[THS] Mike Whitney: Was There A Plan to Blow Up The Economy?

[The Harder Stuff in news and commentary]

http://www.informationclearinghouse.info/article25367.htm

Was There A Plan to Blow Up The Economy?

By Mike Whitney

May 03, 2010 "Information Clearing House" --Many people now believe that the
financial crisis was not an accident. They think that the Bush administration and the
Fed knew what Wall Street was up to and provided their support. This isn't as far
fetched as it sounds. As we will show, it's clear that Bush, Greenspan and many other
high-ranking officials understood the problem with subprime mortgages and knew
that a huge asset bubble was emerging that threatened the economy. But while the
housing bubble was more than just an innocent mistake, it doesn't rise to the level of
"conspiracy" which Webster defines as  "a secret agreement between two or more
people to perform an unlawful act."  It's actually worse than that, because
bubblemaking is the dominant policy, and it's used to overcome the structural
problems in capitalism itself, mainly stagnation.

  The whole idea of a conspiracy diverts attention from what really happened. It
conjures up a comical vision of  top-hat business tycoons gathered in a smoke-filled
room stealthily mapping out the country's future. It ignores the fact, that the main
stakeholders don't need to convene a meeting to know what they want.They already
know what they want; they want a process that helps them to maintain profitability
even while the "real" economy remains stuck in the mud.  Historian Robert Brenner
has written extensively on this topic and dispels the mistaken view that the economy
is "fundamentally strong". (in the words of former Treasury secretary Henry Paulson)
Here's Brenner :

"The current crisis is more serious than the worst previous recession of the postwar
period, between 1979 and 1982, and could conceivably come to rival the Great
Depression, though there is no way of really knowing. Economic forecasters have
underestimated how bad it is because they have over-estimated the strength of the
real economy and failed to take into account the extent of its dependence upon a
buildup of debt that relied on asset price bubbles. In the U.S., during the recent
business cycle of the years 2001-2007, GDP growth was by far the slowest of the
postwar epoch. There was no increase in private sector employment. The increase in
plants and equipment was about a third of the previous, a postwar low. Real wages
were basically flat. There was no increase in median family income for the first time
since World War II. Economic growth was driven entirely by personal consumption
and residential investment, made possible by easy credit and rising house prices.
Economic performance was weak, even despite the enormous stimulus from the
housing bubble and the Bush administration's huge federal deficits. Housing by itself
accounted for almost one-third of the growth of GDP and close to half of the increase
in employment in the years 2001-2005. It was, therefore, to be expected that when
the housing bubble burst, consumption and residential investment would fall, and the
economy would plunge. " ("Overproduction not Financial Collapse is the Heart of the
Crisis", Robert P. Brenner speaks with Jeong Seong-jin, Asia Pacific Journal)

What Brenner describes is an economy that's flat on its back; an economy that--
despite unfunded tax cuts, massive military spending and gigantic asset bubbles--can
barely produce positive growth.  The pervasive lethargy of mature capitalist
economies, poses huge challenges for industry bosses who are judged solely on their
ability to boost quarterly profits. Goldman's Lloyd Blankfein and JPM's Jamie Dimon
could care less about economic theory, what they're interested in is making money;
how to deploy their capital in a way that maximizes return on investment. "Profits",
that's it.  And that's much more difficult in a world that's saturated with overcapacity
and flagging demand.  The world doesn't need more widgets or widget-makers. The
only way to ensure profitability is to invent an alternate system altogether, a new
universe of financial exotica (CDOs, MBSs, CDSs) that operates independent of the
sluggish real economy. Financialization provides that opportunity. It allows the main
players to pump-up the leverage, minimize capital-outlay, inflate asset prices, and
skim off record profits even while the real  economy endures severe stagnation.

Financialization provides a  path to wealth creation, which is why the sector's portion
of total corporate profits is now nearly 40 percent. It's a way to bypass the pervasive
inertia of the production-oriented economy. The Fed's role in this new paradigm is to
create a hospitable environment (low interest rates) for bubble-making so the
upward transfer of wealth can continue without interruption. Bubblemaking is policy.

As we've pointed out in earlier articles, scores of people knew what was going on
during the subprime fiasco. But it's worth a quick review, because Robert Rubin, Alan
Greenspan, Timothy Geithner, and others have been defending themselves saying,
"Who could have known?".

The FBI knew ("In September 2004, the FBI began publicly warning that there was
an "epidemic" of mortgage fraud, and it predicted that it would produce an
economic crisis, if it were not dealt with.") The FDIC knew. ( In testimony before the
Financial Crisis Inquiry Commission, FDIC chairman Sheila Bair confirmed that she not
only warned the Fed of what was going on in 2001, but cited particular regulations
(HOEPA) under which the Fed could stop the "unfair, abusive and deceptive
practices" by the banks.) Also Fitch ratings knew, and even Alan Greenspan's good
friend and former Fed governor Ed Gramlich knew. (Gramlich personally warned
Greenspan of the surge in predatory lending that was apparent as early as 2000.
Here's a bit of what Gramlich said in the Wall Street Journal:

    "I would have liked the Fed to be a leader" in cracking down on predatory
lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this
past week. Knowing it would be controversial with Mr. Greenspan, whose
deregulatory philosophy is well known, Mr. Gramlich broached it to him personally
rather than take it to the full board.

    "He was opposed to it, so I didn't really pursue it," says Mr. Gramlich. (Wall Street
Journal)

So, Greenspan knew, too. And, according to Elizabeth MacDonald  in an article titled
"Housing Red flags Ignored":

"One of the nation’s biggest mortgage industry players repeatedly warned the
Federal Reserve, the Federal Deposit Insurance Corp. and other bank regulators
during the housing bubble that the U.S. faced an imminent housing crash....But
bank regulators not only ignored the group's warnings, top Fed officials also went on
the airwaves to say the economy was "building on a sturdy foundation" and a
housing crash was "unlikely."

    So, the Mortgage Insurance Companies of America [MICA] also knew. And, here's
a clip from the Washington Post by former New York governor Eliot Spitzer who
accused Bush of being a ‘partner in crime’ in the subprime fiasco. Spitzer says that
the OCC launched “an unprecedented assault on state legislatures, as well as on state
attorneys general just to make sure the looting would continue without interruption.
Here's an except from Spitzer's article:


    "In 2003, during the height of the predatory lending crisis....the OCC promulgated
new rules that prevented states from enforcing any of their own consumer protection
laws against national banks. The federal government’s actions were so egregious and
so unprecedented that all 50 state attorneys general, and all 50 state banking
superintendents, actively fought the new rules. (Washington Post)

    So, the Fed knew, the Treasury knew, the FBI knew, the OCC knew, the FDIC
knew, Bush knew, the Mortgage Insurance Companies of America knew, Fitch ratings
knew, all the states Attorneys General knew, and thousands, of traders, lenders,
ratings agency executives, bankers, hedge fund managers, private equity bosses,
regulators knew. Everyone knew, except the unlucky people who were victimized in
the biggest looting operation of all time.

  Once again, looking for conspiracy, just diverts attention from the nature of the
crime itself. Here's a statement from former regulator and white collar criminologist
William K. Black which helps to clarify the point:

"Fraudulent lenders produce exceptional short-term “profits” through a four-part
strategy: extreme growth (Ponzi), lending to uncreditworthy borrowers, extreme
leverage, and minimal loss reserves. These exceptional “profits” defeat regulatory
restrictions and turn private market discipline perverse. The profits also allow the CEO
to convert firm assets for personal benefit through seemingly normal compensation
mechanisms. The short-term profits cause stock options to appreciate. Fraudulent
CEOs following this strategy are guaranteed extraordinary income while minimizing
risks of detection and prosecution." (William K. Black, "Epidemics of 'Control Fraud'
Lead to Recurrent, Intensifying Bubbles and Crises", University of Missouri at Kansas
City - School of Law)

Black's definition of "control fraud" comes very close to describing what really took
place during the subprime mortgage frenzy. The investment banks and other
financial institutions bulked up on garbage loans and complex securities backed by
dodgy mortgages so they could increase leverage and rake off large bonuses for
themselves. Clearly, they knew the underlying collateral was junk, just as they knew
that eventually the market would crash and millions of people would suffer.

But, while its true that Greenspan and the Wall Street mandarins knew how the
bubble-game was played; they had no intention of blowing up the whole system.
They simply wanted to inflate the bubble, make their profits, and get out before the
inevitable crash.  But, then something went wrong. When Lehman collapsed, the
entire financial system suffered a major heart attack. All of the so-called "experts"
models turned out to be wrong.

Here's what happened: Before to the meltdown, the depository "regulated" banks
got their funding through the repo market by exchanging collateral (mainly
mortgage-backed securities) for short-term loans with the so-called "shadow banks"
(investment banks, hedge funds, insurers) But after Lehman defaulted, the funding
stream was severely impaired because the prices on mortgage-backed securities kept
falling. When the bank-funding system went on the fritz,  stocks went into a nosedive
sending panicky investors fleeing for the exits. As unbelievable as it sounds, no one
saw this coming.

The reason that no one anticipated a run on the shadow banking system, is because
the basic architecture of the financial markets has changed dramatically in the last
decade due to deregulation. The fundamental structure is different and the
traditional stopgaps have been removed. That's why no one knew what to do during
the panic. The general assumption was that there would be a one-to-one relationship
between defaulting subprime mortgages and defaulting mortgage-backed securities
(MBS). That turned out to be a grave miscalculation. The subprimes were only failing
at roughly 8 percent rate when the whole secondary market collapsed. Former
Treasury Secretary Paul O'Neill explained it best using a clever analogy. He said, "It's
like you have 8 bottles of water and just one of them has arsenic in it. It becomes
impossible to sell any of the other bottles because no one knows which one contains
the poison."

  And that's exactly what happened. The market for structured debt crashed, stocks
began to plummet, and the Fed had to step in to save the system. Unfortunately,
that same deeply-flawed system is being rebuilt brick-by-brick without any
substantive changes.. The Fed and Treasury support this effort, because--as agents
of the banks--they are willing to sacrifice their own credibility to defend the primary
profit-generating instruments of the industry leaders. (Goldman, JPM, etc) That
means that Bernanke and Geithner will go to the mat to oppose any additional
regulation on derivatives, securitization and off-balance sheet operations, the same
lethal devices that triggered the financial crisis.

   So, there was no conspiracy to blow up the financial system, but there is an implicit
understanding that the Fed will serve the interests of Wall Street by facilitating asset
bubbles through "accommodative" monetary policy and by opposing regulation. It's
just "business as usual", but it's far more damaging than any conspiracy, because it
ensures that the economy will continue to stagnate, that inequality will continue to
grow, and that the gigantic upward transfer of wealth will continue without pause.