by Phillip Torsrud
The Federal Reserve kept interest rates very low in recent years, around 2%. That's the rate banks get, which means they have a greater profit margin on the money they lend people. For the rest of us, since the banks can borrow money so cheaply, they can offer very low interest rates to depositors who put their money in banks. Therefore, the average person would be better off putting the money in the stock market or spending it. As the stock market and consumer spending went up, it looked as though all was well. Yet, Wall Street wasn't satisfied.
Investment banks got the SEC to allow them to leverage at a rate of 30 to 1. In laymen's terms, that would be like being allowed to borrow three million dollars and only have to put up a house worth a hundred thousand as collateral. If you made a six percent profit, minus the two percent you had to pay to borrow it, you'd make $120,000. All by just putting a $100,000 asset at risk! That's why investment banks were borrowing like mad in sums of billions of dollars, which inevitably led to a liquidity crisis. This is not to say that there should be no leveraging by investors, since you can't always have the required capital on hand to make the investments, loans, etc... that make the economy move. Getting a mortgage or getting a car loan are forms of leverage.
Leveraging encourages debt, with the illusion of minimal risk. That's because even though you only have to have one-thirtieth of the capital to make the loan, it doesn't mean you don't have to pay back every dollar of debt if you mishandle the money. That's where AIG got in trouble. They sold insurance on hundreds of billions of dollars of corporate loans, mortgages and other debt. That's why the government had to rescue them. When leveraged at a 30 to 1 ratio, nothing can go wrong because you only have a minimal amount of cash to cough up in comparison to the debts you accrued to make these investments. When all the heavily leveraged investment banks began losing on the sub-prime mortgage mess, the danger was that they'd begin selling off assets to cover the spread. This devalues the assets as they are dumped on the market, while those with cash can gobble them up at fire sale prices. Sovereign wealth funds from China and the Middle East can do well in this transition of wealth. The $700 billion bail-out is a way to prevent American businesses from literally being sold out.
The bail-out doesn't address a number of other problems however. Did the investment bankers have any intention of paying up if their gambles failed? It is no less than blackmail to threaten economic collapse to pressure politicians to buy these toxic securities. People say that the $700 billion is necessary to save our financial system. Is a system so vulnerable to economic terrorism, by the people who have profited the most from it, worth keeping? Osama Bin Laden would be proud. But it's not just the bankers who were greedy. Despite the obvious reason, politicians receive millions in campaign contributions from Wall Street to allow these shenanigans, there is a deeper self-serving reason for their failure to regulate.
Politicians encouraged spending and debt because that gave the American economy a false bill of health. Growth at the expense of haphazard debt. While debt can at times be used to create growth, reckless debt on credit cards and bad mortgages are the equivalent of filling up on junk food. You wouldn't feed your kids on chips and doughnuts and when they gain twenty pounds of fat, brag about their growth. That's what our politicians have been doing. This obesity has now led to cardiac arrest in our financial markets as bad debt clogs the arteries of finance.
Where is the growth in manufacturing, education or other infrastructure during this period of false growth? These are the benchmarks that reflect real growth. We've been sold this idea that it's good to shift to a service economy. Financial services had grown to 20% of GDP before the meltdown, and now 40,000 of those jobs will be lost in New York alone.
Our leaders would rather tell us that all is well as each of these bubbles grow, using the illusion of growth to claim they're doing a great job on the economy. The $700 billion bail-out will not work because providing liquidity to allow banks to make more bad loans does not solve the structural problem of our economy. They continuously say that this plan will not only save Wall Street, but Main Street as well. This reflects their ambivalence towards Main Street. The problem on Wall Street wouldn't be happening if people could pay off their mortgages and credit cards. They are defaulting, filing for bankruptcy and having their homes foreclosed on at record levels. The American economy can no longer grow in this manner, too many people have destroyed their credit. This means less consumer spending, a decrease in profits and more layoffs.
Where is the investment in our future? In the short term, the $700 billion will provide plenty of cupcakes to deceive the public through another election, that our leaders know what they're doing. If they did, they wouldn't repeatedly make the mistake of deregulating to satisfy businessmen. We must demand that our government invests in our infrastructure, with education becoming a priority. That way, the next generation of voters might be smart enough to elect leaders who will actually address our problems, rather than help create them.
Please check out my books, Essays of a Penitentiary Philosopher and Preemptive Strike at Amazon.com or bn.com. Also see my web site www.crimeandculture.com to read my other blogs.
