Debt capitalism self-destructs

Quite the thesis by Liu. It is long, but worth reading for it history of the GSEs and many gems of insight. For example:

The privatization of Fannie Mae and Freddie Mac was an ideological move. It was financially unnecessary as sovereign credit could have funded the entire low-, moderate- and middle-income housing-mortgage needs with no profit siphoned off to private investors and brokers. These agency debt instruments played a crucial role in developing and sustaining the credit bubble in the US that is now coming home to roost.

And it is difficult for even us seasoned Fed-skeptics to trump this statement:

The world is now witnessing the slow but steady collapse of the central banking regime that came into being in the US in 1913, which has since failed to fulfill its mandate of managing the monetary system to maintain price stability and full employment. Dysfunctional monetary policies adopted by all central banks, led by the US Federal Reserve, have allowed the market to take capital out of free market capitalism to turn it into a gigantic Ponzi scheme.

And:

The bailout of Bear Stearns Cos arranged by the Federal Reserve in March signaled to the market that the government would not allow the GSEs to fail or default on their debts. It is clear evidence of the moral hazard effect on the financial market from bailing out one institution. With all the exposure that all banks and non-bank institutions and central banks have to Fannie and Freddie debt default, the ripple effect through the whole financial system would be unbelievable if they were allowed to fail. It was also clear evidence of the "too big to fail" doctrine.

Liu does not say it, but as a result of this trend, US sovereign debt will inevitably (soon?) take its lumps. But he does say:

But unlike 1933 in the days of the New Deal when deficit financing was an operative option to revive the economy because the government was relatively free of debt, the US in 2008 is already deeply in debt, having operated with deficit financing in a boom time for more than two decades.

and:

In 1968, then president Lyndon Johnson, as part of his Great Society program, turned Fannie into a shareholder-owned company as part of a national housing policy to make finance capitalism finance the nationalization of housing. It was the beginning of corporate market socialism in the name of populist economic democracy. The public could only benefit if corporate and financial institutional interests could profit first. And the public must pay if market capitalism fails systemically, absolving the losses of wayward corporations and financial institutions.

"Corporate market socialism" -- very apropos. We may have to re-use that. Liu continues:

Low-income voters were first dazzled by the new homes they were able to acquire with no money down and with monthly payments financed with home equity loans as house prices rose. They acted like Pinocchio in a Pleasure Island - that would soon turn them into jackasses to be sold to work in salt mines. The financial institutions were comforting their pangs of conscience over taking loans off their balance sheets as soon as they made them by excusing themselves with the idea that they were making low-cost mortgage available to millions of homebuyers. Neoliberal economists were celebrating the US miracle of mass capitalism that does not need capital.

"Capitalism that does not need capital"! Liu is on a roll. He also states:

The GSEs have been financially successful because they combine private sector appetite for profit with access to government-backed credit at below market rates. It was a way to nationalize housing through the free market capitalism. The problem was that financial manipulation cannot replace the need for adequate income growth. The mismatch of income with asset price is the definition of a financial bubble. People were buying homes with cheap credit at prices that their income could not afford. The more home prices rose due to cheap credit, the more homeowners fell into the debt trap.

There he brings up the deteriorating real income problem that the vast majority of observers still haven't noticed or fully appreciated -- we cannot support ever-growing debt on ever-shrinking incomes!

And we would be remiss to leave out a succinct quote from page 4 that really wraps up the current governmental actions taking place:

Regulatory reform while necessary cannot be backdated.

Liu closes with this prescription:

The argument for Third World debt forgiveness contains large measures of lender liability and predatory lending. Debt securitization allows predatory bankers to pass the risk to global credit markets, socializing the potential damage after skimming off the privatized profits. The housing bubble has been created largely by predatory lending without any lender liability. The argument for forgiving Third World debt is applicable to low- and moderate-income home mortgage borrowers in the US as well. Let's hear some proactive commitments from the presumptive candidates of both political parties instead of empty populist campaign rhetoric.

However there is a slight problem there: the powers-that-be are identical with the financial interests that would benefit from perpetual indebtedness of the American nation. Just look at who we've got to pick from: A member of the Keating Five S&L scandal set, and a man who is protecting a veritable subprime predatory pioneer (complete with lucrative government bailout).

Even if it would be better for all of us to start with a clean slate (preferably involving disgorgement of the predators and sound money), why would these entrenched interests relinquish control and allow everyone else to enjoy the fruits of true free markets, where real competition could arise?

We'll have to take it from them... and it probably won't be achievable through elections.

—apk