A Bad Idea: Using a Financial Solution to the Financial Crisis

Traditional banking is about selling money you have. Finance, unlike traditional banking, is about the money that is not there. Thus finance is getting from whatever amount of money you have (10 thousand or ten billion) to its doubling, tripling. This means that pumping taxpayers money into the financial system is giving finance more grist for its mill: leveraging.

We have had five bailouts since the 1980s, the decade when the new financial phase took off. Every time taxpayers money was used to pump liquidity into the financial system, finance used it to leverage. That is what finance does. We can't hold it against finance. But we can chose a non-financial solution to the crisis.

It is almost irrational to give finance the instruments to do more of what has brought us to the brink. The prior bailouts each contributed one more element to the unsustainable leveraging we have now reached. The high level of financializing of our economy is reflected in the relation of financial assets (which is to say, debt) to GDP. It has now reached 450% to GDP, according to the recently released McKinley report. Futher, the complexity of this inverted financial pyramid is almost impenetrable. An example is the incapacity of the Treasury to estimate the cost of rescuing AIG -- first estimated at $40 billion by its management, it wound up at $121 billion. Unwinding the credit insurance on Lehman cost far more than the Treasury had estimated, reaching $360 billion.

Yet another indication of this irrationality comes from the participation of the Federal Reserve in this financial "solution": the Fed is now leveraged at a ratio of 50 to 1, a historic high. It looks like a hedge fund, and a very speculative one at that. This puts the federal guarantee system at risk -- for instance, it undermines the capacity of the government to guarantee people's bank deposits.

Re-routing the remaining 350 billion of the bailout money approved by Congress becomes urgent. As of now the first half has been used to feed hungry financial mouths: one third of payments made to the beneficiary banks wend to pay dividends to shareholders; somewhat less went to pay executive bonuses, and the rest went to AIG. So much for the hope that injecting $350 billion into the financial system would get them to make loans to households and small firms.

Now that these basics have been taken care of, the beneficiary banks are ready to do more of what got us here: use the remaining US$ 350 billion to do some leveraging. The IMF recently produced some interesting data showing the extent to which financial leveraging has caused the greater acuteness of the current crisis compared with the other 3 major crises since the 1980s.

This shows that financial leveraging added another whopping 20% to the underlying banking crisis, thereby bringing the current financial crisis up to an equivalent of 40% of global GDP, compared to earlier crises, which rarely went beyond 20%.)

The IMF data also show the extent to which Asia is in a very different position than the US and Europe. Its emergent crisis is economic rather than financial. The stock markets declines are to be distinguished from the leveraging that has fed our crisis -- the outstanding US$ 55 trillion credit default swaps for which there is no money. (Not to mention the $640 trillion in outstanding derivatives). Stock market declines indicate the shrinking resources available to meet all these outstanding amounts.

What would happen if the solution to the financial crisis would emphasize growing the economy -- making sure that a wide and diverse away of (especially) small -- and medium-sized firms are put into fast-track activity. This would raise the demand for workers, especially since a large share of small firms are labor-intensive and small to medium firms account for the largest share of employment in most economies. This would in turn raise household demand which would feed back into all kinds of economic sectors. And so on...

So what would be the mechanisms, the conduits, for transferring tax payers money into small and medium-sized firms that could bring about economic growth, rather than merely being a transfer of money. This will vary across national economies. But let me suggest that in most economies, doing infrastructural work is not a bad starting point. And I am not thinking of building huge dams and major new bridges. That is mostly work that only a few large global engineering firms are able to do. There is so much more people-oriented infrastructural work that needs to be done: building and/or repairing the basic infrastructure of large stretches of cities and towns, cleaning up toxic fields, expanding public transport systems, just to mention a few.

Once a government has decided to put billions into an economy as an emergence measure, it can begin to work on such needs, needs which cannot easily be met through market mechanisms. As these projects get under way, they activate market mechanisms directly increases in demand for inputs from other firms, increases in labor demand and hence in consumer demand, which in turn further feeds demand from firms for more inputs and more workers. This is a very indirect process for growing an economy. Indeed, quite a few more financial firms would have gone down, and credit would be tighter for a while if the government had decided to put that vast amount of money into the rebuilding of infrastructure, from small to large-scale labor intensive projects. But in the long run, we would be in the business of economic growth rather than financial leveraging.

The US government has resisted putting money into the economy even where it is urgently needed -- such as strengthening the 700 bridges that are known to have a faulty design and are likely to collapse sooner or later, causing potentially large-scale injury and death. These are the bridges that have the same flawed design as the Minneapolis bridge that collapsed. Yet the US government has not addressed this, has not even started. And now it has decided to put $700 billion into the financial system. Imagine the multiplier effects across small and medium enterprises and households of that kind of money input. Instead it has put it into money firms, hoping that these will start lending.

Saskia Sassen is the Robert S. Lynd Professor of Sociology and Member, The Committee on Global Thought, Columbia University. Her recent books are Territory, Authority, Rights: From Medieval to Global Assemblages ( Princeton University Press 2008), and A Sociology of Globalization (Norton 2007).

Follow Saskia Sassen on Twitter: www.twitter.com/Saskia S

Comments

[Michale32086]

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It is almost irrational to give finance the instruments to do more of what has brought us to the brink.
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This is so factual, it needs repeating over and over and over again..

Simply pumping more money into Wall Street and the Automakers will not fix the problem. It's like putting a bandaid on a man suffering from a heart attack..

We have to change the mindset of those in charge. If it takes a total collapse of their business to pound that message home, then so be it..

Michale.....

[Soulsurfer]

Its like giving Methadone to a heroine addict.

[Michale32086]

No...

It's like giving heroin to a heroin addict and expecting that it will cure them...

Just as rewarding terrorism simply begets more terrorism, rewarding greed and unscrupulous behavior simply encourages more greed and unscrupulous behavior..

Michale.....

[AContrario]

We have reached the limits of an economy based on scarcity where debt has became the real standard.
Lucky for us, we can pull the plug on the system if we really want to but do we?

[PhilipTaylor]

Your article states that much of the Bailout has gone to dividends and bonuses. This has been:

A CRISIS OF EXCESSIVE FINANCIAL FEES
(including salaries, bonuses, and parachutes)

1. $10's to $100's Million in salaries, bonuses, and other incomes (e.g., Paulson $400+ million)
2. Incrementally High "TRICKY" adjustable mortgage Fees for subsidiaries of Investment Banks
3. High Second Mortgage Fees above property values
4. "Fake" Appraisal Fees
5. Selling loans that exceed value of the property with MORE Fees added
6. Slice and Dice mortgages into packages (Derivatives) by Banks for "MASSIVE" Added Fees
7. Rating Agency Assigns "AAA" rating to High Risk Derivatives and takes Large Fees
8. Sell Derivatives to Customers including HIGH Fees
9. Front end and Back End Insurance Fees
10. Financial Product Maintenance and Customer Service Fees
11. Credit card Excessive Interest Rates and Fees


Unfortunately, these fees have been siphoned off-shore, into massive homes, yachts, paintings, jewelry, real estate all over the world so recovery is difficult.

The Reason Banks will not “MARK TO MARKET” and want that condition removed:
With the decline in home values some products would take a 80% to 90% write-off of the Fees paid by the Derivatives Clients, showing the "degree of greed" in this FEE driven system.

We must regulate FEES and Executive INCOMES to stop this Greed!

Certainly we need to use the remainder of the Bailout to fund REAL THINGS that create REAL JOBS.

[Over50WhiteWoman]

Clearly Paulsen's ideas have not worked, and once again the taxpayers are left with the bad result.
Thank you for some clear thinking. We need more of that. For example, what is to stop the OTHER wealthy folks in the nation from lending to businesses? Anyone can enter a simple contract. And I would just bet those businesses with any smarts are calling around all their friends to put together the funding. Smart people are still investing--just not on Wall Street.

Why do these huge companies need to be saved? Yes, jobs will be lost, but new ones will be found.

The economy will be fine when we stop panicking and start offering to help in all kinds of ways. I like the infrastructure stuff, but I see green businesses as enterprises that could be subsidized as well, given the urgent nature of global warming and the overwhelming magnitude of the demand. The future will start when Americans quit bellyaching and roll up their sleeves. Change is coming--and not just because of Obama. Our world is changing. And we must change, too.

[cduvall]

Thank you.
The free market "leave it to Wall Street" crowd sound like a bunch of medieval blood letters. "The patient got sicker? We probably just need to bleed her some more!"
I suppose this is what we get for leaving our economy to the ideology of a 3rd-rate pulp novelist.

[leftcoastliberal]

Shakespeare said it best, "Neither a borrower, nor a lender be".

[anonimost]

It's become a mindset. Att ack on US? Go shopping.

Natural disaster? Ah, here's some money

Someone dies? Ah, here's some money

This has become the normal way of thinking for millions of people. I'm not sure they have the intelligence or wisdom to grasp the impending doom. Money rules for these people/Money cures problems - that, you cannot argue and win. You just have to sadly watch it all go down and be dragged down with it.

[Thermodynamics]

Thanks

The media seem to be presenting our current mess as only one thing. There are several factors contributing to this perfect storm. Some are cultural changes.

Perfect Storm:

1. Of course the financial crisis Paulson is fighting - this is exerting tremendous deflationary pressure.

2. Many productive parts of the US economy - the manufacturing base - no longer exist. You cannot generate any real money selling yourself lemonade.

3. There are serious problems external to the economy that cost plenty - war, hurricanes, degraded environment, obesity plague, health problems.

4. Real waste is a greater part of our cash flow than it was a generation ago. Economists don't think like this, no concept of waste in economics. Lets take heating/cooling costs. I can happily spend $150 per month. My parents would never do that. They would never run the central AC. You did not "get anything for your money", at least not anything that you could keep. There are plenty of other examples - vastly greater and more expensive prison population, per capita car mileage has doubled, etc.

[JacqueItch]

Nice post.
I agree with your conclusions.
I am reminded here of the analogy of intelligently treating the crying infant by ignoring it and healing the weakened mother. Restored, the strengthened mother can effectively again feed and nourish the baby, and the baby can again be well.
Treating the baby may temporarily quiet the noise, but it won't assist the actual dynamic of mother and child, and in the long run both mother and baby fail to thrive.
The bailout under Paulson is a pacifier stuck into the baby's mouth.

Our economy, like economies worldwide, depends on the profits of labor. Without jobs, without gainful employ, all economies will freeze, and in capitalist economies the end result is always stagflation. Unfortunately the smoke and mirrors of the derivatives no longer hides the artifice that their values are mysteriously underwritten ----- their true value is fictional.