Stopping global book makers

Despite concerted action by central banks, bailouts of unimaginable proportions by the U.S. Treasury, and the disappearance of U.S. investment banker Lehman Brothers, at over $600 billion the largest bankruptcy in history, the major world financial crisis still lies ahead.

As was first revealed Sept. 18, the U.S. Treasury will provide up to $700 billion to buy frozen mortgage related securities from American banks. Astonishingly, decisions made as to what securities will be purchased, and at what price, are "non-reviewable" by courts or legal process under terms made public by Treasury secretary Hank Paulson, a former Goldman Sachs investment banker.

The justification being given for the establishment of a monetary tyranny under Paulsen is that it is needed to settle the crisis arising from the issue of securities made up of bundles of mortgages — which no one now wants to buy, and which no one now knows what they are worth. For the crisis to end, the banks must be allowed to sell these securities to the U.S. Treasury. Using the new money, the American banks lucky enough to be selected by the U.S. Treasury, can then rid themselves of the poisoned securities, rebuild their capital bases, and begin lending again, ending the credit crunch which threatens the American economy.

The reason for using public credit to bail out the banks, but not the people with mortgages is clear enough. What Gore Vidal calls the party of property, that would be the Republicans and the Democrats acting together in Congress, want to protect financial assets, not working families' homes.

The origins of the American financial fiasco are also bi-partisan. Phil Gramm, co-chair of the campaign to elect John McCain, and Robert Rubin a major backer of Barack Obama, acting in 1999 as Senator Gramm and U.S. Treasury Secretary Rubin (under Bill Clinton), jointly engineered financial deregulation. That brilliantly dumb move allowed removal of the Glass-Steagall rules keeping investment banking separate from deposit banking. These measures, which date back to when Franklin Delano Roosevelt was U.S. president, were adopted to prevent a reoccurrence of the Great Depression, precisely what is feared today.

Low interest rates introduced by the U.S. Federal Reserve in 2001 to pump up a lagging U.S. economy help explain the wild lending practices of newly deregulated U.S. financial institutions. By creating financial instruments out of mortgages, and then selling them as securities, American banks thought they were passing on the risk to the proud holders of the new debt. It turns out that financial markets were not up to the task of raising and allocating capital safely, so the U.S. Treasury has stepped in to take control.

Conventional banks take deposits and make loans to credit worthy borrowers who must put up collateral. Deposit banking is best understood as a public utility, and it is best for all if it is publicly owned, like the old Ontario or Alberta Treasury branches; or at least community owned, such as credit unions.

Investment banks sell government and corporate debt, and make markets for debt instruments. American investment banks became famous by taking privately owned companies public, that is to say, by selling stock in family-owned major industrial enterprises to individuals and funds. Stocks entitled the purchasers to share in profits distributed as dividends.

Investment banks valued the shares, sold them, and took commissions on re-sale.

However not content with this old-fashioned business model, the deregulated investment banks adopted the "originate and distribute" model of securitizing mortgage loans made by deposit banks. These securitized loans did not appear as balance sheet items, which allowed the deposit banks to re-lend their capital much faster. As well, cross-ownership between investment banks, and deposit banks, compounded the opportunities for deal making, and risk taking.

If deregulation of finance was a cause of the impeding financial crisis, re-regulation, though desirable is in itself is not the cure. Over 20 years ago, with central bankers, the financial press, the property parties in every country, and academics looking the other way, or pretending all was fine, investment banks to their great profit began dealing in credit derivatives, with huge sales commissions attached.

In addition to raising debt and distributing ownership of assets which represented profits made through production, and trade, in essence, an entire industry was created to make bets on whether of not stocks would rise or fall, bonds would be redeemed or not, or currencies would sink or soar. Thus emerged a finance industry, the derivatives trade, outside national control or regulation which has grown to a stupendous $1,000 trillion while the people responsible for overseeing global finance did nothing to put a stop to what amounted to global book making.

While losing your shirt in Las Vegas is not a fun way to end a vacation, watching the derivatives trade come unglued is a prospect that is frightening beyond belief. That explains why the U.S. Treasury stepped in to nationalize insurance giant American International Group (AIG) injecting $85 billion, in an effort to contain a crisis of cross defaults by various major financial institutions on credit derivatives swap (CDS) trades. These started to unravel when AIG could not pay off on CDS bets following defaults on corporate debt it had insured against the ensuing defaults.

The U.S. Federal Reserve provided the $85 billion to the U.S. Treasury, creating the money out of thin air ("monetizing the debt" is the technical term). The Federal Reserve has been providing loans to U.S. banks taking even poor quality non-marketable bonds as collateral.

Many of the European banks involved in the derivatives scams are too big to rescue. For example, Barclays bank has assets that exceed the GDP of Great Britain.

Putting a stop to global book making is the only way to restore confidence and trust to international finance.

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