Quote:Parsing Mr. Paulson’s Bailout Speech: The Unprecedented Giveaway of Financial Wealth

by Michael Hudson

Mr. Paulson¹s bailout speech on Monday, October 13 poses some fundamental economic questions: What is the impact on the economy at large of this autumn¹s unprecedented creation and giveaway of financial wealth to the wealthiest layer of the population? How long can the Treasury¹s bailout of Wall Street (but not the rest of the economy!) sustain a debt overhead that is growing exponentially? Is there any limit to the amount of U.S. Treasury debt that the government can create and turn over to its major political campaign contributors?

In times past, national debt typically was run up by borrowing money from private lenders and spent on goods and services. The tendency was to absorb loanable funds and bid up interest rates on the one hand, while spending led to inflationary price increases for goods and services. But the present giveaway is different. Instead of money being borrowed or spent, interest-yielding bonds are simply being printed and turned over to the banks and other financial institutions. The hope is that they will lend out more credit (which will become more debt on the part of their customers), lowering interest rates while the money is used to bid up asset prices * real estate, stocks and bonds. Little commodity price inflation is expected from this behavior.

The main impact will be to reinforce the concentration of wealth in the hands of creditors (the wealthiest 10 percent of the population) rather than wiping out financial assets (and debts) through the bankruptcies that were occurring as a result of "market forces". Is it too much to say that we are seeing the end of economic democracy and the emergence of a financial oligarchy * a self-serving class whose actions threaten to polarize society and, in the process, stifle economic growth and lead to the very bankruptcy that the bailout was supposed to prevent?

Everything that I have read in economic history leads me to believe that we are entering a nightmare transition era. The business cycle is essentially a financial cycle. Upswings tend to become economy-wide Ponzi schemes as banks and other creditors, savers and investors receive interest and plow it back into new loans, accruing yet more interest as debt levels rise. This is the "magic of compound interest" in a nutshell. No "real" economy in history has grown at a rate able to keep up with this financial dynamic. Indeed, payment of this interest by households and businesses leaves less to spend on goods and services, causing markets to shrink and investment and employment to be cut back.

Wearing blinders to avoid confronting any reality that would suggest that banks cannot make money ad infinitum by selling more and more credit – that is, indebting the non-financial economy more and more – government officials such as Treasury Secretary Paulson or Federal Reserve Chairman Bernanke are professionally unable to acknowledge this problem, and it does not appear in most neoclassical or monetarist textbooks. But the underlying mathematics of compound interest are rediscovered in each generation, often prompted by the force majeur of financial crisis.

A generation ago, for instance, Hyman Minsky gained a following by describing what he aptly called the Ponzi stage of the business cycle. It was the phase in which debtors no longer were able to pay off their loans out of current income (as in Stage #1, where they earned enough to cover their interest and amortization charges), and indeed did not even earn enough to pay the interest charges (as in Stage #2), but had to borrow the money to pay the interest owed to their bankers and other creditors. In this Stage #3 the interest was simply added onto the debt, growing at a compound rate. It ends in a crash.

This was the flip side of the magic of compound interest – the belief that people can get rich by "putting money to work." Money doesn’t really work, of course. When lent out, it extracts interest from the "real" production and consumption economy, that is, from the labor and industry that actually do the work. It is much like a tax, a monopoly rent levied by the financial sector. Yet this quasi-tax, this extractive financial rent (as Alfred Marshall explained over a century ago) is the dynamic that is supposed to enable corporate, state and local pension funds to pay for retirement simply out of stock market gains and bond investments – purely financially and hence at the expense of the economy at large whose employees are supposed to be gainers. This is the essence of "pension-fund capitalism," a Ponzi-scheme variant of finance capitalism. Unfortunately, it is grounded in purely mathematical relationships that have little grounding in the "real" economy in which families and companies produce and consume.

Mr. Paulson’s bailout plan reflects a state of denial with regard to this dynamic. The debt overhead is self-aggravating, becoming less and less "solvable" and hence more of a quandary, that is, a problem with no visible solution. At least, no solution acceptable to Wall Street, and hence to Mr. Paulson and the Democratic and Republican congressional leaders. The banks and large swaths of the financial sector are broke from having made bad gambles in the belief that money could be made to "work" under conditions that shrink the underlying industrial economy and stifle wage gains, eroding the market for consumer goods. Debt deflation reduces sales and business activity in general, and hence corporate earnings. This depresses stock market and real estate prices, and hence the value of collateral pledged to back the economy’s debt overhead. Negative equity leads to bankruptcy and foreclosures.

By increasing America’s national debt from $5 trillion earlier this year to $13 trillion in almost a single swoop by taking on junk loans and other bad investments rather than letting them to under as traditionally has occurred in the "cleansing" culmination of business crashes ("cleansing" in the sense of clean slates for debts that cannot reasonably be paid), Mr. Paulson’s bailout actions increase the interest payments that the government must pay out of taxes or by borrowing (ore printing) yet more money. Someone must pay for bad debts and junk loans that are not wiped off the books. The government is now to take on the roll of debt collector to "make a profit for taxpayers" by going around and kneecapping the economy – which of course is comprised primarily of the "taxpayers" ostensibly being helped.

It is a con game. Financial gains have soared since 1980, but banks and institutional investors have not used them to finance tangible capital formation. They simply have recycled their receipt of interest (and credit-card fees and penalties that often amount to as much as interest) into yet new loans, extracting yet more interest and so on. This financial extraction leaves less personal and business income to spend on consumer goods, capital goods and services. Sales shrink, causing defaults as the economy is less able to pay its stipulated interest charges.

This phenomenon of debt deflation has occurred throughout history, not only over the modern business cycle but for centuries at a time. The most self-destructive example of financial short-termism is the decline and fall of the Roman Empire into debt bondage and ultimately into a Dark Age. The political turning point was the violent takeover of the Senate by oligarchic creditors who murdered the debtor-oriented reformers led by the Gracchi brothers in 133 BC, picking up benches and using them as rams to push the reformers over the cliff on which the political assembly was located. A similar violent overthrow occurred in Sparta a century earlier when its kings Agis and Cleomenes sought to annul debts so as to reverse the city-state’s economic polarization. The creditor oligarchy exiled and killed the kings, as Plutarch described in his Parallel Lives of the Illustrious Greeks and Romans. This used to be basic reading among educated people, but today these events have all but disappeared from most people’s historical memory. A knowledge of the evolution of economic structures has been replaced by a mere series political personalities and military conquests.

The moral of ancient and modern history alike is that a critical point inevitably arrives at which economies either adopt hard creditor-oriented laws that impoverish the population and plunge downward socially and militarily, or save themselves by alleviating the debt burden. What is remarkable today is the almost total failure of political leaders to provide an alternative to Mr. Paulson’s bailout of Wall Street from the Bear Stearns bankruptcy down through the government takeover of Fannie Mae and Freddie Mac to last week’s giveaway to the banks. Nobody is even warning where this destructive decision is leading. Governments ostensibly representing "free market" philosophy are acting as the lender of last resort – not to households and business non-financial debtors, and not to wipe out the debt overhang in a Clean Slate, but to subsidize the excess of financial claims over and above the economy’s ability to pay and the market value of assets pledged as collateral.

This attempt is necessarily in vain. No amount of money can sustain the exponential growth of debt, not to mention the freely created credit and mutual gambles on derivatives and other financial claims whose volume has exploded in recent years. The government is committed to "bailing out" banks and other creditors whose loans and swaps have gone bad. It remains in denial with regard to the debt deflation that must be imposed on the rest of the economy to "make good" on these financial trends.

Here’s why the plan for the government to recover the money is whistling in the dark: It calls for banks to "earn their way out of debt" by selling more of their product – credit, that is, debt. Homeowners and other consumers, students and car buyers, credit card users and their employers – the "taxpayers" supposed to be helped – are to pay the repayment money to the banks, instead of using it to purchase goods and services. If they charge only 6% per year, they will extract $93 billion in interest charges – $42 billion to pay the Treasury for its $700 billion, and another $51 billion for the Federal Reserve’s $850 billion in "cash for trash" loans.

If you are going to rob the government, I suppose the best strategy is simply to brazen it out. To listen to the mass media, there seemed no alternative but for Congress to ram the plan through just as Wall Street lobbyists had written i, to "save the market from imminent meltdown," refusing to hold hearings or take testimony from critics or listen to the hundreds of economists who have denounced the giveaway.

Hubris has reached a level of deception hardly seen since the 19th century’s giveaways to the railroad barons. "We didn’t want to be punitive," Mr. Paulson explained in a Financial Times interview, as if the only alternative was an enormous gift. Europe did not engage in any such giveaway, yet he claimed that England and other European countries forced his hand by bailing out their banks, and that the Treasury simply wanted to keep U.S. banks competitive. Wringing his hands melodramatically, he assured the public on Monday that "We regret having to take these actions." Banks went along with the pretense that the bailout was a worrisome socialist intrusion into the "free market," not a giveaway to Wall Street in the plan drawn up by their own industry lobbyists. "Today’s actions are not what we ever wanted to do," Mr. Paulson went on, "but today’s actions are what we must do to restore confidence to our financial system." The confidence in question was a classic exercise in disinformation – a well-crafted con game.

Mr. Paulson depicted the government’s purchase of special non-voting stock as a European-style nationalization. But government’s appointed public representatives to the boards of European banks being bailed out. This has not happened in America. Bank lobbyists are reported to have approached Treasury to express their worry that their shareholdings might be diluted. But the Treasury-Democratic Party plan invests $250 billion in government credit in non-voting shares. If a recipient of this credit goes broke, the government is left the end of the line behind other creditors. Its "shares" are not real loans, but "preferred stock." As Mr. Paulson explained on Monday: "Government owning a stake in any private U.S. company is objectionable to most Americans – me included." So the government’s shares are not even real stock, but a special "non-voting" issue. The public stock investment will not even have voting power! So the government gets the worst of both worlds: Its "preferred stock" issue lacks the voting power that common stock has, while also lacking the standing for repayment in case of bankruptcy that bondholders enjoy. Instead of leading to more public oversight and regulation, the crisis thus has the opposite effect here: a capitulation to Wall Street, along lines that pave the ground for a much deeper debt crisis to come as the banks "earn their way out of debt" at the expense of the rest of the economy, which is receiving no debt relief!

Mr. Paulson shed the appropriate crocodile tears on behalf of homeowners and the middle class, whose interest he depicted as lying in ever-rising housing and stock market prices. "In recent weeks, the American people have felt the effects of a frozen financial system," he explained. "They have seen reduced values in their retirement and investment accounts. They have worried about meeting payrolls and they have worried about losing their jobs." He almost seemed about to use the timeworn widows and orphans cover story and beg Americans please not to unplug Granny from her life support system in the nursing home. We need to preserve the value of her stocks, and help everyone retire happily by restoring normal Wall Street financial engineering to make voters rich again.

European executives who steered their banks into the debt iceberg have been fired. England wiped out shareholders in Northern Rock last summer, and more recently Bradford and Bingley. But in America the culprits get to stay on. No bank stockholders are being wiped out here, despite the negative equity into which the worst risk-taking banks have fallen or the prosecutions brought against them for predatory lending, consumer fraud and related wrongdoing.

Government aid will be used to pay exorbitant salaries to the executives who drove these banks into insolvency. "Institutions that sell shares to the government will accept restrictions on executive compensation, including a clawback provision and a ban on golden parachutes," Mr. Paulson pretended – only to qualify it by saying that the rule would apply only "during the period that Treasury holds equity issued through this program." The executives can stay on and give themselves the usual retirement gifts after all, prompting Democratic Congressman Barney Frank complained about how weak the Treasury restrictions are. "Compensation experts say that the provisions, though politically prudent to appease public anger, will probably have little real impact on how financial executives are paid in coming years. They predict banks will simply pay higher taxes and will find other creative ways of paying their executives as they see fit. Some say there could even be a sudden surge in compensation as soon as the government program ends, in a few years, leading to eye-popping numbers down the road. … When Congress limited the tax deductibility of cash salaries to $1 million, for example, it simply led to an explosion in stock options used as compensation and even higher total payouts."

And speaking of stock options, the government shortchanged itself here too, despite its promises to ensure that it will shares in the gains when banks recover. Senator Schumer went so far as to assure voters that "under any capital injection plan that Treasury pursues, dividends must be eliminated, executive compensation must be constrained, and normal banking activities must be emphasized." This was mostly hot air. England and other countries have insisted that banks not pay dividends until the government is reimbursed. The idea is to avoid using public money to pay dividends to existing shareholders and continued exorbitant salaries to their mismanagers! But the terms of the U.S. bailout is made simply call for banks not increase their dividend payouts – a policy they most likely would follow in any case in view of their earnings crunch.

Mr. Schumer verged on the ridiculous when he proclaimed: "We must operate in the same way any significant investor operates in these situations – when Warren Buffett invested in Goldman Sachs and General Electric in recent weeks, he demanded strict, but not onerous terms. The government must be similarly protective of taxpayer interests." But Mr. Buffett obtained a much better deal for his $5 billion investment in Goldman Sachs, including warrants to buy its stock at a price below the going price when he helped rescue the company. Likewise in England, the government took stock ownership at low prices before the bailout, not at higher prices after it! But instead of exercising its warrants at the depressed prices where bank stocks stood at the time Mr. Paulson detailed the bailout terms, the U.S. Treasury would be able to exercise its warrants (equal to 15 percent of its investment) only at prices that were to be set after the banks had time to recover with the Treasury’s aid. Existing stockholders thus will benefit more than the government – which is why bank stocks soared on news of the bailout’s terms. So the government does not appear to be a good bargainer in the public interest. In fact, Mr. Paulson may be guilty of deliberate scuttling of the public interest that, as Treasury Secretary, he is supposed to defend.

Given his financial experience, Mr. Paulson had to know how deceptive his promise was in placing such emphasis on the government’s stock options, the sweetener that has made so many executives fabulously wealthy: "taxpayers will not only own shares that should be paid back with a reasonable return, but also will receive warrants for common shares in participating institutions," he explained. But the "reasonable return" is only 5% annually, just above what the government typically has to pay, not a rate reflecting anything like what the "free market" now charges Wall Street firms with negative equity. The government’s $250 billion in preferred stock will carry a dividend that rises to 9% after five years, with no limit on how long the loan may be outstanding.

All I can say is, Wow! If only homeowners could get a similar break: a reduction in their interest rate to just 5%, rising to a penalty rate of just 9% – without the heavy penalties and late fees that Countrywide/Bank of America charges! By contrast, German banks that receive a public rescue will pay "a fee of at least 2% annually of the amount guaranteed. The U.K. will charge 0.50% plus the cost of default insurance on a bank's debt." A British banker wrote to me that "the government offers 12% preference shares, and ordinary shares at an absolutely huge discount to asset value to provide the cash." But the U.S. Government agreed to exercise its stock options at the post-bailout price, not the price prior to rescue. It even gives up most of these options if the banks do repay the Treasury’s loan. On the excuse of encouraging private Wall Street investors to replace government "ownership" and "intrusion" into the marketplace, banks can "cut in half the number of common shares the government will eventually be able to purchase. That can be done if a bank sells stock by the end of 2009, and raises at least as much cash as the government is investing."

These bailout terms suggest that what Wall Street wants is pretty much what colonialist Britain achieved for so many years in India and Africa: puppet leaders with an imperial political advisor, in America’s case a Secretary of the Treasury and a vice-regent as head of the Federal Reserve System. But what the rest of the economy needs is a genuinely free leader able to impose better and more equitable laws to write down debt, not build it up and bail out more bad loans. Within the present administration itself, Sheila Bair, head of the Federal Deposit Insurance Corporation, complained in a Wall Street Journal interview that she didn’t understand "Why there’s been such a political focus on making sure we’re not unduly helping borrowers but then we’re providing all this massive assistance at the institutional level." She "described painstaking efforts made by lawmakers in crafting the federal Hope for Homeowners program to make sure it limited resale profits for borrowers who received affordable home loans," by giving the government a share of the rising sales price.

The imbalance between creditor demands and debtors’ ability to pay is indeed the problem! Mr. Paulson claimed in his Monday address that he needed to get to the root of the economic problem. But in his view it is simply that the banks "are not positioned to lend as widely as is necessary to support our economy. Our goal is to see … that they can make more loans to businesses and consumers across the nation." As he explained in his Financial Times interview (cited above), "for the first time you have seen an action that is systematic, that is getting at the root causes" of the financial crisis. But his perspective is remarkably narrow-minded. It denies that the problem is debt above and beyond the ability of the economy at large to pay, and higher than the market price of property and assets pledged as collateral.

Creating a system for the banks to "earn their way out of debt" means creating yet more interest-bearing debt for the economy at large. Mortgage loans are what is supposed to restore high housing prices and office costs – precisely what caused the debt meltdown in the first place! Despite Mr. Paulson’s and Ms. Bair’s characterization of the present crisis as merely a liquidity problem, it is really a debt problem. The volume of real estate debt, auto debt, student loans, bank debt, pension debts by municipalities and states as well as private companies exceed their ability to pay.

Shortly after Mr. Paulson’s Monday speech a Dutch economics professor, Dirk Bezemer, wrote me that: "In my thinking I liken it to a Ponzi game where in the final stages the only way to keep things going a bit longer is to pump in more liquidity. That is a solution in the sense that it restores calm, but only in the short run. This is what we now see happening and – despite the 10% stock market rally today – I am still bracing myself for the inevitable end of the Ponzi game – suddenly or as a long drawn out debt deflation." He went on to explain what he and other associates of mine have been saying for many years now: "The actual solution is to separate the Ponzi from the non-Ponzi economy and let the pain be suffered in the first part so as to salvage what we can from the second. This means bailing out homeowners but not investment banks, etc. The qualification to this general approach is that those Ponzi game players whose demise is a real ‘system threat’ need support, but only with punitive conditionalities attached. And just like Third World countries, they won’t have a choice."

The situation has some similarities to global warming. Current U.S. presidential debates propose solving the ³oil problem² not so much by conservation as by extracting more oil from Alaska and along the U.S. seacoast to sustain rising domestic demand. The effect of this policy is to increase air pollution and hence global warming. In a similar fashion, the problem of ³debt pollution² is being ³solved² by creating yet more debt, not by reducing its volume.

Neither the Treasury nor Congress is helping to resolve this problem. The working assumption is that giving newly created government debt to the banks and Wall Street will lead to more lending to re-inflate the real estate and stock markets. But who will lend more to the one-sixth of U.S. homes already said to have fallen into negative equity territory? As debt deflation eats into the domestic market for goods and services, corporate sales and earnings will shrink, dragging down stock prices. Wall Street is in control, but its policies are so shortsighted that they are eroding the underlying economy * which is passing from democracy to oligarchy, and indeed it seems to a bipartisan financial kleptocracy.

Quote:NYT COLUMNIST TAPS JPM CONF CALL; FIRM HAS NO INTENTION OF USING $25B TARP FUNDS TO INCREASE LOANS
-NYT columnist Joe Nocera monitored a recent high-level executive only JPM conference call quoting an executive from JP Morgan's plans for the $25B TARP funds. The executive stated to the call that the banks focus would instead be on using its stronger balance sheet to acquire weak rivals and pick through the wreckage to the banks advantage. He referred to the TARP capital as a "nice backstop"

“Chase recently received $25 billion in federal funding. What effect will that have on the business side and will it change our strategic lending policy?”

It was Oct. 17, just four days after JPMorgan Chase’s chief executive, Jamie Dimon, agreed to take a $25 billion capital injection courtesy of the United States government, when a JPMorgan employee asked that question. It came toward the end of an employee-only conference call that had been largely devoted to meshing certain divisions of JPMorgan with its new acquisition, Washington Mutual.

Which, of course, it also got thanks to the federal government. Christmas came early at JPMorgan Chase.

The JPMorgan executive who was moderating the employee conference call didn’t hesitate to answer a question that was pretty politically sensitive given the events of the previous few weeks.

Given the way, that is, that Treasury Secretary Henry M. Paulson Jr. had decided to use the first installment of the $700 billion bailout money to recapitalize banks instead of buying up their toxic securities, which he had then sold to Congress and the American people as the best and fastest way to get the banks to start making loans again, and help prevent this recession from getting much, much worse.

In point of fact, the dirty little secret of the banking industry is that it has no intention of using the money to make new loans. But this executive was the first insider who’s been indiscreet enough to say it within earshot of a journalist.

(He didn’t mean to, of course, but I obtained the call-in number and listened to a recording.)

“Twenty-five billion dollars is obviously going to help the folks who are struggling more than Chase,” he began. “What we do think it will help us do is perhaps be a little bit more active on the acquisition side or opportunistic side for some banks who are still struggling. And I would not assume that we are done on the acquisition side just because of the Washington Mutual and Bear Stearns mergers. I think there are going to be some great opportunities for us to grow in this environment, and I think we have an opportunity to use that $25 billion in that way and obviously depending on whether recession turns into depression or what happens in the future, you know, we have that as a backstop.”

Read that answer as many times as you want — you are not going to find a single word in there about making loans to help the American economy. On the contrary: at another point in the conference call, the same executive (who I’m not naming because he didn’t know I would be listening in) explained that “loan dollars are down significantly.” He added, “We would think that loan volume will continue to go down as we continue to tighten credit to fully reflect the high cost of pricing on the loan side.” In other words JPMorgan has no intention of turning on the lending spigot.

It is starting to appear as if one of Treasury’s key rationales for the recapitalization program — namely, that it will cause banks to start lending again — is a fig leaf, Treasury’s version of the weapons of mass destruction.

In fact, Treasury wants banks to acquire each other and is using its power to inject capital to force a new and wrenching round of bank consolidation. As Mark Landler reported in The New York Times earlier this week, “the government wants not only to stabilize the industry, but also to reshape it.” Now they tell us.

Indeed, Mr. Landler’s story noted that Treasury would even funnel some of the bailout money to help banks buy other banks. And, in an almost unnoticed move, it recently put in place a new tax break, worth billions to the banking industry, that has only one purpose: to encourage bank mergers. As a tax expert, Robert Willens, put it: “It couldn’t be clearer if they had taken out an ad.”

Friday delivered the first piece of evidence that this is, indeed, the plan. PNC announced that it was purchasing National City, an acquisition that will be greatly aided by the new tax break, which will allow it to immediately deduct any losses on National City’s books.

As part of the deal, it is also tapping the bailout fund for $7.7 billion, giving the government preferred stock in return. At least some of that $7.7 billion would have gone to NatCity if the government had deemed it worth saving. In other words, the government is giving PNC money that might otherwise have gone to NatCity as a reward for taking over NatCity.

I don’t know about you, but I’m starting to feel as if we’ve been sold a bill of goods.

•

The markets had another brutal day Friday. The Asian markets got crushed. Germany and England were down more than 5 percent. In the hours before the United States markets opened, all the signals suggested it was going to be the worst day yet in the crisis. The Dow dropped more than 400 points at the opening, but thankfully it never got any worse.

There are lots of reasons the markets remain unstable — fears of a global recession, companies offering poor profit projections for the rest of the year, and the continuing uncertainties brought on by the credit crisis. But another reason, I now believe, is that investors no longer trust Treasury. First it says it has to have $700 billion to buy back toxic mortgage-backed securities. Then, as Mr. Paulson divulged to The Times this week, it turns out that even before the bill passed the House, he told his staff to start drawing up a plan for capital injections. Fearing Congress’s reaction, he didn’t tell the Hill about his change of heart.

Now, he’s shifted gears again, and is directing Treasury to use the money to force bank acquisitions. Sneaking in the tax break isn’t exactly confidence-inspiring, either. (And let’s not even get into the less-than-credible, after-the-fact rationalizations for letting Lehman default, which stands as the single worst mistake the government has made in the crisis.)

On Thursday, at a hearing of the Senate Banking Committee, the chairman, Christopher J. Dodd, a Connecticut Democrat, pushed Neel Kashkari, the young Treasury official who is Mr. Paulson’s point man on the bailout plan, on the subject of banks’ continuing reluctance to make loans. How, Senator Dodd asked, was Treasury going to ensure that banks used their new government capital to make loans — “besides rhetorically begging them?”

“We share your view,” Mr. Kashkari replied. “We want our banks to be lending in our communities.”

Senator Dodd: “Are you insisting upon it?”

Mr. Kashkari: “We are insisting upon it in all our actions.”

But they are doing no such thing. Unlike the British government, which is mandating lending requirements in return for capital injections, our government seems afraid to do anything except plead. And those pleas, in this environment, are falling on deaf ears.

Yes, there are times when a troubled bank needs to be acquired by a stronger bank. Given that the federal government insures deposits, it has an abiding interest in seeing that such mergers take place as smoothly as possible. Nobody is saying those kinds of deals shouldn’t take place.

But Citigroup, at this point, probably falls into the category of troubled bank, and nobody seems to be arguing that it should be taken over. It is in the “too big to fail” category, and the government will ensure that it gets back on its feet, no matter how much money it takes. One reason Mr. Paulson forced all of the nine biggest banks to take government money was to mask the fact that some of them are much weaker than others.

We have long been a country that has treasured its diversity of banks; up until the 1980s, in fact, there were no national banks at all. If Treasury is using the bailout bill to turn the banking system into the oligopoly of giant national institutions, it is hard to see how that will help anybody. Except, of course, the giant banks that are declared the winners by Treasury.

Jan Klimkowski Wrote:Here's an October 18 article by Michael Hudson:



http://www.globalresearch.ca/index.php?context=va&aid=10597

Quote:IMF may need to "print money" as crisis spreads
The International Monetary Fund may soon lack the money to bail out an ever growing list of countries crumbling across Eastern Europe, Latin America, Africa, and parts of Asia, raising concerns that it will have to tap taxpayers in Western countries for a capital infusion or resort to the nuclear option of printing its own money.

By Ambrose Evans-Pritchard
Last Updated: 1:22PM GMT 28 Oct 2008

The Fund is already close to committing a quarter of its $200bn (£130bn) reserve chest, with a loans to Iceland ($2bn), Ukraine ($16.5bn), and talks underway with Pakistan ($14.5bn), Hungary ($10bn), as well as Belarus and Serbia.

Neil Schering, emerging market strategist at Capital Economics, said the IMF's work in the great arc of countries from the Baltic states to Turkey is only just beginning.

"When you tot up the countries across the region with external funding needs, you get to $500bn or $600bn very quickly, and that blows the IMF out of the water. The Fund may soon have to start calling on the West for additional funds," he said.

Brad Setser, an expert on capital flows at the Council for Foreign Relations, said Russia, Mexico, Brazil and India have together spent $75bn of their reserves defending their currencies this month, and South Korea is grappling with a serious banking crisis.

"Right now the IMF is too small to meet the foreign currency liquidity needs of the larger emerging economies. We're in a dangerous situation and there is the risk of extreme moves in the markets, as we have seen with the Brazilian real. I hope policy-makers understand how serious this is," he said.

The IMF, led by Dominique Strauss-Kahn, has the power to raise money on the capital markets by issuing `AAA' bonds under its own name. It has never resorted to this option, preferring to tap members states for deposits.

The nuclear option is to print money by issuing Special Drawing Rights, in effect acting as if it were the world's central bank. This was done briefly after the fall of the Soviet Union but has never been used as systematic tool of policy to head off a global financial crisis.

"The IMF can in theory create liquidity like a central bank," said an informed source. "There are a lot of ideas kicking around."

For now, Eastern Europe is the epicentre of the crisis. Lars Christensen, a strategist at Danske Bank, said the lighting speed and size of Ukraine's bail-out suggest the IMF is worried about the geo-strategic risk in the Black Sea region, as well as the imminent risk a financial pandemic. "The IMF clearly fears a domino effect in Eastern Europe where a collapse in one country automatically leads to a collapse in another," he said.

Mr Christensen said investor sentiment towards the region has reached the point of revulsion. The Budapest bourse plunged 10pc yesterday despite the proximity of an IMF deal Meanwhile, Standard & Poor's issued a blitz of fresh warnings, downgrading Romania's debt to junk status, and axing the ratings Poland, Latvia, Lithuania, and Croatia.

The agency said Romania was "vulnerable to a sudden-stop scenario where capital inflows dry up or even reverese", leaving the country unable to cover a current account deficit of 14pc of GDP.

Romania's central bank has taken drastic steps to defend the leu, squeezing liquidity so violently that overnight rates shot up to 900pc. But there are growing doubts whether this sort of shock therapy can obscure the fact that economic booms are now turning to bust across the region.

Merrill Lynch has advised to clients to take "short" positions against the leu. "The fundamental picture suggests that Romania may face a currency crisis in the near term, similar to what Hungary has gone through over the last week," it said. The bank also warned that Turkey and the Philippines are vulnerable.

Hungary was forced to raise interest rates last week by 3 percentage points to 11.5pc to defend its currency. Even Denmark has had to tighten by a half point to keep within its Exchange Rate Mechanism, raising fears that every country on the fringes of the eurozone will have resort to a deflationary squeeze.

The root problem is that Eastern Europe and Russia have together borrowed $1,600bn from foreign banks in euros and dollars to fund their catch-up growth spurt over the last five years, according to data from the Bank for International Settlements. These loans are now coming due at an alarming pace. Even rock-solid companies are having trouble rolling over debts.

Mr Schering said Turkey was likely to join the queue for bail-outs very soon. "Their external liabilities have reached $186bn, and a lot of this is short-term debt that has to be rolled over in coming months," he said.

Turkey's prime minister Recep Tayyip Erdogan said over the weekend that his country would not "darken its future by bowing to the wishes of the IMF", but it is unclear how long Ankara can maintain its defiant stand as capital flight drains reserves.

Pakistan - now facing imminent bankruptcy - has also raised political hackles, balking at IMF demands for deep cuts in military spending as a condition for a standby loan. Diplomats say it is unlikely that the West will let the nuclear-armed Islamic state slip into chaos.

Jan Klimkowski Wrote:Hmmm - "Spooky" Ambrose Evans-Pritchard, onetime print assassin of Clinton & currently roving "business correspondent" for the Daily Telegraph is today floating the idea, through Council for Foreign Relations sources, of the IMF printing money.

That would be a whole new type of Shock Therapy.

It's BOHICA time.



http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3269669/IMF-may-need-to-print-money-as-crisis-spreads.html

Quote:MH: Now so far, people have talked about the $700 billion that is at stake and the government has said we’re going to put securities in here, however what the media has not reported, although the British newspaper The Economist had a wonderful chart last week, showing that the Federal Reserve has already swapped $500 billion worth of Treasury bonds for junk. The cash for trash has already begun since March by the Federal Reserve so $500 billion is almost as much as the $700 billion that the Treasury is talking about, this has already been given away by the Fed to Wall Street insiders and nothing has been said in the media about this at all. Although its been statistically reported by the Fed. The Fed reports its holdings and securities. It reports its holdings of Treasury Securities, which have gone down by $ 500 trillion.

It reports its overall securities, which are now $1.1 trillion compared to less than $500 billion in Treasury Securities. And this leaves between $500 billion and $600 billion in essentially non-treasury securities, which are the junk they’ve taken on with these swaps that it’s arranged. And the Fed has been swapping this not only with the banks that its supposed to represent but its been doing cash for trash with insurance companies, investment banks and people who have no relation at all under the Fed and this is being done under the Fed’s special small print of the Fed’s Articles of Incorporation saying it can do this to save the economy. Well its not saving the economy at all. It’s wrecking the economy by doing this. It’s wrecking the economy by buying trash from insiders and as I said, creating a new Kleptocracy.

BF: Well I’ve never heard of this other, this previous $500 billion. No, that wasn’t reported. Well if they don’t have to…Why are they…

MH: Well the Fed says that it has reported it. Anybody can go online on the Federal Reserve and check the daily and weekly Federal Reserve Statistics. You can be sure that just everybody on Wall Street that has a stake in the financial system has done that. The media has blacked it out.

BF: Well if they gave away $500 billion previously with a media blackout why did they even bother to go public with the $700 billion?

MH: Because they need altogether about $5 trillion to create… If they’re going to create 500 billionaires to run the country for the next century and to create really a new feudal class they need $5 trillion and they don’t want the people to know what’s occurring because if they did the voters would get so upset they’d create probably a new political party, an alternative. And they don’t want the voters to have an alternative certainly before this election. They’ve got one candidate, McCain who is advised by Phil Gramm’s who is in completely in [???]’s pocket. They have another presidential candidate, Obama, whose financial advisor is Treasury Secretary Rubin. If you want to see what is likely to happen to the United States you should look at what Mr. Rubin did when America had a completely free hand in redesigning the Russian economy. This was their ideal. You’ve seen since the 1996 giveaways in Russia, the Russian population has fallen more than it fell in World War Two. The financial devastation today is even more devastating than military destruction. The result is a shortened life expectancy, lower birth rate, depression. The effect is psychological and social, not merely economic.

BF: Well why didn’t they keep their subsequent $700 billion a secret? Did they just feel they couldn’t?

MH: Because it’s become so large, larger than the Federal Reserve has on its balance sheet. The Federal Reserve only had $1.1 trillion and the Treasury can print an infinite amount of bonds to exchange for trash and what they needed was much more than just a trillion, they need really trillion after trillion to bail out the bad debts because that is how deep the hole is that Wall Street (and behind it, Free Market Economics of the Chicago School variety) has led the country into.

BF: Well then would you say it’s too big to bail out?

MH: In essence yes. It can’t really be bailed out. But what you can do is let the insiders get as much money as they can as quickly as they can under emergency conditions so that they can take their money and run. Of course it can’t be bailed out. But you can have a lot of insiders take their money and run. And they’re going to run--out of the dollar.

Quote:Can the IMF Keep Up?

But what happens if the IMF runs out of money? The Washington-based financial fire department has already promised to pony up €27 billion ($34.3 billion) for Iceland, Ukraine and Hungary. This is about one-fifth of the funds the IMF currently has available for such packages, and Pakistan is looming.

Should the virus of financial failure continue to spread, the €156 billion currently available to the IMF would soon be exhausted. If that happened, the major industrialized nations would have to inject additional funds and provide the IMF, possibly through loans, with fresh capital for the high-risk countries. Global investors would hardly be interested.

And what happens if capital flight from the faltering threshold countries fuels the greed of speculators even further? For months now, they have been betting their money on, not just the ruin of banks and insurance companies, but the demise of entire countries. "It's blood in the water for the hedge fund sharks," wrote Britain's Sunday Telegraph, noting that economies like Hungary's are simply too weak to resist.

"Major players in the foreign currency market, like hedge funds and banks, are betting on the further decline of Eastern European currencies," says Hans-Günter Redeker, chief strategist with the foreign currency division of French banking conglomerate BNP Paribas. The gamblers have also set their sights on Ukraine, Poland, the Czech Republic, Romania and Turkey. Even Russia, the natural resource paradise, is seen as a worthwhile bet, because it will hardly be able to defend the ruble for much longer, given the massive exodus of capital.

The entire world is currently spooked by the Argentine ghost. Even if wealthy countries reach out to ailing nations, some governments will not survive the storm. Even this would not be truly dramatic. But if the industrialized nations then decide to leave the threshold countries to their own devices, the ensuing wildfire will burn indefinitely.