10/18/2008 05:12 am ET | Updated May 25, 2011

They're using the "D" word

They're Using the "D" Word

You want to know how all of this ends? In the year 2025, after secret meetings with European and selected Asian finance ministers, the United States selectively defaults on its bonds: only those held by China.

Okay, that's not a serious suggestion. Neither is this: The failure of Fannie Mae, Freddy Mac, and AIG - and who knows how many others - was deliberately engineered by the Bush administration to pay for the Iraq War.

THAT WAS NOT SERIOUS EITHER! Sheesh. And yet . . .

Let's do a quick review. The economic world is going to hell in a handbasket because . . .well, because an enormous amount of capital became tied up in instruments that were entirely outside the system of regulation of required transparency, and an equally enormous volume of more traditional, regulated securities had their values attached to these new "shadow" financial instrument.

Okay, that's still too complicated. You know who we need? Bill Clinton. Bill may be the only politician in history who could explain this in a way that the American people would understand. I'm going to try and channel Bill.

Two things happened at the same time. One was that banks gave mortgages to people on less collateral, on more favorable term, with less attention to risk, than at any time in our modern economic history. The second was that Alan Greenspan pedaled a theory of super-low interest rates and the magic of the self-correcting markets, and led everybody into borrowing against everything they owned.

It's exactly like the Savings and Loan crisis in the 1980s. (I litigated some of those cases on behalf of the government.) We deregulated the banking industry, which is just like hanging out a big sign saying "please come steal from us." You know who followed S&L deregulation really closely? The Mafia. When federal agents swooped down on a big Mafia conference in New York State, they found documents showing that organized crime had been following S L deregulation from the days when it was still a gleam in the eyes of a Congressional sub-committee. See, the Mafia understood that a deregulated class of banking institutions was the world's greatest money-laundering system.

The S&L crisis was a combination of two things: an old-school Democratic - before the DLC Third Way types arrived - "business as usual" mentality, and a lunatic laissez-faire Republican ideology the somebody (named Bush) once called voodoo economics. Those two things met, and a $500 billion taxpayer bill was the result.

Well, now we're facing something even worse. All those mortgages got bundled up in packages that people bought, sold, borrowed against and insured, all without any of the requirements of transparency - showing which mortgages were good and which ones were bad, for example - that would have applied if there had been any serious federal regulations in place. And then all of those deals got what they thought was insurance; enormous amounts of money trading hands in "debt swaps" and "credit default obligations" and all kinds of other complicated deals that all boiled down to the same thing: everyone figured they had nothing to lose, because if anything went wrong, somebody else would pay for the privilege of covering the losses on the hope of getting a share of the gains.

Which all works great, until things start going south. When that happens, all the investors who are holding shares of these bundles of mortgages suddenly realize that they have no way on knowing whether what they are holding is actually worth anything. And all the investors who are holding shares of funds that offer insurance on those deals realize that they have even less assurance that there anything of value at the end of their debt. And as bad as things really are, they get even worse when the lack of transparency, the lack of the rule of law, makes fear the only rational motivator.

And that's why we're hearing the "D" word - "Depression." In 24 hours our government went from saying it would not intervene to rescue private companies to an $85 million buy-out of AIG assets, the largest intervention in the history of the Federal Reserve. In less than a week John McCain went from the most avid proponent of deregulation and self-regulating markets in Washington to an instantaneous convert to economic populism.

But somehow there's this one piece that neither the Bush administration nor John McCain wants to mention. That's the $12 billion per month being spent in Iraq. Here's just one small piece of that expenditure: the "surge" that constited of inserting 30,000 more troops into Iraq is widely credited - even by Obama! - with the sharp decline in sectarian violence over the past 6 months. But that surge was accompanied by a program in which we put 120,000 Sunni fighters on the U.S. payroll at rates of $300-$500--per month, a $50 million per month expense. That had at least as much (I would say a lot more) to do with the successful campaign against Al Qaeda in Iraq as the increase in U.S. troop levels.

It also raises a host of concerns, but I'll leave those for another post. The point for this post is that the cost of operations in Iraq is not separate from the desperate straits of the U.S. economy. We cannot afford to add to the existing $1 trillion Iraq price tag, and the wholesale government purchase of AIG is an exemplar case of the reasons why. The point is that the economy and Iraq are not separate issues. When we choose between candidates we are choosing between philosophies and styles of governance that affect every issue, not just one and then another.

Bill Clinton could have explained this in a way that people would have understood. Can Barack Obama do the same thing? Can he do it in the setting of presidential debates? I think the answer to this question will determine the identity of our next president.

Oh, right, about that conspiracy thing. Here goes:
As the private equity markets collapse, investors are fleeing into U.S. bonds. Incredibly, today the government was able to sell short term (35-day) bonds at a reported 0.02% interest rate. Translation: investors are so freaked out they will lend money to the government for no gain, so long as they do not actually lose anything.

To appreciate this, you have to go back to the Civil War. In the Civil War, the North and South adopted very different approaches to financing their wars. The South relied on taxation and, ultimately, confiscation. The North relied on private financing through the sale of bonds. Since that time the U.S. government has treated the bond market as the primary source of its revenue for military activities; that's why at times the government has seemed to favor the bond market over the tax base. Taxes pay for schools, health care, Social Security . . . all that fluffy liberal Democratic stuff. Bonds pay for our wars. You want a really serious conspiracy theory? The outcome of all of this panic may be an enhanced ability to pay for our wars and a necessity to abandon the social welfare and investment projects that defined the New Deal. The perfect solution for certain neocons who are prominent among both Bush's and McCain's advisors. . .

Needless to say, I don't propose this theory seriously. Richard Viguerie probably admits this outcome as a possibility if you got him really, really drunk, but I don't really think there is anyone on the McCain staff who could even come up with a plan this complex. Still, it shows you something. Evil results from stupidity more often than from clever malice. How great is the evil that could result from a continuation of the stupidity that is expressed in 26 years of John McCain's economic philosophy?

I'll give you a hint. They're using the "D" word.