- America has become a pretty discouraging place. Americans,
for the most part, will never know what happened to them, because they
no longer have a free and responsible press. They have Big Brother's press.
For example, on September 28, 2008, a New York Times editorial blamed the
current financial crisis on "antiregulation disciples of the Reagan
Revolution."
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- What utter nonsense. Every example of deregulation that
the New York Times editorial provides is located in the Clinton Administration
and the George W. Bush administration. I was a member of the Reagan administration.
We most certainly did not deregulate the financial system.
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- The repeal of the Glass-Steagall Act, which separated
commercial from investment banking, was the achievement of the Democratic
Clinton Administration. It happened in 1999, over a decade after Reagan
left office.
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- It was in 2000 that derivatives and credit default swaps
were excluded from regulation.
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- The greatest mistake was made in 2004, the year that
Reagan died. That year the current Secretary of the Treasury, Henry M.
Paulson Jr, was head of the investment bank Goldman Sachs. In the spring
of 2004, the investment banks, led by Paulson, met with the Securities
and Exchange Commission. At this meeting with the New Deal regulatory agency
tasked with regulating the US financial system, Paulson convinced the SEC
Commissioners to exempt the investment banks from maintaining reserves
to cover losses on investments. The exemption granted by the SEC allowed
the investment banks to leverage financial instruments beyond any bounds
of prudence.
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- In place of time-proven standards of prudence, computer
models engineered by hot shots determined acceptable risk. As one result
Bear Stearns, for example, pushed its leverage ratio to 33 to 1. For every
one dollar in equity, the investment bank had $33 of debt!
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- It was computer models that led to the failure of Long-Term
Capital Management in 1998, the first systemic threat to the financial
system. Why the SEC went along with Paulson and set aside capital requirements
after the scare of Long-Term Capital Management is inexplicable.
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- The blame is headed toward SEC chairman Christopher Cox.
This is more of Big Brother's disinformation. Cox, like so many others,
was a victim of a free market ideology, itself a reaction to over-regulation,
that was boosted by academic economic opinion, rewarded with Nobel prizes,
that the market "always knows best."
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- The 20th century proves that the market is likely to
know better than a central planning bureau. It was Soviet Communism that
collapsed, not American capitalism. However, the market has to be protected
from greed. It was greed, not the market, that was unleashed by deregulation
during the Clinton and George W. Bush regimes.
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- I remember when the deregulation of the financial sector
began. One of the first inroads was the legislation, written by bankers,
to permit national branch banking. George Champion, former chairman of
Chase Manhattan Bank, testified against it. In columns I argued that national
branch banking would focus banks away from local business needs.
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- The deregulation of the financial sector was achieved
by the Democratic Clinton Administration and by the current Secretary of
the Treasury, Henry Paulson, with the acquiescence of the Securities and
Exchange Commission.
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- The Paulson bailout saves his firm, Goldman Sachs. The
Paulson bailout transfers the troubled financial instruments that the financial
sector created from the books of the financial sector to the books of the
taxpayers at the US Treasury.
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- This is all the bailout does. It rescues the guilty.
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- The Paulson bailout does not address the problem, which
is the defaulting home mortgages.
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- The defaults will continue, because the economy is sinking
into recession. Homeowners are losing their jobs, and homeowners are being
hit with rising mortgage payments resulting from adjustable rate mortgages
and escalator interest rate clauses in their mortgages that make homeowners
unable to service their debt.
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- Shifting the troubled assets from the financial sectors'
books to the taxpayers' books absolves the people who caused the problem
from responsibility. As the economy declines and mortgage default rates
rise, the US Treasury and the American taxpayers could end up with a $700
billion loss.
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- Initially, the House, but not the Senate, resisted the
bailout of the financial institutions,whose executives had received millions
of dollars in bonuses for wrecking the US financial system. However, the
people's representatives could not withstand the specter of martial law
and Great Depression with which Paulson and the Bush administration threatened
them. The people's representatives succumbed as they did during the New
Deal.
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- The impotence of Congress traces to the Great Depression.
As Theodore Lowi in his classic book, The End of Liberalism, makes clear,
the New Deal stripped Congress of its law-making power and gave it to the
executive agencies. Prior to the New Deal, Congress wrote the laws. After
the New Deal a bill is merely an authorization for executive agencies to
create the law through regulations. The Paulson bailout has further diminished
the legislative branch's power.
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- Since Paulson's bailout of his firm and his financial
friends does nothing to lessen the default rate on mortgages, how will
the bailout play out?
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- If the $700 billion bailout is based on an estimate of
the current amount of bad mortgages, as the recession deepens and Americans
lose their jobs, the default rate will rise. The $700 billion might not
suffice. The Treasury will have to go hat in hand to its foreign creditors
for more loans.
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- As the US Treasury has not got $7, much less $700 billion,
it must borrow the bailout money from foreign creditors, already overloaded
with US paper. At what point do America's foreign bankers decide that the
additions to US debt exceed what can be repaid?
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- This question was ignored by the bailout. There were
no hearings. No one consulted China, America's principal banker, or the
Japanese, or the OPEC sovereign wealth funds, or Europe.
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- Does the world have a blank check for America's mistakes?
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- This is the same world that is faced with American demands
that countries support with money and lives America's quest for world hegemony.
Europeans are dying in Afghanistan for American hegemony. Do Europeans
want their banks, which hold US dollars as their reserves, to fail so that
Paulson can bail out his company and his friends?
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- The US dollar is the world's reserve currency. It comprises
the reserves of foreign central banks. Bush's wars and economic policies
are destroying the basis of the US dollar as reserve currency. The day
the dollar loses its reserve currency role, the US government cannot pay
its bills in its own currency. The result will be a dramatic reduction
in US living standards.
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- Currently Treasuries are boosted by the habitual "flight
to quality," but as Treasury debt deepens, will investors still see
quality? At what point do America's foreign creditors cease to lend? That
is the point at which American power ends. It might be close at hand.
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- The Paulson bailout is predicated on cleaning up financial
institutions' balance sheets and restoring the flow of credit. The assumption
is that once lending resumes, the economy will pick up.
-
- This assumption is problematic. The expansion of consumer
debt, which kept the economy going in the 21st century, has reached its
limit. There are no more credit cards to max out, and no more home equity
to refinance and spend. The Paulson bailout might restore trust among financial
institutions and enable them to lend to one another, but it doesn't provide
a jolt to consumer demand.
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- Moreover, there may be more shoes to drop. Credit card
debt could be the next to threaten balance sheets of financial institutions.
Apparently, credit card debt has been securitized and sold as well, and
not all of the debt is good. In addition, the leasing programs of the car
manufacturers have turned sour. As a result of high gasoline prices and
absence of growth in take-home pay, the residual values of big trucks and
SUVs are less than the leasing programs estimated them to be, thus creating
more financial problems. Car manufacturers are canceling their leasing
programs, and this will further cut into sales.
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- According to statistician John Williams [ <http://www.shadowstats.com/section/commentaries>http://www.shadowstats.com/section/commentaries
] who measures inflation, unemployment, and GDP according to the methodology
used prior to the Clinton regime's corruption of these measures, the US
unemployment rate is currently at 14.7 per cent and the inflation rate
is 13.2 per cent. Consequently, real US GDP growth in the 21st century
has been negative.
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- This is not a picture of an economy that a bailout of
financial institution balance sheets will revive. As the Paulson bailout
does not address the mortgage problem per se, defaults and foreclosures
are likely to rise, thus undermining the Treasury's estimate that 90 per
cent of the mortgages backing the troubled instruments are good.
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- Moreover, one consequence of the ongoing financial crisis
is financial concentration. It is not inconceivable that the US will end
up with four giant banks: J.P. Morgan Chase, Citicorp, Bank of America,
and Wachovia Wells Fargo. If defaulting credit card debt then assaults
these banks' balance sheets, who is there to take them over? Would the
Treasury be able to borrow the money for another Paulson bailout?
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- During the Great Depression of the 1930s, the Home Owners'
Loan Corporation refinanced one million home mortgages in order to prevent
foreclosures. The refinancing apparently succeeded, and HOLC returned a
profit. The problem then, as now, was not "deadbeats" who wouldn't
pay their mortgages, and the HOLC refinancing did not discourage others
from paying their mortgages. Market purists who claim the only solution
is for housing prices to fall to prior levels overlook that rising inventories
can push prices below prior levels, thus causing more distress. They also
overlook the role of interest rates. If a worsening credit crisis dries
up mortgage lending and pushes mortgage interest rates higher, the rise
in interest rates could offset the fall in home prices, and mortgages would
remain unaffordable even in a falling housing market.
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- Some commentators are blaming the current mortgage problem
on the pressure that the US government put on banks to lend to unqualified
borrowers. However, whatever breaches of prudence there may have been only
affected the earnings of individual institutions. They did not threaten
the financial system. The current crisis required more than bad loans.
It required securitization and its leverage. It required Fed chairman Alan
Greenspan's inappropriate low interest rates, which created a real estate
boom. Rapidly rising real estate prices quickly created home equity to
justify 100 percent mortgages. Wall Street analysts pushed financial companies
to improve their bottom lines, which they did by extreme leveraging.
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- An alternative to refinancing troubled mortgages would
be to attempt to separate the bad mortgages from the good ones and revalue
the mortgage-backed securities accordingly. If there are no further defaults,
this approach would not require massive write-offs that threaten the solvency
of financial institutions. However, if defaults continue, write-downs would
be an ongoing enterprise.
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- Clearly, all Secretary Paulson thought about was getting
troubled assets off the books of financial institutions.
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- The same reckless leadership that gave us expensive wars
based on false premises has now concocted an expensive bailout that does
not address the problem, which will fester and become worse.
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- Paul Craig Roberts was Assistant Secretary of the Treasury
in the Reagan administration. He was Associate Editor of the Wall Street
Journal editorial page and Contributing Editor of National Review. He is
coauthor of The Tyranny of Good Intentions.He can be reached at: PaulCraigRoberts@yahoo.com
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