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Ismael Hossein-zadeh Headshot

"Too Big To Fail": A Bailout Hoax

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How Schemes to Rescue Wall Street Gamblers Are Prolonging this Recession

Using the "too big to fail" scare tactic, the U.S. government has kept a number of terminally ill Wall Street gamblers on an expensive life-support system that is estimated to cost taxpayers $8.5 trillion. In light of the fact that (according to IRS Data Book) there were 138 million taxpayers in 2007, this figure represents a burden of $61,594.20 per tax payer. Or, to put it differently, it represents a burden of $28,333.33 per man, woman and child for the entire U.S. population.

This massive giveaway of public money has been devoted to a wide range of fraudulent programs, including asset purchases of insolvent institutions, loans and loan guarantees, equity purchases in troubled financial companies, tax breaks for banks, assistance to a relatively small number of struggling homeowners, and a currency stabilization fund.

The rationale behind this unprecedented taxpayer rip-off is that the current economic crisis is largely due to the ongoing credit crunch in financial markets; and that government injection of money into financial institutions will help unfreeze the credit market by absorbing toxic assets off their balance sheets.

Despite the massive infusion of public money into the coffers of Wall Street giants, however, the banking industry has shown no interest in lending. Government's showering mega banks with taxpayers' money is thus very much like throwing people's money into a black hole without any questions asked as to where it all ended up, or how it was spent. Not surprisingly, the credit crunch continues unabated and economic conditions deteriorate out of control.

The question is why? If "illiquidity is the core economic problem," as policy makers argue, why is then the government's injection of enormous amounts of liquidity failing to unfreeze the credit market?

The answer is that government policy makers, Wall Street financial gamblers, and the mainstream media are misrepresenting the ongoing financial difficulties as a problem of illiquidity or lack of cash. In reality, however, it is not a problem of illiquidity or lack of cash, but of insolvency or lack of trust and, therefore, of hoarding cash. The current credit crunch is a symptom, not a cause, of the paralyzed, unreliable financial markets.

John Maynard Keynes, the well-known British economist, attributed this type of credit crunch to what he called "liquidity trap," not lack of liquidity, implying that under market conditions of widespread insolvency and distrust lending comes to a standstill not because money is scarce but because it is hoarded, or "trapped," as a safe instrument of preserving assets.

The theory of "liquidity trap" has been corroborated by empirical evidence from the Great Depression of the 1930s, as well as from the recent financial difficulties in Japan -- known as "Japan's lost decade." It is also evidenced in the current credit crunch in global markets.

There is strong evidence that major money-center banks (such as Citigroup and Bank of America) that have received huge sums of the bailout money are technically bankrupt, but they are not declared as such out of a fear that it may cause turbulence in global financial markets. "Here is the ugly, unofficial truth that neither Wall Street nor the government will acknowledge: the pinnacle of the US financial system is broke -- with perhaps $2 trillion in rotten financial assets on the books. Nobody knows, exactly. The bankers won't say, and regulators won't ask, or at least don't dare tell the public".

By virtue of years of Wall Street's expanding bubble, which came to a burst in the late 2007 and early 2008, these banks managed to accumulate huge sums of fictitious capital on their balance sheets. However, since there is no transparency and the extent of toxic assets thus accumulated is not disclosed, nobody really knows the amount of the worthless assets that are hidden in the books of major Wall Street banks and brokerage houses.

One thing is certain, however: the amount of these toxic assets is in terms of trillions or (as some experts point out) tens of trillions of dollars. There is simply not enough money -- in the United States or in the entire world -- to bailout these toxic assets. Although not many people know of this fraudulently kept secret, the banks of course know it. And that's why inter-bank lending has come to a standstill, as the banks do not trust each other or, for that matter, businesses and consumers.

This explains what happened to hundreds of billions of bailout dollars that government bestowed upon Wall Street mega banks: they simply grabbed the loot and stashed it into their coffers, without dispensing a single penny of it as credit to businesses or consumers.

It also explains the continued freeze of credit markets and the ongoing financial or market stalemate: neither the giant financial institutions (in collusion with government policy makers) are willing to accept the consequences of their gambling policies and submit to their deserved fate of bankruptcy; nor is there enough money to bailout all of their toxic assets.

Either of these two options could remove the massive toxic assets from financial markets and restore confidence in lending. But since the former alternative is not acceptable to the powerful financial interests and the latter option is not feasible due to insufficient money to buy a ton of worthless assets, the oppressive debt overhang continues to keep credit markets frozen and the economy paralyzed -- hence, the persistent stalemate and prolonged crisis.

In a subtle but real sense, this stalemate is a reflection of two opposing forces: on the one side stand the competitive forces of market mechanism that require exposure, transparency and the cleansing of the balance sheets of the insolvent mega banks. On the other side stand the monopolistic power of these financial giants, supported by government policy makers, that is preventing the forces of competition from determining the value of their toxic assets.

The apparent rationale behind the refusal to acknowledge the bankruptcy of Wall Street mega banks is that they are "too big to fail," implying that admission of their failure may cause major turbulence in global financial markets. A closer examination of this claim reveals, however, that it is more of a scare tactic designed to protect the powerful interests vested in these financial giants than a genuine rationale to protect national interests.

While it is true that exposing Wall Street mega banks for what they are -- bankrupt -- may cause a severe short-term jolt to global financial markets, such a short-term turbulence would be a necessary price to pay for a "clean break" from the current financial stalemate and a long, protracted economic malaise. It would also serve as an effective way to prevent massive redistribution of resources from taxpayers to Wall Street gamblers. In the history of socio-economic developments such cataclysmic but inescapable shocks are variously called "regenerative or creative destruction," "shock therapy," or "birth pangs" of a new dawn and a fresh start.

The alternative to a painful but swift cleansing of the mega banks' toxic assets is to keep these technically bankrupt banks on a financial life-support system that, like parasites, would suck taxpayers' metaphorical blood, drain national resources, and eventually corrupt or devalue the dollar. What's more, there is no timeframe as to how long these mega banks should or would be kept on the costly crutches provided by the taxpayers, which means the financial stalemate and economic paralysis can go on for a long time. Two historical precedents can be instructive here.

In the face of the Great Depression of the 1930s, the Hoover administration, using the "too big to fail" scare tactic currently used to bail out the insolvent Wall Street Gamblers, created the Reconstruction Finance Corporation that showered the influential bankers with public money in an effort to save them from bankruptcy. All it did, however, was to postpone the inevitable fate of the banking industry: almost all of the banks failed after nearly three years of extremely costly bailouts policies.

In a similar fashion, when in the mid- to late-1990s major banks in Japan faced huge losses following the bursting of the real estate and/or lending bubble in that country, the Japanese government embarked on a costly rescue plan of the troubled banks in the hope of "creating liquidity" and "revitalizing credit markets." The results of the bailout plan have been disastrous.

Although the amount of sour assets has never been disclosed, it is obvious (in retrospect) that such worthless assets must have been colossal. For despite a number of huge bailout giveaways, no noticeable improvement in the ailing conditions of Japan's troubled banks is visible.

Not surprisingly, more than a decade after the debt overhang of Japan's troubled banks first came to surface in 1997-98, most of the affected banks continue to be vulnerable, the nation's credit market still suffers from a lack of trust, and the broader economic activity remains anemic.

So, the undisclosed, tightly-kept-secret tons of toxic assets simply cannot be bailed out. Not only will efforts to do so fail, they are also bound to make things worse by draining public finance, redistributing national resources in favor of incompetent and irresponsible financial institutions, accumulating national debt, weakening national currency, and prolonging economic crisis.

Only by burying the oppressive deadweight of mountains of fictitious assets and cleansing the market off their toxic effects can trust be restored in credit markets. This requires opening the books of the troubled financial institutions and letting them go belly up if they are technically bankrupt. As William Greider of The Nation magazine puts it, "Facing facts will be painful, but it's better than continuing a costly charade".

The current policy of keeping the toxic assets of insolvent financial institutions on costly crutches is nothing short of price fixing. The logical way to realistically evaluate the price of these assets is, therefore, to do away with the current policy of price fixing and let market forces determine the price. As Mike Whitney points out,

The appropriate way to establish a price for complex securities in a frozen market is to create a central clearinghouse where they can be auctioned off to highest bidder. That establishes a baseline price, which is crucial for stimulating future sales...Bernanke [the head of the Federal Reserve Bank] would be better off letting the market decide what these debt-instruments are really worth. There are always buyers if the price is right.

While pulling the plug on the insolvent banks and letting them go belly up may cause short term convulsions in financial markets, it will have several advantages that would far outweigh such temporary pains.

To begin with, this would shorten the wrenching economic crisis and usher in a clean start. Second, it would avoid rewarding mismanagement, inefficiency and irresponsibility. As Jim Rogers, founder of the Quantum Fund, points out:

What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent. . . . What's happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics.

"Governments are making mistakes. They're saying to all the banks, you don't have to tell us your situation. You can continue to use your balance sheet that is phony.... All these guys are bankrupt, they're still worrying about their bonuses, they're still trying to pay their dividends, and the whole system is weakened.

Many smaller but financially sound regional and community banks could greatly benefit from the opportunity to buy out the realistic, market-based or devalued assets of the insolvent mega banks. Not only will this benefit the healthier financial institutions, it will also lighten taxpayers' bailout burden.

Third, in light of the fact that the bailout giveaway dollars represent a subtle redistribution of national resources from taxpayers to Wall Street gamblers, declaring these gamblers bankrupt would protect taxpayers from having to shoulder the costly bailout burdens, thereby helping to protect the nation from further plunging into debt. There is absolutely no reason why taxpayers should bailout giant banks, insurance companies, investment banks, and hedge funds.

Indeed, for all the money that the government is (or would be) paying for the insolvent banks' toxic assets, taxpayers could actually own those banks if they are let to be priced according to realistic market values, which are bound to be only a small fraction of their inflated book values.

For example, in exchange for the $20 billion bailout money that the Citigroup received on November 23rd, 2008, the government/taxpayers could technically take the possession of the bank since its net market worth at the time was estimated to be only equal to $20.5 billion -- down from $255 billion in mid 2007.

But Citigroup has received much more than $20 billion of taxpayers' money. The $20 billion injection was in addition to the $25 billion the company had received the month before (October 2008) under the Troubled Asset Relief Program (TARP). More importantly, at the same time that Citigroup received the $20 billion injection, it also "received $306 billion of U.S. government guarantees for troubled mortgages and toxic assets to stabilize the bank after its stock fell 60 percent last week."

Obviously, this means that, while Citigroup's ownership remains legally in the existing private hands, taxpayers have, in fact, paid for the company's net market value of $20.5 billion 17 times over with the $351 billion paid (or committed to pay) to date (351 = 20 + 25 + 306).

With varying degrees, what is true in the case of Citigroup is also true in the case of a number of other mega banks. For example, Bank of America has received $45 billion cash and $118 billion worth of guarantees against bad assets. Yet, its market value as of January 20th, 2009, was estimated to be only $33 billion -- down from $228 billion in mid-2007. This means that, like the case of Citigroup, taxpayers have purchased (paid for) Bank of America many times over.

That the ownership of these banks remains, nonetheless, in the existing private hands is indicative of the fact that government policy makers are more committed to the interests of Wall Street gamblers than those of taxpayers.

In the absence of corrupt, incestuous Wall Street-government relationship (including the new, Obama administration), nationalization of insolvent financial institutions is not as complicated or difficult as it sounds. It is certainly easier than public ownership and management of manufacturing enterprises that require much more than record keeping and following regulatory or legal guidelines. "Nationalizing the banks sounds more radical than it is, since banking law already empowers regulators to impose extraordinary controls and close supervision over troubled institutions."

The idea of nationalizing banks under conditions of a financial meltdown is not necessarily socialistic or ideological. It has, indeed, been occasionally used to deliver capitalism from its own systemic sins. Thus, in the face of the Great Depression of the 1930s, and following the Hoover administration's failed policy of trying to bailout the insolvent banks, the FDR administration was compelled to declare a "bank holiday" in 1933, pull the plug on the terminally-ill banks and (temporarily) take control of the entire financial system.

Likewise, in the face of the collapse of its banking system in early 1992, the Swedish state assumed ownership and control of all the insolvent banks in an effort to revive its financial system and prevent it from bringing down its entire economy. While this wiped out the existing shareholders, it turned out to be a good deal for taxpayers: not only did it avoid costly redistributive bailouts in favor of the insolvent banks, it also brought taxpayers some benefits once banks returned to profitability.

Both in Sweden and the United States once profitability was returned to insolvent banks (following policies of nationalization), their ownership was once again returned to private hands! It is perhaps this kind of government commitment to powerful financial-corporate interests that has prompted a number of critics to argue that one definition of capitalism is that it is a system of socializing losses and privatizing profits.

This is, indeed, a classical political economy argument, maintaining that "in the advanced capitalist societies, what actually happens is that state policies assure that more resources flow to the rich than to the poor. . . . The term corporate welfare is widely used to describe the bestowal of favorable treatment to particular corporations by the government. One of the most commonly raised forms of criticism are statements that the capitalist political economy toward large corporations allows them to 'privatize profits and socialize losses."

Few governments in the world have been so utterly under the influence of corporate-financial interests as in the United States. According to the Government Accountability Office (GAO), two-thirds of corporations in America paid no federal income taxes at all between 1998 and 2005. This includes a fourth of all large US companies (those with assets worth of $250 million or more). An earlier GAO report showed that 61 per cent of US corporations paid no federal income taxes between 1996 and 2000 -- a period of high growth and huge corporate profits.

After reviewing these and similar statistics, which indicate a steady redistribution of national resources from the bottom up since the early 1980s, P. Sainath, author of Everybody Loves a Good Drought, wrote: "There's 'corporate governance' for you -- they simply run the country. Administrations exist. Corporations govern."

There are strong indications that Barack Obama's administration is no exception to this pattern -- all the promises of change and elevated hopes notwithstanding. Of course, this is not to deny the truly historic importance of his election, an event or victory that should be celebrated as such.

Nor is it meant to deny or downplay the importance of a number of reforms he was elected to bring about. These would include improvements in largely non-economic (or non-class) issues and areas such as civil liberties, the environment, regulatory issues, race relations, diplomatic protocols, and so on -- areas that would rehabilitate some of the excesses and damages done by George W. Bush without burdening powerful financial-corporate interests.

Obama's changes, however, would not include some of the more fundamental economic or class issues such as reversing or stopping the costly bailout giveaways to Wall Street gamblers and nationalizing the insolvent banks, downsizing the military establishment and reallocating part of the military to non-military public spending, implementing an affordable universal healthcare program, reversing the excessive neoliberal tax cuts for the wealthy, and the like.

Obama's commitment to powerful business interests is best reflected in his unwavering support for giant Wall Street gamblers. Instead of calling for dismissal and accountability of the economic team of advisors that played a catalyst role in bringing about this systemic financial meltdown, he has placed them in decision-making positions, ensuring the continuance of the failed Bush policies of looting taxpayers and giving it to Wall Street financial titans.

The longer his administration (in concert with the labial congress) continues on this doomed path, the longer the crisis, the more indebted the nation, and the more oppressive the economic hardship will get.

There is some speculation that the Obama administration might be compelled to nationalize the insolvent banks. Considering the financial-economic team of neoliberal advisors who would be in charge of carrying out the rumored nationalization, this measure would be committed largely to the powerful Wall Street interests. If implemented, the measure would be tantamount to the proverbial palace coup designed to salvage the rule of the royal family, that is, of the financial Kleptocracy.

There is no indication that, in the process of the rumored bank nationalization, there would be a seat around the decision-making table for taxpayer representation, or any room for public oversight and control of the nationalization policies and procedures. Instead, as pointed out by Jerry White, "taxpayers would assume responsibility for the worthless assets held by the banking giants so they could take these liabilities off their books and once again become profitable. After a temporary period of government direction, the banks would be turned over once again to private investors, who would buy the now lucrative shares for pennies on the dollar."

While representing an improvement over the currently-confused bailout/rescue plans, this kind of (Wall Street-Sponsored) bank nationalization would not be able to wipe out all of the worthless assets of the insolvent banks and bring about an effective economic recovery, as it would not break free from the fraudulent influence of powerful financial interests.

Only a swift and unadulterated nationalization that does not pay taxpayers' cash for gamblers' trash would be able to cleanse the badly tainted financial markets of the gamblers toxic assets, shorten economic pains and cut taxpayers' losses. By bringing the insolvent banks under public control (independent of the Treasury or the Fed that have abundantly proven to be representing the interests of Wall Street giants, not the people), this measure can then lead to the issuance of loans at reasonable rates by the thus nationalized banks, thereby unfreezing credit markets and rekindling investment and economic activity.

Furthermore, by allowing insolvent homeowners to pay affordable mortgage installments based on reduced or realistic home prices, this alternative would help citizens facing the specter of homelessness stay in their homes, thereby also gradually restoring trust in the mortgage market.

This type of nationalization of insolvent banks would, of course, require new politics on the part of the people who are suffering the most from the daunting economic hardship but do not seem to have a voice or representation in the fraudulent process of the bailout scam, which means the overwhelming majority of the American people.

The new politics has to go beyond the traditional channels of demanding change. It needs to draw upon the lessons of the protest movements of the 1930s that squeezed all kinds of economic guarantees and social safety net programs (known as the New Deal reforms) out of the Congress and the FDR administration.

The financial-corporate governments rarely, if at all, carry out grassroots-targeted reforms voluntarily. Only people pressure, pressure that would include a sustained and widespread protest movement, that is, pressure that would threaten the status quo, can bring about reforms that would benefit the grassroots.

Ismael Hossein-zadeh, author of the recently published The Political Economy of U.S. Militarism (Palgrave-Macmillan 2007), teaches economics at Drake University, Des Moines, Iowa.

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