by Gilles d'Aymery
"A goal without a plan is just a wish."
—Antoine de Saint-Exupéry (1900 - 1944)"Finance is the art of passing money from hand to hand until it finally disappears."
—Robert W. Sarnoff (1918 - 1997)
(Swans - September 22, 2008) DIZZY ENOUGH, CLASS? Do you hear lawmakers, government officials, and the punditocracy wringing their hands in despair and wondering how come this financial tsunami came crashing down on us so suddenly (though if you are regular readers of these pages you should not be surprised) and how we need to learn what went wrong so that we don't repeat the same errors in the future? Methinks these people -- our dear leaders -- are either clueless, hypocrites, or have a very short memory. We are witnessing a repeat of the Savings and Loan crisis of the 1980s and '90s, except that the order of magnitude of the current crisis is at least 15 times larger and counting.
LITTLE HISTORY LESSON: In 1986, as I was burning out from a job in the oil industry and trying to keep afloat a small New York subsidiary of a midsize British group, working 15 to 18 hours a day, I asked advice from a couple of contacts back in France -- kind of elder advisers who looked after my well being. Both of them held high positions in the French banking system and not surprisingly suggested that I moved to that sector. One of them, who was close to the Belgian Groupe Bruxelles Lambert, assured me that he could easily get me a plush job with Drexel Burnham Lambert (DBL), the fifth largest American investment bank with some 10,000 employees -- one of them being the infamous Michael Milken, who created the market for so-called high yield bonds, better known as "junk bonds." That year, the firm made almost $550 million in profit and offered Milken, its most valuable rainmaker, compensation in the same amount -- $550 million -- the following year. I carefully considered the opportunity. I was tired (actually, exhausted) of trading and brokering oil and gas. However, moving to doing the same thing, this time with bonds and other financial instruments, just did not feel right and I chose to follow a different path -- which money-wise was the dumbest decision I have ever made.
THE S&L CRISIS came from a housing bubble that burst, fraudulent real estate lending, deregulation, and, of course greed. Sounds familiar? It cost taxpayers over $120 billion to bail out the Savings and Loan associations (upwards of 1,000 of them). Meanwhile, DBL got embroiled with the Justice Department, which wanted to indict the firm on charges of insider trading, stock manipulation, and other malfeasances. It had to pay a $650 million fine. For his part Michael Milken was indicted in March 1989 on charges of racketeering, insider trading, and various securities fraud. The firm laid off half of its workforce the following month, and by February 1990 it filed for Chapter 11 bankruptcy protection. The Junk Bond King was convicted, fined $200 million, had to pay $400 million to aggrieved shareholders, and condemned to 10 years in jail (but only served less than two years). He was hailed as a financial innovator and made more in one hour than an average worker did in one year. If you think that Mr. Milken is now living quietly and modestly you'd be wrong. According to Forbes Milken is worth about $2.1 billion. Crime does pay!
FAST FORWARD to the current crisis. It's worth noting that Lehman Brothers, which filed for Chapter 11 last week, was also the fifth largest investment bank (like DBL used to be). Here again the crisis came from a housing bubble that burst, fraudulent real estate lending (junk bonds became subprime mortgages), even more deregulation and greed, but on a gigantic, international scale. When DBL failed in 1990, it had about $3.5 billion in assets and 5,000 remaining employees. Lehman Brothers had 25,000 employees and assets of over $600 billion. Here is a firm that brought an average of 22+ percent return per year to its shareholders over the past 14 years and lavished its executives with gargantuan financial compensation packages (like all other financial institutions and corporate America), while its leverage ratio was over 30:1 -- that is, for each dollar of capital it had over $30 of debt. Mind-boggling, no?
SO WHERE IS THIS TSUNAMI GOING, or this financial Frankenstein? I have no idea, and frankly nobody has. Bear Sterns is gone, bought by JP Morgan (and a $29 billion bailout package from the Fed). Lehman Brothers is gone. Fannie and Freddie have been taken over by the government (price tag: $200 to $300 billion, and over $5 trillion in liabilities). Merrill Lynch got gobbled up by Bank of America at a fire-sale price. AIG, in spite of an $85 billion loan from the government, is by all accounting standards near insolvency (that's a company with over $1 trillion in assets, operating in some 130 countries, and over 100,000 employees). Morgan Stanley is being hammered. So is Goldman Sachs. Washington Mutual is dead in the water. Hundreds of banks are on the brink of the cliff. The FDIC will soon need additional funds from the government to keep insuring personal bank accounts up to $100,000. According to Reuters, the government has already injected over $900 billion of (future) taxpayer money in one way or the other to try to stabilize the so-called free market, the largest single bailout in history. Furthermore, as these efforts have so far failed, the White House has announced a new plan to purchase up to $700 billion of toxic debts to clean financial institutions' balance sheets. No one knows the real price tag. It can only keep growing.
AND PLEASE, do not think that the Fed is spending its own money. The Treasury Department issued a press release very quietly last week. It read:
The Federal Reserve has announced a series of lending and liquidity initiatives during the past several quarters intended to address heightened liquidity pressures in the financial market, including enhancing its liquidity facilities this week. To manage the balance sheet impact of these efforts, the Federal Reserve has taken a number of actions, including redeeming and selling securities from the System Open Market Account portfolio.
The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives.
Announcements of and participation in auctions conducted under the Supplementary Financing Program will be governed by existing Treasury auction rules. Treasury will provide as much advance notification as possible regarding the timing, size, and maturity of any bills auctioned for Supplementary Financing Program purposes.
SO WE ALL are on the hook. Of course, the Fed can run the presses and inflate the money supply, thus creating monetary inflation, which is nothing else but a tax on savers, or a transfer of assets from savers to borrowers. Either way, we get slammed.
CAN THE CANCER METASTASIZE? Take AIG. So long as it kept its focus centered on traditional insurance business, it was doing fine, rock-solid fine. But when it helped create that other Frankenstein, the credit-default swaps (an insurance instrument that allows defaulted bonds to be paid by the insurers), a market of over $62 trillion -- yes, TRILLION -- of which AIG holds some $450 billion (again, no one knows for sure), its balance sheet essentially went into the red zone. Now, I hear that the extent of financial instruments floating around the world borders on $455 trillion -- yes, TRILLION -- and nobody knows exactly what they are. I think that we ought to be deeply worried. Just to give you a perspective, the US economy is about $14 trillion a year (fast contracting), and the entire world's economy is about $54 trillion. Can you grab your calculator?
WHAT'S SO SCARY about the entire mess is that the guys (they are mostly men, white men) who created the mess, or were a part of its creation, are the same guys who are in charge of a solution. Take Ben Bernanke, the Fed chairman: In 2004, he talked about the "new moderation" in, and the "stability" of, the financial system and economic life. Hank Paulsen, former CEO of Goldman Sachs, who was so much a part of the mayhem that is unraveling and a strong proponent of further deregulation, is the man at the helm of the Treasury Department. These are the people that are devising the new policies that are supposed to squelch the hemorrhage. Most of their advisers come from the financial world, a bunch of them directly from Goldman Sachs. They created the problems with the clapping approval of Congress (in utter bipartisanship, always happy to rake in huge sums of money from Wall Street) and all the White House tenants, all the way back to Ronald Reagan and Jimmy Carter. In other words, the people responsible for the problems (though you too, dear readers, share responsibility -- at least those of you who have lived on credit for the past three decades and repeatedly voted for those bums) are in charge of the solution. Talk about the fox guarding the henhouse!
OH, AND IF YOU THINK that the new bums will make a difference, check out one of the chief economic advisers to Barack Obama, Robert Rubin, and the other guy on John McCain's side, Phil Gramm. Mr. Rubin is a past CEO of Goldman Sachs, former Treasury Secretary in the Clinton administration, and former board member and eventual chairman of Citigroup. He was instrumental in advocating and passing the Gramm-Leach-Bliley Act of 1999 that overthrew the Glass-Steagall Act of 1933, enacted to prevent another Great Depression. Mr. Clinton obligingly signed the law that tore down the protective barrier between commercial banks and investment banks. Both sides of the aisle have contributed to, been deeply involved in the creation of, and have financially benefited from this financial disaster.
LET ME INJECT a dose of irony before you get wholly furious (hopefully). Last year, Wall Street as a whole set aside $3 billion to distribute bonuses to their rainmakers. Richard S. Fuld Jr., Lehman Brothers' hard-charging CEO, got $40 million to run the firm into bankruptcy -- and he is possibly getting a $16 million golden parachute now that his firm is bankrupt and the remaining pieces are purchased at a few cents on the dollar by bigger fishes. Fun, no?
WHERE ARE WE and where are we going? Where we are is pretty simple: We are injecting huge amounts of taxpayers' money -- that taxpayers do not have, whether in the present or in the future -- to bail out the "banksters" and the foreign investors (ah, the delights of globalization) in the hope of unfreezing the financial markets so that banks can start lending again to businesses and consumers. Remember that 70 percent of the US economy is based on consumption. In other words, the government is borrowing huge amounts of money that it does not have to inject liquidities in the economy so that consumers may again borrow to fuel the economic engine. That is, our masters of finance want to solve a huge debt issue by…creating more debts. In addition, Congress wants to add tens of billions to help the close-to-bankrupt car manufacturers ($25 to $50 billion), and more billions for infrastructure and public works, homeowners facing foreclosures, victims of hurricanes and flooding, etc. -- funds that will also need to be borrowed. And, politically, of course, putting aside the blame game, everybody's trying to let this nitroglycerine-filled Titanic sail downwind with the hope that global warming will melt the iceberg before it is hit.
WILL IT WORK? No one knows. Housing keeps contracting; exports are slowing as the world economy is contracting; the labor market is in the doldrums (at least 600,000 more layoffs so far this year); and it's far from certain that the tight credit market will loosen up or that consumers, already maxed-out, their home equity down, will take on more debts to satisfy the praying wishes of our Princes. No one knows what is the next shoe about to fall -- one or more banks? AIG? General Motors? The list is long. (Oh, I almost forgot: You are aware that we are very close to a national gasoline shortage as 95 percent of the oil from the Gulf of Mexico remains shut in the wake of Gustav and Ike -- the US may need international assistance here too.) And no one either knows whether the stock markets will stabilize or the ride is going to become much bumpier.
WHAT WE KNOW FOR SURE, however, is that we are witnessing the biggest transfer of wealth up the food chain. Pension funds, retirement accounts like 401k's, saving accounts, etc., will be crippled. Municipalities will be forced to dramatically curtail the services they provide… If you have a belt, better start tightening it now.
AND REMEMBER, you voted for these bums and are readying yourselves to vote for them again. Get it? Vote for Ralph Nader, for chrissake!
Finally, I wanted to address all those Paulistas who sent their oh-so-friendly missives (or were they missiles?), but I am out of time and space. Perhaps next time. The most dispiriting part of it all was not the nastiness of the published e-mails (with a couple of exceptions) and the non-published ones left cowardly unsigned, which demonstrated once more that there is little "love" in the Ron Paul rEVOLution, but lots of angry white people. No, the most dispiriting part was the fact that my piece was read over ten times more than the extraordinary Letters Against the War by Tiziano Terzani -- a fitting reflection of how deeply debased our culture has become.
. . . . .
C'est la vie...
And so it goes...
La vie, friends, is a cheap commodity, but worth maintaining when one can.the life line won't hurt you much, but it'll make a heck of a difference for Swans.