Wednesday, October 15, 2008

Not Enough Money In The World To Fix Things

The Real Monster In The Meltdown Closet
Written By Chris Floyd
10-15-8

The myth has quickly taken hold that the global financial crash was caused by bad mortgages.
This has allowed rightwing hatemongers to blame the meltdown on the "liberal" programs
that encouraged home ownership among a small percentage of lower-income people (a poisonous
canard that parts of the mainstream media have actually done a fairly good job of knocking
down), while "progressives" of various stripes have denounced banks and other financial institutions
for pushing over-easy credit on people who couldn't really afford it.

Unsustainable mortgages are a key factor in the global crash, of course. And many people (most of
them white, by the way) did take out mortgages they would not be able to afford if the housing bubble
ever burst, which it has, most spectacularly. And yes, it is undeniable that the financial services
industry has been tempting people with easy credit like schoolyard pushers flashing reefers.

All of this was bound to end badly, and did. But this alone would not have been enough to threaten
the destruction of the entire global financial system, nor cause the blind, screaming panic that has
strangulated the financial markets, seized up the vital flow of money between banks, and caused the
"free" market-worshipping governments of the Western world to carry out nationalizations and
interventions that, in sheer numbers, dwarf anything ever seen following a Communist revolution.
(As John Lancaster notes in the London Review of Books, the Bush Administration's takeover of
Fannie Mae and Fannie Mac alone was "was, by cash value, the biggest nationalisation in the
history of the world." And that was just the beginning.)

What has struck mortal fear in the heart of markets and governments is not bad mortgages,
but the almost incomprehensibly huge and complex market for "derivatives," based in part on
mortgage debt -- but also on a vast array of other sources that were "securitized," turned into
tradable if ghostly commodities then sold off in a bewildering variety of increasingly arcane forms.
This was accompanied by the expansion of yet another vast market in insurance mechanisms
designed to protect these derivatives -- mechanisms which themselves became "securitized."

At the same time, the financial services industry used its paid bagmen in governments around
the world to loosen almost all restrictions not only on securitization and the trading of derivatives,
but also on the amount of debt that institutions could take on in order to play around in these
vastly expanded and deregulated markets. For example, as Lancaster points out, UK's Barclays
Bank had a debt-to-equity ratio of 63 to 1:
Imagine that for a moment translated to your own finances, so that you could stretch what you
actually, unequivocally own to borrow more than sixty times the amount. (I'd have an island.
What about you?)

The result of all this has been the construction of a gargantuan house of cards, based on next
to nothing, and left alone in the shadow of building "perfect storm" of greed, deregulation and
political corruption.

That storm has now struck. The house of cards has fallen down, and revealed a hole of
derivatives-based debt that could not be filled, literally, by all the money in the world, much
less by the mere trillions that national governments are frantically throwing at it today.

Yes, "mere" trillions. As Will Hutton explains in the Observer:

...the dark heart of the global financial system [is] the $55 trillion market in credit derivatives
and, in particular, credit default swaps, the mechanisms routinely used to insure banks
against losses on risky investments. This is a market more than twice the size of the combined GDP
of the US, Japan and the EU. Until it is cleaned up and the toxic threat it poses is removed, the
pandemic will continue. Even nationalised banks, and the countries standing behind them,
could be overwhelmed by the scale of the losses now emerging.


Try to imagine that: a $55 trillion market now at risk of complete destruction. Even the derivative
debt owed by individual institutions stands at nation-wrecking levels. For example, a single
bank in Britain, Barclays again, holds more than $2.4 trillion in credit default swaps, the tradable
"insurance" mechanism against securities default. This is more than the entire GDP of Great Britain.
If all this paper goes bad, there are not enough assets in the entire country to pay it off. And that's
just one bank, in one country.

Hutton gives the details:

This market in credit derivatives has grown explosively over the last decade largely in response to the
$10 trillion market in securitised assets - the packaging up of income from a huge variety of
sources (office rents, port charges, mortgage payments, sport stadiums) and its subsequent sale as
a 'security' to be traded between banks.

Plainly, these securities are risky, so the markets invented a system of insurance. A buyer of a
securitised bond can purchase what is in effect an insurance contract that will protect him or
her against default - a credit default swap (CDS). But unlike the comprehensive insurance contract on
your car which you have with one insurance company, these credit default contracts can be
freely bought and sold. Complex mathematical models are continually assessing the risk and
comparing it to market prices. If the risk falls, the CDSs are cheap; if the risk rises - because,
say, a credit rating agency declares the issuing company is less solid - the price rises. Hedge funds
speculate in them wildly.

Their purpose was a market solution to make securitisation less risky; in fact, they make it more
risky, as we are now witnessing. The collapse of Lehman Brothers - the refusal to bail it out has
had cataclysmic consequences - means that it can no longer honour $110bn of bonds, nor
$440bn of CDSs it had written. On Friday, the dud contracts were auctioned, with buyers paying a
paltry eight cents for every dollar. Put another way, there is now a $414bn hole which somebody
holding these contracts has to honour. And if your head is spinning now, add the three bust
Icelandic banks. They can no longer honour more than $50bn of bonds, nor a mind-boggling
$200bn of CDSs....

While every bank tries to pass the toxic parcel on to somebody else, the system has to find the money.
So will compensation for the near valueless contracts and thus now uninsured debt ultimately
be made - and by whom? And because nobody knows - not the regulators, banks or governments -
who owns the swaps and whether they are credit-worthy, nobody can answer the question. Maybe
holders of insurance policies will get the cash due to them, but will that weaken somebody else?
The result - panic.

This is the ultra-dangerous downward vortex in which the system is locked. It is why share prices
are plummeting. As recession deepens, there will be defaults on securitised bonds and the
potential collapse of more banks outside the G7 ring-fence. Nobody knows what proportion of
the $55 trillion of credit default contracts that have actually been written will be honoured and
who might bear losses running into trillions of dollars.

This is the beast in the dark that is haunting the feckless leaders of the developed world: $55
trillion of unaccountable debt, and no way of knowing how much of it is even now being flushed
down the toilet, taking the global economy with it.

The massive interventions we are seeing might stabilize the markets temporarily, or at least arrest
their free fall long enough to come up with some kind of massive restructuring of the global
financial system. Or they might not. For it is by no means certain that the wisdom, and the political
courage, to come up with a more viable system can be found among the world's political leaders -- all
of whom, as we noted here the other day, have risen within the present system and, to one degree or
another, owe their own power and privilege to the "malefactors of great wealth" and the extremist
cult of market fundamentalism. There is no indication anywhere that the circle of collusion and
corruption between governments and Big Money has even lessened, much less been broken, by the
economic catastrophe. All of the various bailout plans and "coordinated actions" still have as
their chief aim the preservation of the malefactors in their current state of wealth, privilege and
domination. As Jonathan Schwarz notes:

Still, U.S. elites will try to impose as much of a structural adjustment as they can get away with,
in order to make the bottom 80% of America pay the price for the elites' spectacular screw-ups.
The Washington Post has already started writing about how the current crisis demonstrates
that we must cut Social Security. Look for much more of this to come.

The only slim hope we have for any genuine reform -- even an imperfect, conflicted, compromised
reform, which is the only kind we will ever have in this world, until the lion lies down with the
lamb -- is that the sheer scale of the real problem -- the $55 trillion beast, the very real potential
for the complete destruction of the global economy, and the state power that depends upon it -- might
force some politicians to turn apostate, renounce the market cult, and bite the hands that have fed
them for so long.

Absent this near-miraculous possibility, we will be left with yet another rickety house of cards,
slapped together on the fly -- largely at the malefactors' direction and for their benefit -- while the
beast gapes wide his ponderous jaws, and prepares to swallow us whole.


http://www.chris-floyd.com/component/content/article/3/1628-not-enough
-money-in-the-world-the-real-monster-in-the-meltdown-closet.html


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