Saturday, January 31, 2009

Interview on the Crash of 2008

The Crash of 2008: An Update
Interview with Dr. Peter Chojnowski
October 10, 2008
In the July CFN, you published the article "American Foreclosed: The $500 Trillion Debt Bubble Pops." Could you give us a quick recap of that article and how it relates to the present economic meltdown?
Yes. I would like to thank CFN for giving me this opportunity to provide an up-date to the articles written this summer, which tried to outline the causes and the consequences of the implosion of the financial system that could be foreseen earlier this year. So much has changed since that the first article, "America Foreclosed" was written in June. Talk about a financial implosion due to the credit and mortgage crisis and the popping of the housing bubble has gone from the "fringe" to the halls of Congress and the main stream media. In fact, where can you go today where you don’t hear everyday people speaking about "the Fed," "depression," asking "How many hundreds of points did the market fall today?" To hear public school teen-agers speaking about the origin of the Federal Reserve at an athletic facility, as I did yesterday, is truly an exceptional and new experience. Only 4 months ago, this was unthinkable. To date, nothing stated in "America Foreclosed" has to be taken back, with one exception, which I will mention shortly. In that article, I tried to trace the origins of the sub-prime housing crisis that was then very much in the news. Much of the present crisis can be traced to the action of Richard Nixon taking the United States off the gold standard and, thereby, creating an infinite possibility for the US government to create an infinite supply of money to benefit the current party in power and their financial and political backers. The ability to create money or credit (N.B., these two are actually identical in our present financial system) at will, without having to worry about a tie to a very finite quantity of a precious metal, was the necessary condition for the "liquidity and credit binge" which marked the years 1987-2006, the years that Alan Greenspan was chairman of the Federal Reserve Bank. Through constant interest rate cuts and incessant liquidity injections, Greenspan created debt bubble in the history of the human race. As an example, in the year 2001, interest rates were cut 11 times in the year 2001. This followed huge liquidity injections of at least 200 billion dollars in the months leading up to the Y2K non-event. This amounted to a 14% yearly increase in the money supply. Easy credit and an abundant supply of money created the biggest financial bubbles that the globe has ever seen. The bubble was transformed into a stock market equity bubble, which became a housing bubble, which itself became a home-equity credit bubble. These financial bubbles, while wildly exaggerating the worth of Internet companies, stocks, and houses, also, drove the American people into a chasm of debt. The United States became ridiculously "overleveraged." As I mention in the article, the American people racked up more mortgage debt from 2003 to 2005 ($3.7 trillion) as they had in all the years since the founding of the United States to 1990 ($3.8 trillion). It was the absurdity of the "Ninja loan," no income, no job, and no assets, which is at the root of this present global systemic crisis, that, as of today, threatens to collapse the entire Capitalist financial system.
Would you do the same for your September CFN article, "The Fall of the Phantom Assets: Economic Autumn 2008"?
In this second article, written in August of 2008, I tried to present the details of the "New Economy" and, what I called, "Win/Win Capitalism," which, in the 2 months since, has ceased to exist or, rather, has shown itself to be the illusion that it always was. According to "Phantom Assets," what is "Win/Win Capitalism"? "Win-Win Capitalism" is a economic form in which speculative risk has been eliminated. This is actually the most proximate cause of the present financial meltdown. Even though, according to Charles Morris in his Trillion Dollar Meltdown, American Capitalism has always tried to minimize risk by establishing various domestic monopolies, it was only beginning in the 80s under Reagan, intensifying in the 90s under Clinton, and, finally, reaching absurd heights of recklessness under Bush in the years 2003-2007, that there has been a New Economy conceived of in which financial speculators and banks can eliminate risk, or so they thought, by "packaging" and "securitizing" debt. If the mortgage-issuing bank could sell the debt to Fannie Mae or Freddie Mac and, in the process, gain all relevant fees for initiating the loan, it had made money and was free of any worries concerning defaults on the loans they issued. The loan-initiating bankers were willing to issue loans to any and all, since they benefited by the initial fees taken and did not have to worry about the new "homeowners" defaulting. Masses of mortgages were packaged up into CMOs (collateralized mortgage obligations) and sold to investors who believed that they were investing in risk-free securities since the mortgage investment "packages" were tranched so that high-yield, but high-risk, "junk bonds" were supported by low-yield but "investment" grade "secure" bonds. Everyone was going to make money or have the house of your dreams and every one was financially "safe". Risk had been eliminated.
All variety of derivative contracts, also, "hedged" investments so that they seemed relatively-risk free. To quote derivative specialist Satyajit Das, "CDO [Collateralized Debt Obligation] tranching is the black art of dissimulation. Investors are told that they are getting access to a ‘diversified’ portfolio of credit risk and are promised highly customized credit risk. It is very clever spin." Options, Puts, futures contracts, credit-default swaps, were all ways of hedging risk by either "swaping" debt liability (thereby providing a kind of insurance against the risk of default) or "betting" on the rise or fall of stocks --- or even, financially betting on the state of the weather! There was a derivative contract for every taste. Such was the "financial economy" that was estimated to be, before the crash that is, worth 1,000x the "real economy" (i.e., the one that actually produces goods and services). It was a huge inverted pyramid of debt and financial claims upon debt, with a question mark where the asset capstone was supposed to be.
You were well aware of what would happen and sounded a warning. Why, in your opinion, did the US House and Senate appear to be caught off guard when the meltdown struck? First, they believe in the system as a substitute religious faith. How can such a gigantic and all-encompassing reality fail? Just as we believe that God has all the wherewithal within Himself to triumph in any situation, no matter how adverse to His cause, so too these men and women hold that the system that they have served so faithfully had all the wherewithal, within itself, to smooth out any "bumps in the road." Think about it. What if I had said in my summer articles that in September we would have the chairman of the Senate finance committee Chris Dodd on Good Morning America saying that he had been informed by the Secretary of the Treasury and the Federal Reserve Chairman that the United States was within days of the meltdown of its entire financial system. Who would have believed such "extremism," and, yet, that is exactly what happened. Who would have believed that within 4 months of the first article the phrase, "imminent systemic global meltdown" would be part of the headline news on CNBC. It is time for all to give a warm hug of apology to your much-maligned local "doom and gloomster"; the economic implosion that they predicted is happening before our very eyes.
What do you think of the government’s explanation of the crisis? The explanation of the politicians, that this is due to the greed of financiers, is tainted by hypocrisy, since it was the administrations of both parties that enabled the financiers to engage in this wildly profitable orgy of "risk-free" capitalism. They are, also, the beneficiaries of political donations from the banking industry to the tune of hundreds of millions of dollars. Listen, the reason for the present collapse of the stock market (as of October 10th, 2008, the DOW has lost 40% of its value since its height exactly one year ago) is simple. In a very real way, nothing has changed. What we are now realizing, however, is that risk avoidance is a two-headed coin, it made for the boom and it is making for the bust. According to investor and New York University professor Nouriel Roubini, "The world is experiencing the simultaneous bursting of housing, equity, bond, credit, commodity, hedge fund and private equity bubbles….The financial system is breaking down, panic and lack of confidence in any counterparty is sharply rising and investors have totally lost faith in the ability of policy authorities to control the meltdown." In their continued attempt to avoid risk, investors and banks are no longer investing in derivative contracts and "financial instruments" or loaning to everyone and anyone with "don’t ask, don’t tell" loans, rather they are hoarding cash and refusing to loan to anyone. This is why the bond markets and credit markets have frozen up. According to David Wyss, chief economist at Standard & Poor’s in New York, "Nobody wants to take on any risk. Everybody just wants to get their money and put it under the mattress." Here we have one connection between the financial economy and the real economy. Businesses cannot finance themselves in the bond market, since there are no buyers. If they cannot finance themselves by selling paper in the commercial paper markets, they must cut on business expansion, lay-off workers, or simply declare bankruptcy. Martin Crutsinger, writing for AP Economics, "The credit markets remain stubbornly locked up. The benchmark rate that banks charge each other for loans, known as Libor, rose to 4.75% from 4.52% a day earlier, signaling banks are still afraid to make loans because they worry they won’t be paid back." The credit markets cannot remain frozen long before you have the halting of economic activity. The entire Capitalist/Credit-based economic system depends upon trust. According to one financial specialist I spoke with yesterday, banks are simply avoiding loaning and investing and simply "fleeing to safety" by investing in very low-yield Treasury bills. The deluge of cash and credit that the Fed has injected into the financial system, there was an injection of over 800 billion last week, is not being loaned out but rather returned to the US government. These huge capital injections will not restart the economy, but, eventually, will ignite hyper-inflation.

What is your opinion of the $700 billion dollar bailout?
I was outraged at first --- that the taxpayer should pick up these bonds and mortgages just when they have ceased to be profitable, while the major investment banks made an incredible amount of money when these bonds were "high-risk" and "high-yield." Secondly, it does not address the real problem. The system is awash in debt and there no way of paying it back. There is, in any commercially advanced country, three layers of debt, governmental debt, the debt of banks and businesses, and finally, private consumer debt (e.g., your mortgage). This legislation simply would transfer the debt problem from the second to the first tier. It does nothing to alleviate the debt problem fastened on to the backs of the American people. It is the sinking fortunes of the American people which is causing the implosion of the House of Usury that is currently shaking the world. It was exciting when the House Republicans defeated the measure. It was disgusting when, with added pork for all, the bailout was so easily passed. Most of the money for this bailout will be going to only a few banks, such as Goldman Sachs, Morgan Stanley, and J.P. Morgan. If this bailout was, as the politicians said, meant to "prop up the market," it failed dismally. Why did the House pass the resubmitted bailout when Senate passage produced a several hundred point drop in the Dow. It is very likely, that the national governments will not be able to handle this crisis. It will be quickly sent up to the international level and some international solution will be imposed, which may or may not work. Indeed, yesterday (October 10th), Silvio Berlusconi, premier of Italy, after a cabinet meeting, said that the leaders of the world might close down the markets and then "rewrite the rules of international finance" (i.e., change the current world system in a fundamental way).

Since the meltdown hit, we have seen some people driven to despair rather quickly. A 49 year old British millionaire with a wife and young son committed suicide by throwing himself from a moving train; a 90 year old woman in Ohio twice shot herself in the stomach when she was threatened with foreclosure eviction (she lived and the bank then said she could keep her home); a man in California murdered his entire family and then killed himself because he could not find work; a 60 year old frustrated investor in Stamford, CT walked into a bank and threatened to blow it up. As a Catholic professor, specializing in Ethics, could you comment on this? What does this say about modern society when it comes to facing suffering and hardship?
I really think that this economic crash will hit our world even harder than did the 1929 Crash. That is saying a lot, but I cannot avoid thinking it. If you have had a people who have been taught for generations that the essence of life is the fulfillment of the "American Dream," a purely secular fulfillment, then we wonder how these people can maintain their equilibrium when that "Dream," which for the past 40 years or so has depended upon cheaper and cheaper credit, begins to resemble a nightmare. Clearly most people in our own civilization do not understand St. Augustine’s famous prayer that, "you have made us for yourself, and our hearts are restless until they rest in Thee, Oh Lord." Personally, I have held for a long time that it was the easy credit economy which propped up the Liberal political, economic, social, and educational system. Without this prop, the inherent instability of such a system will reappear. We have "families" which are not really families, we have "neighbors" who are not really neighbors, we have "schools" that are not really schools, we have governments who have lost their concern for the common good, "banks" don’t really have any money. The list could go on and on. When all the credit cushioning is taken away, how will we react to the primary realities of human existence that we have covered over by comfort and technology, realities which our ancestors knew about and dealt with daily? More and more we are going to have to have mercy in our hearts and pity in our minds for the people around us as they suffer through the downfall of the phantasmagoric world that Wall Street has created. If times get tough, how will we cope? Most people have lost those survival skills, the self-sufficiency, and the familial and community ties necessary to continue on even when the system has ceased to function. One opinion I will venture here, we miss the point if we only focus on the obvious day to day unfolding of the economic implosion or the stock market crash. I believe that what we are going through is a "paradigm shift," a changing of the "world-view" or philosophical, religious, and ideological scheme that has dominated our world since the Enlightenment. The change may be slow or very fast, but very soon we will realize that --- while we were watching the market crash on CNBC, Liberalism died. We always knew that it would. As a Viennese wit would have it, "everything has an end, except the sausage, which has two"! What will replace the Liberal System? I really cannot even guess, other than to say that what ever it is, it will be more "real," either in an enlivening way or in a very frightening way.
What stage are we now at in the Systemic Global Economic Crisis?
With the collapse of Lehman Brothers on September 15, 2008, the Systemic Global Financial Crisis was upon us. Overlooking the fact that the National Debt Clock temporarily ran out of digits, when the National Debt passed to $10.148 trillion, the US government has either nationalized or bailed out the major mortgage lenders and the largest insurance company in the world. All these things have happened within the last 2 months. "Unprecedented" has been a word on the lips of innumerable financial analysts since this summer. When it looked like Goldman Sachs, Morgan Stanley, and J.P. Morgan were going down and when it became clear how much the failed Lehman Brothers was involved in every aspect of international finance, the Secretary of the Treasury, Hank Paulson, proposed that the US government pay these newly minted savings banks (they had to change their status as "investment banks") for all the formerly profitable bad debt they had accumulated. It seems as if the Parable of the Bad Steward gives us our explanation as to the reason for the Crash of 2008. Whereas the Federal Government has forgiven the bad debt of the major former investment banks, actually planning to pay them, at a decent price, for the bad debt in order to "recapitalize" them, it seems as if Goldman Sachs, J.P. Morgan, and Morgan Stanley are not as forgiving towards their own debtors. It seems that there is a research note circulating around financial circles, which indicates that the recent plunge in the stock market has been due to the "newest" large banks, who have changed their status as investment banks so as to have more of a cash base, have issued "margin calls" to hedge funds and other professional traders who use these banks as prime brokers. Since margin calls require hedge funds and investors to put up actual dollars to back up their "leveraged" financial assets, they are a very serious matter. They help reveal how little actual "money" is in the system. These margin calls were not issued because of market loses, but more because the recently-bailed out big banks arbitrarily decided that they wanted their customers too use less leverage (i.e., they wanted a larger ratio of cash to debt). Margin rates as low as 15% for broker deals were raised to 35%, hedge funds who had been used to operating with large amounts of debt (i.e., high leverage) were told that they had to bring accounts up to a much larger percentage of equity. With credit markets frozen, the only place to raise case to meet margin calls was to sell stock. That is what really sent the market over the edge. First notice of these margin calls were issued on October 2nd. Rumors are that the most massive calls are due on October 13, 2008. It seems as if the stock market will go down much more than the 40% it is down already. The bear market, beginning this summer is still very much underway.
Make a prediction as to how this economic crisis will unfold in the coming months and what will be the consequences for the average American?
Clearly we are not experiencing merely a recession or a simple bear market. On October 11, 2008, the head of the IMF (International Monetary Fund) Dominique Strauss-Kahn said, "Intensifying solvency concerns about a number of the largest US-based and European institutions have pushed the global financial system to the brink of systemic meltdown." Clearly, we cannot imagine the financial system returning to the way it was before this present crisis in which $8.4 trillion has been lost in the stock market. That must stricken value must have an effect on the real economy. With the British government planning to nationalize their banking system, beginning with The Royal Bank of Scotland and HBOS, and Secretary Paulson speaking in the same vein, we must say that laissez-faire economics will not set the agenda for a very very long time. If the System can be saved, the governments of the world will attempt Statist solutions, whether on the national or the international levels. They realize that if another huge bank goes bust, so does the global financial system. The problem with the present situation is that the massive injections of liquidity, the nationalizations, and the transference of toxic debt from private banks to the government, is that the more the disappearance of trillions of dollars from the world economy and its inevitable effect on the real economy will simply increase the number of loan defaults, both on the personal and corporate levels, thus leading to further write-downs and the further evaporation of financial trust which is the glue holding together the system. According to Nouriel Roubini, "In a typical year US corporate default rates are about 3.8% (average for 1971-2007); in 2006-2007 (the height of the easy credit regime) this figure was a puny 0.6%....Corporate default rates will surge during the 2008 recession and peak well above 10% based on recent studies." These inevitable defaults will likely produce a vicious circle of losses, write-offs, credit contraction, forced liquidation, fire-sales of assets at below fundamental prices, and bankruptcies of businesses and banks who are suffocated by not having sufficient access to credit. My guess would be that the world is going through a "controlled" systemic meltdown right now, but the corporate media is supporting their corporate financial masters by focusing solely on the day to day "rallies" and "runs." I still do not believe that people realize the implications of the Fall of the House of Usury.