MUSINGS ON THE ECONOMIC CHAOS

A few years ago when spectrum was just taking off and new cell phone companies were expanding, I was asked to teach a finance course to radio-frequency engineers and technicians who were unfamiliar with the financial side of things. I had to update myself as I had been out-of-touch with the 'great' new developments in the finance field following my 1982 MBA, because I had been swamped fighting legal battles (allegations of the feminist type - see for instance my blog article on the Right to Not Support of January 2009).

Aside from new terms such as IPO to describe old things, new stuff such as 'securitization' and 'off-balance sheet financing' had mushroomed, not to mention derivatives. I did not immediately catch on that 'off-balance sheet financing' was basically illegal, since the balance sheet is required by law to provide 'full disclosure'.

Perhaps fortuitously in retrospect, there wasn't enough money in my manager's training budget to send me on a course for this topic of off-balance-sheet magic. But it should have been clear even then that securitization was a ripoff of sorts - creating new securities from existing assets, in some cases more than once. so that multiple levels of CMOs/CDOs (collateralized mortgage/debt obligations - try to understand that term) were created, with a loss of trail of who really owned the original mortgages and was responsible for managing them.

The original mortgages issued by a bank for example, were shuffled off to another corporation created for this purpose, which took over the bank's mortgages and replaced them with 'securities' (CMOs), and this process could happen again as the second corporation parcelled off pieces of the mortgages to a third new corporation.

All this was motivated by the need for investment banks to make a quick buck - fat commissions and bonuses on these 'new deals'. In the process however, a system of accountability which originally existed with the issuing bank managing its mortgages with trained staff, was diffused and shifted away to corporations owned by individual investors who had no clue what the mortgages were or what they were worth. They were simply enticed into buying the newly created CMOs with attractive rates of return offered on them, with no idea of how risky the CMOs were.

This is what the geniuses of Wall Street were upto, encouraged by what Soros even then was calling 'market fundamentalism' fueled by the Reagan-Thatcher 'revolutions' of killing regulation, selling off government enterprises to the private sector at give-away prices, and relieving the super-rich of any responsibility for taxes, leaving that for the poor and middle-class whose social programs were being ratcheted down. This was the so-called 'supply-side' economics, later labelled 'voodoo' economics by Bill Clinton, by which tax-cuts would stimulate investments by the rich so that the poor and middle-class would benefit - the super-rich 'Atlas' supporting everyone else per the Ayn Rand theory.

The reality of why this worked for a decade and half is a little different - massive WMD expenditures under Reagan created giant fiscal deficits which were financed by overseas lenders such as oil-exporting countries, as the rest of the world absorbed American inflation caused by such currency expansion (way, way beyond the monetarist limits recommended by Friedmanites) since the US dollar continued to be accepted as the international reserve currency because of America's political dominance and economic clout. All that is now all but over, as the latest G20 summit in London, UK, mused about creating an alternative reserve currency the world could accept, the US dollar no longer being valued after the squandering of American political capital by the Bushites.

On the derivatives question, Niall Ferguson, a brilliant star historian (who I despise because he helped sell the 'Armageddon' myth that Iran was building a bomb to evaporate Israel, while saying not a word about the 200+ nuclear weapons Israel already had which could easily evaporate Iran) has written in his latest book The Ascent of Money (a sort of followup to Galbraith's book of a few decades ago Money - Whence it came, Where it went) that the world economy's GNP is around $45 trillion (if I remember right), the stock and bond markets worth approx. $ 47 trillion, and the derivatives markets worth $473 trillion (all figures from 2006 - current estimates exceed a quadrillion!). Huge sums are also involved in credit default swaps..... another ticker. All of this shows how dangerously leveraged the financial house of cards is compared to actual economic output. And how fantastically overpriced the world of finance is compared to the actual value of goods and services.

Paul Krugman was one of the first big-name economists to 'finger' former Federal Reserve Chairman Alan Greenspan for keeping tight control over inflation (unless there was a recession-threat in which case liquidity was quickly released and interest-rates slashed) but (except for occasional comments about 'irrational exuberance') exercising ZERO control of 'asset-prices' - ie the prices of stocks and real-estate and other financial instruments where speculation allowed all sorts of dangerous bubbles to develop. This massive casino allowed a few people to make gigantic fortunes but left millions exposed to huge losses when the bubbles came to a bust. What drives these bubbles and busts?

No real basis in economic or technological advancement, but mostly expectations - the fantasies and panics of investors. For example the 'dot-com' bubble, in which inflated claims of the 'information super-highway' led to huge amounts of venture capital being given to very questionable propositions (sometimes on the basis of a PowerPoint presentation) and the vastly over-priced internet stocks. The Economist predicted the crash of these stocks, and Krugman was one of the lone voices who tried to explain that the Internet could not grow more food, or manufacture more products, or ship anything other than information.

'Fergie' also discusses the 'Chimerica' phenomenon (inspired by Chimera - a fabled monster and name of virus in Mission Impossible 2, plus the word 'Chindia' to describe the re-emergence of China and India which were the world's biggest economies 200 years ago before guns and imperialism transferred wealth to the West) by which massive American trade deficits with China were financed by the latter from its low-but-growing wage-earners with high savings rates, and how the sub-prime mess happened because all this finance flowing from China to America led to billions the Wall-Street geniuses did not know how to invest, so they came up with the brilliant idea of lending to people with no income or job or collateral - the so-called 'ninja loans', predicated on the belief that real estate would keep on going up indefinitely.

Now we are seeing the financial collateral damage. And it is poetic given how much murder and genocide America has done in other parts of the world, shrugging it off as collateral damage, as it was done in the worthy cause of making American capitalists richer than ever. And while the lower and middle classes are paying much of the price in lost jobs, many of these people would have voted for the politicians that created the environment in which the seeds of the current chaos were sown.