transcript by Peter Myers, July 30, 2009
Fred Harrison: How do we solve the Debt problem today?
Michael Hudson: The only way to do it is to wipe out the debts that can't be paid. If a mortgage is $500,000 on a $250,000 house, you've got to write down the mortgage to the market price, and you've got to have the creditors take a loss for their bad loans. (And we may ask ourselves that as this is the obvious path to go, why did no government TD in Ireland suggest this solution? Jocelyn Braddell, editor)
FH: Is the bailout of the banks going to solve this financial crisis?
MH: No, the bailout of the banks is only paying the creditors, and giving the creditors the money for the bank loans, without giving a penny of debt relief to the actual debtors who owe the loans. All it means is that the government is taking over the creditor position, and it's taking out the home-owners, and throwing the homes on the market.
FH: But won't the tax-payers get their money back in the end?
MH: If the tax-payers could get their money back, then you can be sure that private enterprise would have come in, and THEY would have bought the mortgages. If you have the market-place NOT buying the mortgages, if you have the banks saying, "These are JUNK mortgages, and this is toxic waste", how on earth can the tax-payers make money off toxic waste? Is it really a good investment for the tax-payers to come in and bail out the banks that say, "We've made junk mortgages, and this is toxic waste, and we weren't able to sell it, to find a greater fool." There's no way the tax-payers can make money out of that.
FH: Ok, now I know you've been an economist in Wall St., you teach economics in universities, all over the world, actually. You're a consultant to governments around the world, and yet you think there are lessons to be learned from the Ancient World that somehow in the Biblical times the debt-cancellation was something that we can learn from today. In what way?
MH: Well, for 3,000 years, from Sumer to Babylonia to the Jewish lands with the Jubilee law, they all had the same policy. And when a new ruler would take the throne for the second year in Babylonia and Sumer, he had a three-pronged solution: he would liberate the debt-bondsmen, he would return the lands to people who'd lost them for foreclosure, for homes the basic self-support - and he would annul the personal debts. And by wiping the bad debts off the books, he'd create a clean slate. And this was exactly the policy that was taken over in Jewish law, in Leviticus, by the Jubilee Year.
FH: So you're now saying that there is a way to translate that history into modern economics, to solve the global financial crisis.
MH: Yes. Antiquity managed to last for 3,000 years, without a financial bubble, without an economic bubble, and continually restoring order. And Antiquity realized something that the modern economists don't: they realized that debts tend to grow in excess of the ability to pay. And when the debts did that in Antiquity, the ruler would cancel the debts. Now that was very easy in Antiquity, because most debts were tax debts owed to the Palace and it's easy to cancel debts when the debts are owed to you. It's harder to cancel debts once you got to Greece and Rome, and the debts were owed to private creditors; that's where the problem began.
FH: So, now, 2,000 years later, we can't just cancel the debts by rule of the Government.
MH: Well, you actually can, because the debts are going to be written off already they estimate they've said there are 8 trillion dollars worth of bad real estate debts. Now if the Government would have just left market conditions to take their place, when Lehman Brothers went bankrupt in September, Lehman Brothers mortgages were trading on the market at 22 cents on the $. Now at this point, buyers could have come in, bought the mortgages at 22 cents on the $, and then gone to the home-owners and the real-estate on this, and said, "OK, we're going to re-negotiate your mortgage at 22 cents, maybe 24 cents on the $, or even 25 cents on the $" - that would have given them a profit. They would have marked down the debts to the ability to pay, or to the market price. And one way or other the debts are going to have to be written down to the ability to pay, otherwise they're not going to be paid. If people can't pay more debt, they won't pay. The question is, "How won't they pay"?
FH: So why aren't Governments doing that, writing off the debts, or allowing the debts to be cancelled today?
MH: Very good question. The reason is that the largest contributor to the political campaigns is the Financial Sector, and the Governments have a choice they can save the economy, or they can save the creditors who made the bad loans. They've said, "We don't care about the economy, we're bailing out the creditors that's our constituency." And that's what the Governments are doing today. They're not saving the economy; they're saving their constituency, the creditors: they're saving London City, they're saving Wall St., and they're saving the bourse, and the economy's left to shrink. And until the Government saves the economy, and writes down the debts to the ability to pay, there's not going to be a recovery.
FH: You're saying, then, Governments are acting in bad faith.
MH: They're not acting democratically. What the Governments have done has been to turn from a Democracy into an Oligarchy. And we're seeing an Oligarchy, and in fact a Kleptocracy emerge here. And the Governments are not doing what the people expected them to do they're not representing the interests of their constituents.
FH: But President Obama says he's going to effect a change, it's not business as usual in Washington.
MH: When Obama talks about change, he's not talking about financial change; he's not talking about economic change. He's talking about workmen's laws, health reform, racial equality; he's not talking about any economic change at all, because, in fact, he's re-appointed the Bush administrators and the Clinton administrators. He's brought back the same people who brought us the Russian crisis. And if you want to see what their plans are for the United States, look what Obama's team did when they had a free hand in Russia in the 1990s. They brought the biggest inequality and kleptocracy in modern times.
FH: So, Michael, you're in London to address a conference here at the University of London. What is it that you're going to tell them?
MH: Well, I'm going to tell them that the Finance sector, and the Real Estate and the Insurance sector are not part of the real economy of production and consumption. The asset and wealth sector is different from the production sector. You can think of the financial sector as being wrapped around the real economy, almost like a parasite, and that's why it's been called parasitic for so long. The financial sector extracts interest from the economy, the property sector extracts economic rent, as do monopolies. Now the key thing about parasites, is that it's not simply that they extract nourishment from the host. The parasite takes over the host's brain, to make it think it's part of the economy, to make it think it's part of the host's own body, and, in fact, that's it almost like a child of the host, to be protected. And that's what the financial sector has done today. You have Obama coming out and saying, "We have to save the banks in order to save the real economy." The fact is, you can't serve both the parasite and the host.
Now the amazing thing is that we have the economic training tablets from Babylonia, from 2000 BC, and the mathematical models they had of the economy, in 2000 BC, are more sophisticated than any of the mathematical models that they use today for government planning. And the reason is that they calculated how long it takes for a debt to double. Any interest-rate has a doubling time. They knew in 2,000 BC that the debts double; they also knew that the economy grew in an S-curve. They had mathematical models for the growth of herds in an S-curve, for agricultural production, so they knew that the tendency was for debts to grow faster than the economy can grow, and that's why, when every new ruler took the throne, they cancelled the debts.
FH: But, look, we've had Nobel-prize-winning economists telling hedge funds how to operate. Are you saying they are clueless on mathematics?
MH: Well, that's a very good question. You look at the fact that Long Term Credit Management went broke using the Nobel-prize-winners. The mathematical models that won the Nobel Prize have led to 450 trillion dollars of Derivative contracts that are now junk. So, what they won the Nobel Prize for, is junk mathematics that have led to junk derivatives and junk mortgages. That's what's happened.
To understand this particular giveaway, look back to September 21, 2008. It was a frenzied night for Goldman Sachs and the only other remaining major investment bank, Morgan Stanley. Their three main competitors were gone. Bear Stearns had been taken over by JPMorgan Chase in March, 2008, Lehman Brothers had just declared bankruptcy due to lack of capital, and Bank of America had been pushed to acquire Merrill Lynch because the firm didn't have enough cash to survive on its own. Anxious to avoid a similar fate, hat in hand, they came to the Fed for access to desperately needed capital. All they had to do was become bank holding companies to get it. So, without so much as clearing the standard five-day antitrust waiting period for such a change, the Fed granted their wish.
Bank holding companies (which all the biggest financial firms now are) come under the regulatory purview of the Fed, the Office of the Comptroller of the Currency, and the FDIC. The capital they keep in reserve in case of emergency (like, say, toxic assets hemorrhaging on their books, or credit derivatives trades not being paid) is supposed to be greater than investment banks'. That's the trade-off. You get access to federal assistance, you pony up more capital, and you take less risk.
Goldman didn't like the last part. It makes most of its money speculating, or trading. So it asked the Fed to be exempt from what's called the Market Risk Rules that bank holding companies adhere to when computing their risk.
Keep in mind that by virtue of becoming a bank holding company, Goldman received a total of $63.6 billion in federal subsidies (that we know aboutprobably more if the Fed were ever forced to disclose its $7.6 trillion of borrower details). There was the $10 billion it got from TARP (which it repaid), the $12.9 billion it grabbed from AIG's spoilseven though Goldman had stated beforehand that it was protected from losses incurred by AIG's free fall, and if that were the case, would not have needed that money, let alone deserved it. Then, there's the $29.7 billion it's used so far out of the $35 billion it has available, backed by the FDIC's Temporary Liquidity Guarantee Program, and finally, there's the $11 billion available under the Fed's Commercial Paper Funding Facility.
Tactically, after bagging this bounty, Goldman asked the Fed, its new regulator, if it could use its old risk model to determine capital reserves. It wanted to use the model that its old investment bank regulator, the SEC, was fine with, called VaR, or value at risk. VaR pretty much allows banks to plug in their own parameters, and based on these, calculate how much risk they have, and thus how much capital they need to hold against it. VaR was the same lax SEC-approved risk model that investment banks such as Bear Stearns and Lehman Brothers used, with the aforementioned results.
On February 5, 2009, the Fed granted Goldman's request. This meant that not only was Goldman getting big federal subsidies, but also that it could keep betting big without saving aside as much capital as the other banks. Using VaR gave Goldman more leeway to, well, accentuate the positive. Yes, Goldman is a more risk-prone firm now than it was before it got to play with our money.
Which brings us back to these recent quarterly earnings. Goldman posted record profits of $3.4 billion on revenues of $13.76 billion. More than 78 precent of those revenues came from its most risky division, the one that requires the most capital to operate, Trading and Principal Investments. Of those, the Fixed Income, Currency and Commodities (FICC) area within that division brought in a record $6.8 billion in revenues. That's the division, by the way, that I worked in and that Lloyd Blankfein managed on his way up the Goldman totem pole. (It's also the division that would stand to gain the most if Waxman's cap-and-trade bill passes.)
Since Goldman is trading big with our money, why not also use it to pay big bonuses? It's not like there are any strings attached. For the first half of 2009, Goldman set aside $11.4 billion for compensation34 percent more than for the first half of 2008, keeping them on target for a record bonus yeareven though they still owe the federal government $53.6 billion, a sum more than four times that bonus amount.
But capital is still key. Capital is the lifeblood that pumps through a financial organization. You can't trade without it. As of June 26, 2009, Goldman's total capital was $254 billion, but that included $191 billion in unsecured long-term borrowing (meaning money it had borrowed without putting up any collateral for it). On November 28, 2008 (4Q 2008), it had only $168 billion in unsecured long-term borrowing. Thus, its long-term unsecured debt jumped 14 percent. Though Goldman doesn't disclose exactly where all this debt comes from, given the $23 billion jump, we can only wonder whether some of it has come from government subsidies or the Fed's secret facilities.
Not only that, by virtue of how it's set up, most of Goldman's unsecured funding comes in through its parent company, Group Inc. (Think the top point of an umbrella with each spoke being a subsidiary.) This parent parcels that money out to Goldman's subsidiaries, some of which are regulated, some of which aren't. This means that even though Goldman is supposed to be regulated by the Fed and other agencies, it has unregulated elements receiving unsecured fundingjust like before the crisis, but with more of our money involved.
As for JPMorgan Chase, its profit of $2.7 billion was up 36 percent for the second quarter of 2009 vs. the same quarter last year, but a lot of that also came from trading revenues, meaning its speculative endeavors are driving its profits. Over on the consumer side, the firm had to set aside nearly $30 billion in reserve for credit-related losses. Riding on its trading laurels, when its consumer business is still in deterioration mode, is not a recipe for stability, no matter how much cheering JPMorgan Chase's results got from Wall Street. Betting is betting.
Let's pause for some reflection: The bank "stars" made most of their money on speculation, got nearly $124 billion in government guarantees and subsidies between them over the past year and a half, yet saw continued losses in the credit products most affected by consumer credit problems. Both are setting aside top-dollar bonuses. JPMorgan Chase CEO Jamie Dimon mentioned that he's concerned about attracting talent, a translation for wanting to pay investment bankers big bucksbecause, after all, they suffered so terribly last year, and he needs to stay competitive with his friends at Goldman. This doesn't add up to a really healthy scenario. It's more like bad déjà vu.
As a recent New York Times article (and many other publications in different words) said, "For the most part, the worst of the financial crisis seems to be over." Sure, the crisis may appear to be over because the major banks of Wall Street are speculating well with government subsidies. But that's a dangerous conclusion. It doesn't mean that finance firms could thrive without the artificial, public-funded assistance. And it certainly doesn't mean that consumers are any better off than they were before the crisis emerged. It's just that they didn't get the same generous subsidies.
Additional research by Clark Merrefield.