Wednesday, July 23, 2008

The self-destruction of debt capitalism.

I recommend to you an article by renowned economist Henry Liu which explains how our economy is imploding.

Asia Times Online
Jul 22, 2008
Debt capitalism self-destructs
By Henry C K Liu

An excerpt from page four:

...The problem of this good policy intention [of near universal home ownership] was that during the era of neoliberal ascendancy, the light regulatory environment was used to negate a more fundamental economic law: the need to increase worker income to match mortgage payments, subsidized or not.

The GSEs have been financially successful because they combine private sector appetite for profit with access to government-backed credit at below market rates. It was a way to nationalize housing through the free market capitalism. The problem was that financial manipulation cannot replace the need for adequate income growth. The mismatch of income with asset price is the definition of a financial bubble. People were buying homes with cheap credit at prices that their income could not afford. The more home prices rose due to cheap credit, the more homeowners fell into the debt trap.

Yet in all the current talk about finding ways to deal with the crisis, not one single voice is heard from official circles about the need to increase worker income. Instead, false hopes on one-time stimulant tax rebates are hailed as the magic bullet....

...The bigger problem for Washington is that merely stabilizing Fannie and Freddie is not enough. With US banks seriously distressed by the credit crisis, the GSEs, which hold or guarantee 22% of the $24.3 trillion outstanding debts borrowed by US households and the non-financial sector, are a major source of credit. Yet the market is clearly uncomfortable with the inability of the GSEs to maintain its over-bloated balance sheet. The options are either to shrink the balance sheet drastically, thus exacerbating the credit crisis, or to seek a massive injection of new capital, both requiring government action at an unprecedented scale.

Despite these ad hoc measures, which may or may not receive congressional approval, the whole world knows that credit capacity is shrinking drastically in the market. There are rumors that the US is pressing foreign central banks to acquire more GSE debt, but the market is inundated with fear of new crises before the housing market recovers. And the housing market is lying in a coma in intensive care with an oxygen tank of new credit running near empty.

As the housing market collapses, both GSE companies are reporting steep losses. But the subprime mortgage meltdown has also made the GSEs more important than ever in holding up the housing finance sector. Since the credit markets seized up, Fannie and Freddie have regained their central role in mortgage finance after losing significant market share to investment banks during the housing boom. They have issued the vast majority of mortgage securities sold in the last six months because investors have lost confidence in deals put together by big investment banks...

...While officials in successive administrations, both Republican and Democrat, have for many years repeatedly denied that the trillions of dollars of debt Fannie and Freddie issued is guaranteed by the government, the Paulson package, if adopted, would bring the Treasury closer than ever to exposing taxpayers to potentially huge new liabilities. The two GSEs are expected to face significant new losses this year as the wave of housing foreclosures continues and rises...

...While many expect Congress to have no option except to approve the Paulson plan, a few skeptics were voicing their opposition in public hearings. Senator Jim Bunning, a Republican from Kentucky, described Paulson as "asking for a blank check ... for this unprecedented intervention in our free markets." He also vowed to try his best to stop a proposal that would give the Federal Reserve sweeping new powers aimed at protecting the nation's shaky financial system. Bunning said the Federal Reserve "can't be trusted with the power it already has". He says the Fed's policies in recent years have contributed to economic woes, including surging inflation, a declining dollar and the housing bust.

"When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed's purchase of Bear Stearns' assets was amateur socialism compared to this," thundered the Republican Senator against his own party's Treasury secretary. In US political discourse, socialism is a dirty word, albeit what Paulson proposes is not anywhere near what socialism is commonly understood to be in the rest of the world, but a scheme to use public funds to save debt capitalism by frustrating the right to fail in market capitalism...

...Ron Paul, Republican congressman from Texas, told Bernanke that the Federal Reserve is a "predatory lender". But he did not mention that by law, predatory lenders forfeit any right of collection.

Lender liability is embodied in common and statutory law covering a broad spectrum of claims surrounding predatory lending. It is a key concept in environmental-cleanup litigation. If a lender knowingly lends to a borrower who is obviously unable to make reasonable beneficial gain from the use of the funds, or causes the borrower to assume responsibilities that are obviously beyond the borrower's capacity, the lender not only risks losing the loan without recourse but is also liable for the financial damage to the borrower caused by such loans. For example, if a bank lends to a trust client who is a minor, or someone who had no business experience, to start a risky business that resulted in the loss not only of the loan but of the client trust account, the bank may well be required by the court to make whole the client.

In the United States, although predatory lending is not defined by federal law, and various states define abusive lending differently, it usually involves practices that strip equity away from a homeowner, or equity from a company, or condemn the debtor into perpetual indenture. Predatory or abusive lending practices can include making a loan to a borrower without regard to the borrower's ability to repay, repeatedly refinancing a loan within a short period of time and charging high points and fees with each refinance, charging excessive rates and fees to a borrower who qualifies for lower rates and/or fees offered by the lender, or imposing new unjustifiably harsh terms for rolling over existing debt. Predation breaks the links between an economy's aggregate resource endowment and aggregate consumption and between the interpersonal distribution of endowments and the interpersonal distribution of consumption...

...The argument for Third World debt forgiveness contains large measures of lender liability and predatory lending. Debt securitization allows predatory bankers to pass the risk to global credit markets, socializing the potential damage after skimming off the privatized profits. The housing bubble has been created largely by predatory lending without any lender liability. The argument for forgiving Third World debt is applicable to low- and moderate-income home mortgage borrowers in the US as well. Let's hear some proactive commitments from the presumptive candidates of both political parties instead of empty populist campaign rhetoric.


To render that into somewhat plainer English, the robber barons acted as predators, purposefully keeping wages down and knowingly leading their prey into business/mortgage transactions they could not afford - which under the law in most countries means that not only are the victims not liable for the mortgage loans, but the robber barons should be made to compensate each and every victim to restore their finances and credit. And then the banks and investment houses should be allowed to go bankrupt, because that's what happens in a real free market. You screw up, you go out of business. The principle should be the same whether we're talking about the corner store or giant firms like bear sterns and goldman sachs.

Any suggestion that the government has an obligation to prop up the robber barons is completely against so called free market capitalism, which the robber barons have been using as their excuse to rob everyone blind. They lived by it, they should be allowed to die by it.

In other words, you reap what you sow.

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