There’s always been a tension between markets and democracy, which market fundamentalists like Friedman sought to elide with brazen statements about ‘Capitalism and Freedom’ that neatly conflate economic and political freedom, as if one necessarily and sufficiently underpinned the other. For the neo-liberal economists who underplay the normative aspect of their ‘discipline’ issues of positive freedom are sidelined; the ‘freedom’ that matters is the ‘negative’ freedom from interference by government, with little recognition of the fact that without certain guarantees that can only be enforced by the democratic state (access to education, healthcare, pensions and social security) the ‘freedom’ on offer to individuals without any power in the market is likely to be nasty, brutish and short.

The general trajectory offered by apologists of market dogma is that the excessive inequalities produced through capitalist enterprise are temporary, and that the great improvements in the lives of the majority in capitalist societies prove the efficacy of free markets. But this offers a complete misreading of economic history. As Ha-Joon Chang has eloquently documented, it was only in states with strong and active government that capitalism could prosper, and it was only in states where the democratic process could tame the more extreme tendencies of <em>laissez-faire</em> that the benefits of capitalism began to be shared through the provision of public services, rising median wages and pensions.

As the power of corporations grew, ‘free markets’ led inexorably to oligopoly, culminating in the ‘Gilded Age’ of excessive and accelerating inequality, and Depression; capitalism started to collapse and had to be rescued by massive government intervention causing a reset in the democratic deficit.  As a result, for a short post-war period, a balance (or stand-off) between the dictates of ‘free markets’ and democratic government acting to promote equality of opportunity resulted in a reversal of the trend to the polarization of income and wealth and a consequent increase in social mobility, with improved access to education and healthcare and a more adequate level of social security.

But this period of social democracy became a victim of its own success, encouraging a belief that markets would now provide the sort of protections only government had hitherto guaranteed. The super-rich fought back under the cover of a neo-liberal ideology that promised ‘Capitalism and Freedom’ – since which time capitalism in its red-in-tooth-and-claw ‘free market’ interpretation has been unleashed, governments stacked with politicians looking for post-parliamentary sinecures have been willingly complicit and the regulatory system duly captured, tied and bound and dumped in a shallow grave.

In truth, Hayek’s ‘Road to Serfdom’ had a fork in it. One way led to authoritarian, over-powerful government, but the other, the path Hayek ignored, led inexorably to concentrations of wealth and political power which have their own feedback loop resulting in oligopoly.

So, in place of parliamentary democracy with one-person-one-vote, we have the democracy of the market, where the oligarchs, through the mechanism of the ‘invisible hand’ can vote according to their bank balances – hence the trashing of the public sector and the privatization of anything of value – with a gun to the head of any government that objects. Our parliaments have little influence on the conduct of policy conducted behind closed doors by technocrats working to the neo-liberal agenda.

Exploding the Myth

Of course this austerity can’t possibly work. Greece could lay off the entire public sector and sell ALL its assets – it still wouldn’t be able to pay off the debts accumulated in the private sector and dumped on the public accounts. To quote Michael Hudson: ‘Debts that cannot be repaid, won’t be repaid’. But, at the end of the process the financial oligarchy will have a much more impoverished and compliant working class.

  

This article (originally published in Nov 1990) is worth reading, just to point out that this debased form of ‘capitalism’ has been gathering pace for a long time, exploding the myth that the 2008 crash came out of a clear blue sky and couldn't have been anticipated. In fact, it was 30 years in the making, with the Savings and Loans collapse being the precursor. Instead of learning the lessons, those at the controls ordered full steam ahead despite iceberg warnings.

"Have the poor suckers of this world ever lived in an age that offered such entertainment? Costly, to be sure, and they are the ones who are going to pay for it, but at least they are getting to watch some wonderful burlesque–first the pirates of a fraudulent system of communism forced to scuttle their own ship, and then the pirates of a fraudulent system of capitalism beginning to do the same.
So long as their focus was on Eastern Europe, our press and politicians couldn’t talk enough about “the triumph of capitalism and democracy.” But now that they begin reluctantly to concentrate on the piracy at home, they are–perhaps because so many of them are part of that piratical crew–understandably reluctant to admit the obvious: that our system is just as bogus and corrupt and irrelevant and defeated in its own way, offering neither the risks of true capitalism nor the safeguards of true democracy. Our system is a hoax.

If anyone still had faith in the system, the savings and loan adventure surely must have brought him to his senses and to his knees. The gambling debt of $500 billion ($150 billion plus interest and other incidentals)–or will it be, as some economists predict, a trillion four?–that the S&L industry left with the taxpayers has prompted even that deadpan Tory, George Will, to remark in wonderment, “We seem to have a capitalism here in which profits are private and we socialize the losses. Why are we, in effect–if you’re big enough, if you’re a huge bank or a savings and loan–why, in effect, are we guaranteeing everything? … What I’m asking is isn’t there a way to reform the system so that the taxpayers don’t get stuck with what happens when you have deregulation and risk taking that goes wrong?”

The answer to his question is: No, there is no way to reform the present system, because the system is owned and controlled by those who are ruining it. Voters, ordinary taxpayers, have nothing to say about it.

Martin Mayer, a conservative economic historian, has seen his world crumble and become meaningless. The capitalism he set his watch by has stopped ticking. He finds the thrift mess almost unbelievable: “Players entered the game through a government charter and continued to play, however severe their losses, in violation of all capitalist principle–courtesy of a government that continued to insure their borrowings. This was not an accident: it was public policy.”

When he talks about “players,” he makes it sound like customers at a casino. And that in fact is what it has become. Capitalism has become the Big Casino, with players guaranteed against loss, because in effect they have bought the house managers. That is public policy.

Mayer predicts plaintively that “future sociologists…will study the irruption of criminality into what had been conservative, even beneficent, organizations….They will seek to learn why the fiduciary ties that had set the unspoken, self-dignifying rules of a competitive society had been so grievously weakened in the late years of the twentieth century.”

But in fact, this has never been a competitive society, neither in the mythical “capitalist” commercial world nor in the even more mythical “democratic” world of politics. Big-big uncontrolled money has ruled both through special privileges, and the S&L disaster simply illustrates again what Mayer calls “the corruption that must ultimately infect any government where the costs of running for office are greater than those that can or will be borne by the relatively small community of the public-spirited.”

Of course, this is nothing new; “democracy,” at least in modern times, has always been equated with the purchase of politicians by those with the money to do it. “Suppose you go to Washington and try to get at your government,” Woodrow Wilson said back in 1912 when he was running for President. “You will always find that while you are politely listened to, the men really consulted are the big men who have the biggest stakes–the big bankers, the big manufacturers, the big masters of commerce….Every time it has come to a critical question, these gentlemen have been yielded to, and their demands treated as the demands that should be followed as a matter of course. The government of the United States is a foster child of the special interests.” (He knew from experience, having capitulated to so many special interests himself.)

In the 1980s that trend reached the point where financial contributions from ordinary voters were hardly even sought. In the House of Representatives, writes Brooks Jackson, Democratic members commonly received “more than half their re-election funds from PACs and much of the rest from lobbyists and business executives.” The Congressional banking committees, the grand colluders in this conspiracy, were inundated with money from sleazy financial institutions and sleazy real estate developers, and from the hundreds of sleazy, high-priced law firms and sleazy accountants and sleazy appraisers that laid the foundation for their dirty work. From S&L interests alone, members of Congress received $11 million on the record–probably twice that much off the record–in the Looting Decade . . .

Painful as the bailout cost will be, it is not nearly so painful and dangerous to the economic health of America as the shift in and concentration of the control of credit, which we are already beginning to see. Ten years ago there were about 4,500 S&Ls in the country. Now there are fewer than 3,000. By the time the bailout storm troops get through selling them off, the number is expected to be down around 1,500, with a corresponding drop in mortgage money. Most will have disappeared, via mergers, into super-S&Ls and superbanks whose social usefulness will be equivalent to supertankers like the Exxon Valdez. . . .

In the past decade, nearly twice as many banks failed in Texas as did in the whole nation between 1943 and 1979. Nine of the ten largest Texas banks (which had 40 percent of their loans tied up in oil) went under. Nearly all of them were bought up by or merged with out-of-state banks . . .
Ordinary people are, obviously, being screwed–in the name of “reform.” Whenever the money-masters of government carry out something “reformist,” we are in deep trouble. The disastrous S&L rule changes of the early 1980s were called “reforms.” Now the bailouts that concentrate wealth and credit are also called “reforms.” And the Bush Administration has other even more noxious “reforms” planned for the immediate future . . .

Monopoly CapitalThe plan adds up to the complete deregulation of commercial banks. Since 1985, when Vice President Bush was head of a task force studying financial market restructuring, he has been a patsy for the banks, which have been lobbying and finagling with considerable success to (1) reduce the S&L industry to an insignificant source for government-backed home mortgages (that goal is in sight), (2) allow banks to enter the securities business (the Federal Reserve recently made the first ruling in that direction) and (3) let banks do just about any damn thing they want to do.
The tainted S&Ls have provided the banks and the Administration with a wonderful rationale: The S&Ls are booed as the bad guys–ruffians, vandals, thieves–and the banks are patted and praised as the gentlemen–decorous, wellregulated (by comparison), sound, safe.

In fact, commercial banks are anything but. Since the mid-1980s they have been lending with as much abandon and stupidity as the S&Ls, and with as little supervision from the Feds. The industry has been falling apart for at least five years (Seidman’s vaunted chairmanship of the F.D.I.C. notwithstanding).

Only ten banks, with assets totaling $232 million, failed in 1980. Eight years later, 220 banks, with assets of $54 billion, either closed or were given emergency cash injections by the Federal Reserve. Bad management, bad luck, fraud and lousy supervision by Seidman’s cops all contributed. In 1986, with 1,400 of the nation’s 14,500 banks in serious trouble, Seidman admitted that half the problem banks hadn’t been examined in more than a year. “We’re spread very thin,” he said. “We don’t have enough people to catch the problems.”

Things didn’t improve. Nor did thrifts have a corner on crooks. In 1987 the F.D.I.C. admitted that one-third of the banks that failed were brought down, at least in part, by insider dishonesty. The same year, with banks collapsing right and left, Stephen Aug reported on ABC Business World that “huge segments” of the commercial banking industry were “restructuring in what some say is a giant controlled bankruptcy organization.” And much of the emergency oxygen was being fed to the giants–Citicorp, Chase Manhattan, Bankers Trust, Manufacturers Hanover and Bank America.

But most of the popular press, to the extent that it was writing about moneylenders’ problems at all, was concentrating on the S&Ls. Don Dixon’s prostitutes were much more entertaining than Chase Manhattan’s disappearing Third World loans. And they were indeed disappearing. By last year all the big banks mentioned above were writing off huge portions–some by as much as two-thirds–of their Third World loans, thus admitting they would never be repaid.

In the past two years particularly, there was an orgy of bank gambling with leveraged buyouts and takeovers financed by junk bonds, and now the earth is beginning to shake. Indeed, the General Accounting Office has warned that seven of the nation’s ten largest banks plunged so deep into those risky loans that if even one of the highly leveraged companies should go bankrupt, an extremely dangerous chain reaction could result. Oceans of speculative commercial real estate loans made during the 1980s are also turning rancid.

The percentage of banks losing money keeps climbing; by this summer it had passed 11 percent. The bigger they are, the wider their cracks. In late September Chase Manhattan, the nation’s second-largest bank, laid off 5,000 employees, cut its stock dividend by half and admitted a probable $625 million loss for the quarter. Chemical Banking Corporation, the holding company for the nation’s sixth-largest bank, was right behind, only its stock dividends were cut 63 percent. And then Citicorp, the nation’s largest bank, answered sick call with a 38 percent drop in earnings. Poisoned by lousy loans, the biggies up and down the East Coast were turning green. Will California banks, which have been playing Nathan Detroit for the developers’ floating crap game, be next? Many experts think so.

The rot in commercial banking has been carefully covered up for years–just as the rot in the thrift industry was covered up. The duplicity is shared by bank owners and regulators. Writing two years ago about this trickery, Jerry Knight of The Washington Post told us, “For months, Seidman and Comptroller of the Currency Robert E. Clarke have insisted publicly that the problems of Texas banks are not serious enough to require any extraordinary government action. Behind the scenes, however, federal regulators have been bending the rules of banking to keep weak Texas financial institutions from going under and taking unusual steps to keep the public from learning how bad things are.”

Sound like a replay of the S&L coverup? Stanford economist Brumbaugh, who was one of the first to discover the true condition of the S&Ls, sure thinks so. He says, “We are in the midst of the largest government cover-up of a financial scandal ever in the country’s history.”

Just how big is the mess they’re trying to hide this time? Last year 200 banks failed; another 200 are expected to go under this year. That’s for starters. In those numbers are none of the monster banks that are “too big to fail”–that is, banks so big the government is afraid to let them collapse, lest they drag down the whole banking system. What shape are the monsters in?

The scariest appraisal was given three months ago by Brumbaugh: “I believe that the following banks are very close to true insolvency…Chase, Chemical, Manufacturers Hanover, Bankers Trust and even Citibank and Bank of America…. In addition to that, there are 460 banks with $42 billion [in assets] that have had losses in each year since 1986. Those institutions are going to exhaust their net worth on an accounting basis this year. There are another $30 billion in assets at institutions that have had negative net income for the last two years.”

By “true insolvency” Brumbaugh means that the government’s bookkeeping system is phony: “The accounting method that we use in this country covers up true market insolvency when these institutions get to the end of the rope, and that’s exactly what happened with the savings and loan crisis, and it’s happening all over again with commercial banks. And in my opinion, the total losses that are embedded in those banks that are insolvent…are so great that the bank insurance fund is not going to be able to handle it, and taxpayer dollars are going to be necessary…. In order to resolve the problem, the taxpayers are going to have to pay a large portion of the losses that are embedded in commercial banks.”

What? Another bailout, and this time one that will make the S&L bailout seem trivial? No, no, no, Seidman sputtered furiously (he and Brumbaugh were facing each other on Nightline). Brumbaugh, he said, was being “irresponsible.” He was “shouting fire in a crowded theater.” He was launching “a typical professorial-type attack.” Brumbaugh’s charges were “preposterous.”

But, as evidence showed in the next few weeks, Brumbaugh’s charges were not at all preposterous. In early September Charles Bowsher, who as Comptroller General heads the General Accounting Office, the agency that does audits and investigations for Congress, gave the chilling news: His investigators had discovered that whereas the F.D.I.C. claimed to have $13.2 billion on hand to help failing banks (an inadequate amount, even if it had been accurate), in fact, “if we had a more realistic” accounting practice, it might turn out that the fund was sucking air. Whatever the right figures were, he said, “not since it was born in the Great Depression has the federal system of deposit insurance for commercial banks faced such a period of danger as it does today.”

Once again Seidman rushed in to contradict the evidence, sounding very much like the cheerful Danny Wall of 1988: “I’ve said it before and I’ll say it again, the fund will be able to meet its obligations.” Is he bothered by the fact that more banks have failed in the past two years than in any comparable time since the Depression, and that these failures have reduced the insurance fund by 40 percent? Oh dear no. “I don’t think it’s a question of crisis and panic,” he told reporters after a Congressional hearing. “It’s a sign of increased stress.”

Back to the 1920sNevertheless, though it is obvious that the tottering commercial banking world needs tighter regulations than ever, the industry and the Administration push on pell-mell for deregulation. In fact, the dismal condition of the industry is being used by the deregulating claque as their strongest, and weirdest, argument. Just as St. Germain, Garn, Pratt and Wall argued that the best way to help zombie thrifts recover was to remove all regulations so that they could “grow out” of their problems, now Bush, Fed chair Greenspan, Treasury Secretary Nicholas Brady, Seidman and others demand that the government dismantle what Seidman calls the “archaic laws” that for many years have controlled commercial banking. They, too, want to “grow out” of their perilous condition. What these laws do is protect the banking industry from its worst instincts by insisting that banks remain banks, and not become gamblers, hucksters and hustlers in other lines as well.

The deregulators will probably make their big power-play next spring, when, under mandate from Congress, the Treasury Department must come up with its “reform” plans for the banks. You can expect the other side to try to sell some blind horses to us, like offering to swap a lower ceiling on deposit insurance for wholesale abandonment of regulations–as if the rotters wouldn’t be just as happy engaging in risky activity under a lower ceiling as they have been gambling under the present one. If there is a double agent to be on guard against, it will be Donald Riegle, chair of the Senate Banking Committee. He and the moneylenders are–could any old saw be more apt?–thick as thieves. Riegle is recorded as receiving $200,900 from S&L officials and PACs between January 1981 and May 1990–second only to California’s Senator Pete Wilson ($243,334). Now that S&L money is seen to be tainted, Riegle has scrambled to redeem his reputation by returning $120,000 of it. But the commercial banks have stuffed his pockets too, and there is no record of his having returned any of that money.

Recently Greenspan–that trustworthy fellow who guaranteed the morality of Keating and was one of the chief boosters of junk-bond purchases by S&Ls–guided his Fed colleagues into a disastrous decision. They ruled that J.P. Morgan (Morgan Guaranty Trust) could trade and sell corporate stocks. With this cloven hoof in the door, other banks will follow, and that will be the death of the Glass-Steagall Act, which Congress passed in 1933 to separate commercial banks from investment banks and thereby control some of the outlawry that had caused thousands of banks to fail. Next they will probably be targeting the Bank Holding Act of 1956, which was intended to keep banking out of commerce, and the McFadden Act, which limits interstate banking.

What Greenspan, Seidman and their gang say to critics is, Oh, we want banks to be banks, too, but we want them to be universal banks. Which can be translated to mean uncontrolled banks, banks completely unfettered by regulations that restrict their operations–in short, pretty much a return to the reckless and lawless 1920s and early 1930s, which, if measured by the drama and excitement of collapsing financial structures, had it all over the 1980s.

Brumbaugh, for one, is dumbfounded by what he’s seeing. “The administration and Congress just don’t want to acknowledge the problem,” he says with a sigh. “This is déjà vu all over again. You can’t believe it’s happening, but there it is.”

 Robert Sherrill, The Nation, November 19, 1990

A Modern Fairy Story

Once upon a time the humble borrower would apply to a bank (or building society – remember those?) for a mortgage and the financial institution would assess their creditworthiness and advance a loan. The debt would sit on the bank’s books until term, when the borrower’s repayments would pay off the debt plus compound interest, unless the borrower defaulted, in which case the bank would repossess the borrower’s property and suffer any loss.

Then along came securitisation.

Now banks could take their borrowers’ IOUs and bundle them into mortgage-backed securities which could be sold on to willing buyers. In this way they could clear much of this debt off their books and ensure a steady income. As credit controls were lifted and debt flooded into the property market, derived demand for housing grew, creating a classics a Minsky-style asset-price feedback loop – as house prices rose, so demand increased, creating more debt, higher prices, more demand, and repeat until well cooked . . .

Pretty soon, banks could see they were on a one-way bet, with rising house prices providing a cushion against the occasional default. And, anyway, by the time any defaults occurred, the debt would have been sold on . . . and on . . . In short, they were no longer left holding the baby.

As mortgage origination became a sure way to make risk-free money, so more players entered the market, and standards started to be relaxed. Did it really matter if the borrower was lying about their income? If they could keep up payments long enough for the originator to sell on the loan it would be somebody else’s problem. And, with house prices rising, the collateral was sufficient to cover the losses.

Meanwhile as Mortgage-Backed Securities were bundled into Collateralised Debt Obligations, then sliced into different levels of risk, there was something for everyone. Pension funds could take the most secure AAA tranches, while those looking for higher yields could take a risk with the junk end of the market.

But the really clever trick was to take that lowest tranche and reconstitute it into a CDO2 – with the least-worst being re-graded as AAA by the ratings agencies (paid for their services by the banks who held the CDOs!) – creating a latter-day philosopher’s stone capable of turning base metal into gold.

Moreover, with the explosion of Credit Default Swaps, any residual risk could be offset by buying insurance against default (even though ‘insurers’ like AIG weren’t sufficiently capitalised to underwrite that risk). Magically, risk had been virtually eradicated from the risk models.

So, it was no surprise that, with rising property prices and seemingly risk-free investment opportunities, demand for the products of these latter-day alchemists soared.

The problem now was supply, the housing market was becoming saturated, families with no income, no jobs and no assets were encouraged to take on ‘teaser’ loans, but where do you go from there?

The answer was ‘synthetic CDOs’. No longer would you need new real-world mortgages to bundle up and sell, you could simply ‘reference’ existing CDOs and sell on derivatives of derivatives, creating an endless supply of virtually risk-free investment.

The only problem was . . .

When banks loan out money for mortgages, they don’t take it from depositors, they create it from nothing. The debt is simply the corollary of a promise to pay from the borrower, increasing the money supply until it is paid off. But, with compound interest, the arithmetic starts to get interesting as more money must be created than the original loan if the interest is ever to be paid off. As that interest accrues, so the whole system takes on the characteristics of a giant Ponzi scheme, with more borrowers required to enter the market to keep the process in motion.

However, as those sub-prime chickens start to roost on the hen-house and defaults mount, it gets harder to refloat the repossessions (incidentally, the myth that has grown up that government efforts to force mortgage lenders to consider riskier loans because it helped the poor onto the housing ladder is exploded by the statistic that 80% of sub-prime mortgages went to existing home-owners using their property as an ATM). As house prices start to slide with fewer new entrants into an over-heated market the asset-price feedback loop starts to go into reverse. But the interest on the debt, and the interest on the interest continues to accrue. So, while debt levels increase and income levels stagnate (or, in the current case of Greece in particular, are slashed), the maths no longer makes any sense. Pretty soon much of the debt created by banks out of thin air becomes unserviceable.

Defaults rise, the bubble starts to collapse. Banks are left holding CDOs which are virtually worthless. Calls on their Credit Default Swaps start to rise. CDS ‘underwriters’ like AIG realise they don’t have the capital to stay in business. Clients like Goldman Sachs know that if those payments aren’t made they will soon be underwater.

The banking system freezes as banks refuse to lend . . . to each other! Like traders on a market stall who have stacked the bottom of their baskets with rotten fruit, they know that those CDOs, which look so juicy on the surface, are well past their sell-by date. Trust, that essential lubricant of markets has evaporated.

The whole banking system is on the verge of collapse. Who you gonna call?

Then you remember, Hank Paulson, the US Secretary to the Treasury is an ex-CEO of Goldman Sachs. His friends in government, like James Rubin, Larry Summers and everyone’s favourite Ayn Rand disciple Alan Greenspan, are likewise Wall St. alumni.

What if you could persuade them to offload all that debt onto the public accounts? It doesn’t take much arm-twisting. Pretty soon the government is plying the banks with billions of taxpayers’ future income – like there’s . . . er . . . no tomorrow. They buy up the toxic assets, or insure the banks against future losses on those assets. It’s the only way to Save the World.

A sigh of relief all round.

Except . . .

All those debts that were unserviceable in the private sector now look unserviceable in the public sector. Well, say the banks, you should’ve thought of that. Yes, say the markets, it was totally irresponsible for government to hold so much debt – it amounts to a sovereign debt crisis.

That’s the problem, say the ratings agencies, government has too much debt – we’re going to have to downgrade your creditworthiness – as a result you will owe the banks even more money for bailing them out.

Well, say the heads of government in unison, then we’re just going to have to cut back on our profligate spending on healthcare, education and pensions to make more room for debt repayment. If it means raiding the incomes of the sick and disabled, well, these are tough times, calling for tough decisions. We’re all in this together, or, at least, YOU’RE all in this together.

Somehow, I don’t think there’s going to be a happy ending.

“Debts that cannot be repaid, won’t be repaid.” - Michael Hudson.

Melanie Reid and her Audience

It’s not exactly a secret that the right are intent on dismantling the welfare state.

Which is why the disconnect between Melanie Reid's excellent articles on her slow recovery from a riding accident for The Times newspaper and its editorial content are so jarring. 

Ms Reid writes eloquently of the physical and psychological struggles of living with SCI – but for anyone less talented in their profession, spinal injury often brings with it the prospect of a lifetime of impoverishment as they lose their employment. This is an aspect that is entirely missing from her narrative, and one to which her readership should be exposed.

Meanwhile the paper continues to support the dismantling of the sort of NHS care she has received, and cuts in benefits which will leave anyone in her position – but without her connections or privilege - more destitute than ever.

For many, the disability is the easy part – it’s the stress of the public stigmatisation of benefit claimants living in a ‘dependency culture’ that really demoralises.