audience, if one lumps in the $700 billion with odds and ends like Freddie, Fannie, AIG, the Federal Reserve’s $30 billion rescue of Bear Stearns and other public largesse since the crisis erupted the end of July 2007. At this point the taxpayer bailout of the appropriately nicknamed FIRE sector – finance, insurance, real estate – would still be a bargain – if indeed it rescues the smoldering dollar system.
Concern for the dollar
Since this is being done as usual on the open-ended tab of deficit-spending, however, unintended consequences may not be ruled out. “You can’t create money like we’re doing … because ultimately it hurts the dollar,” said Rep. Ron Paul, a fiscally conservative, 10-term congressman who objects to private financial gambling losses being socialized at the expense of the middle class. “One of these days we’re just going to have to wake up and say that we need to liquidate debt.”
Indeed, the public rescue announcement instantly changed the market outlook for the dollar. Gold, oil, the euro and other foreign currencies surged in tandem. Billionaire investor Jim Rogers predicted in a televised interview that the dollar would soon lose its world reserve status. And the foreigners who actually could pull the plug on the debt-burdened currency showed obvious impatience:
“The world urgently needs to create a diversified currency and financial system and fair and just financial order that is not dependent on the United States,” concluded a front-page commentary in China’s official state newspaper, People’s Daily, and signed by Professor Shi Jianxun of Shanghai’s Tongii University. Another finance professor, Xu Xiaonian, told a professional conference that “Wall Street’s meltdown is caused by Federal Reserve overissuing currency.” Since China is holding a vast stash of U.S. Treasury bonds to show for its export trade with the United States, reaction to the latest U.S. financial acrobatics has focused critically on U.S. policies that appear to devalue the dollar.
Endless credit expansion
No such concern for the currency can be found in Washington’s response to Wall Street’s latest problem, though. As in past financial emergencies, policymakers still seek salvation in the post-Bretton Woods economic paradigm of limitless credit expansion, private and public. Behind that bias is an impressive track record. U.S. growth, prosperity and rising domestic asset values of the past decade were partly driven by copious incoming foreign capital associated with the widening current account imbalance. Deficit trade financing was no problem amid the spreading use of the dollar, promoted by the international pricing convention for key traded commodities and heavy petrodollar recycling. Released from the stringent discipline of gold backing, the fiat currency already had an inherent tendency to expand. And the full benefits of worldwide dollar circulation, which wouldn’t have worked without deficits, made even the downside off-shoring effect on U.S. manufacturing seem like an acceptable tradeoff.
If deficit can turbocharge such a mighty growth engine, some might say, Pour it on! Alas, all good things turn toxic if done to excess. The markets’ current behavior shows how. The fact that close to half of the annual fiscal red ink is now also being covered by foreign creditors should have been a warning sign. Alone the congressional spending authorization for military policy measures in the 2009 fiscal year, for example, comes to $613 billion, almost rivaling the proposed fiscal bailout of Wall Street. The Congressional Budget Office projects a fiscal deficit of $407 billion, followed by more than $500 billion next year as the domestic economy weakens and the wars drag on at a cost of $2 billion a week. Yet this whole fiscal tapestry is interwoven with fraying threads of foreign confidence in the fiat dollar. The limping credit markets can be temporarily doped with another infusion of public money partly borrowed abroad. But the underlying predicament practically shouts for austerity. And that is nowhere in sight.
Translated into the modern neoliberal parlance, there seems to be something fundamentally wrong with the national business model. It has become overextended in the pursuit of both guns and butter, the provision of warfare and welfare. Much the same could have been said about the demise of the rival model of centrally planned economies nearly 20 years ago. That episode showed what can befall a system without a market mechanism or a real currency, things needed to mobilize dormant capital assets. The creeping paralysis of credit markets today has wholly different antecedents but could easily lead to a comparable political outcome. Reckless credit expansion has gradually undermined the currency. The crisis can’t end until balance is somehow restored between bloated debt and authentic collateral assets. An out-of-control financial sector that has been crowding out the production sector and hogging too much of the country’s wealth and economic resources must shrink back to normal size.
Years ago large investment banks began using the word “manufacturing” to describe what they do before their new financial products are moved onto the market. The broad money supply has ballooned apace with this creative financial manufacturing, and an exotic profusion of structured debt products and derivatives can now be found in public, private and institutional investment portfolios around the world. Much harder to find are the collateral assets with which these are supposedly backed. Meanwhile, U.S. policymakers failed to notice that the listed financial sector tripled its share of all profits to 30% in the past four decades as manufacturing withered. Like the junk bonds and fraudulent dot-coms of yore, none of the latest financial legerdemain troubled the laissez-faire regulators and the central bank until the market regurgitated some of this dubious paper. Too many large players now mistrust one another too much to enter the market without demanding huge risk premiums. Who know what the offered paper is worth or whether the counterparty is solvent? The cumulative effect of unrestrained credit expansion has all but crippled the market’s essential pricing mechanism.
A cash-for-trash intervention by the public lender of last resort offers at least a temporary respite from the systemic debt poisoning. If it critically weakens the dollar, though, it could also inadvertently nationalize the spreading crisis of confidence. “The end comes,” said Rep. Ron Paul, “when people reject the dollar, and I think we’re getting awfully close to this.”
Main Street vs. Wall Street
In Washington, congressional leaders agreed to quick bipartisan action on the rescue plan that would transfer extraordinary powers to the Treasury secretary, a former Goldman Sachs boss, while excluding all judicial and administrative review. But some lawmakers also balked at the prospect of unsupervised payouts to culpable special interests or speculators while homeowners and taxpayers bleed. Some compromise seemed inevitable.
Should Main Street be required to bailout Wall Street? That blunt question raised in the middle of the presidential election campaign rendered both candidates temporarily speechless. Skeptical of the proposed remedy, frustrated Americans set out in search of culprits for their financial dilemma. Blame for the meltdown was pinned variously on private greed, political corruption, interest conflicts, rollbacks of regulation, credit derivatives, assorted financial weapons of mass destruction, cynical kleptocrats with golden parachutes, the curse of neoliberalism, even an oligarchic coup against the middle class. Given the stakes involved, though, no one could offer a serious alternative to quick public intervention. In uncharacteristically diplomatic language, President Bush managed to sum it up best: “Confidence in our financial system and in its institutions is essential to the smooth operation of our economy, and recently that confidence has been shaken.”
If the purpose of the public rescue is to save a few well connected banks, the responsible answer must be a resounding No. If the alternative happens to be the credit market meltdown the government says it fears, then everyone must pitch in for the common good. But the abrupt commandeering of public funds to place at the disposal of private bankers demands frank discussion of whether U.S. elected officials are now more responsive to influential special interests than to their broader constituency. Thoughtful voters who cannot afford to live in gated communities might now reflect on Aristotle’s observation that democracy is the evolutionary stage a society passes through before oligarchy.
