The Capitalist Catch (1)

(or how the financial wallahs went from snafu to fubar)

"The United States banking system is effectively insolvent," (Professor Nouriel Roubini, Stern School of Business, NYU)

Who can argue against security? We all love it: security of job, family, wealth, health, and so on, all the way up to nation.

Including banks, believe it or not.

Because with secure banks – that is, banks that are truly solvent, properly managed and rigorously regulated – we can all continue to get all those secure niceties that we all enjoy. Without banks for effective functioning of the capitalist system most of us are dead in the water

So, don't begrudge the recent action by the new US Treasurer, Tim Geithner, in laying out his new, 2.5 trillion bail out plan for the US banking system as detailed in The New York Times. The USA needs bold government action to save the financial system from itself – not only for the USA, but also for the rest of the world. Unhappily, in the words of Paul Krugman, Geithner's plan was "vague. It left everyone trying to figure out where the administration was really going."

From my perspective, the fact that such a large bail out is necessary simply shows, first, that the financial system has gone from snafu to fubar. Second, it highlights the grand idiocy of a system that creates enormous wealth for some even as it digs its own grave.

I say snafu because, let's face it: the capitalist system inevitably concentrates capital (read 'money') into the hands of only a few people while the bulk of the population just gets by, most of the time. Oh, sure, living standards rise, but so does debt – especially in the lower and middle income brackets that can least afford to carry it. A laissez-faire capitalist system is very risky, and eventually results in significant social disparities but fabulous wealth for some. A more socially responsible system provides less risk and a greater measure of personal security for the masses, particularly; the trade off may be a slower rate of growth.

Now: leave the market alone long enough and, sure enough, we reach fubar when large capitalist enterprises finally realize they can't pay back debt and close up shop or put their hands out. Remember Leaman Brothers? Yes, let's remember it as the joker in the deck, the one that very few thought would start the process to bring down an entire global financial system.

Oh, we can't wholly blame the management of Leaman's: they were only doing what hundreds of other thrifts, hedge funds, banks and insurance companies were doing: a feeding frenzy in a sea of green – dollars, that is. Monkey see, monkey do, and so on.

Let's step back a moment: what is the function of a bank? Depends whom you ask, of course, because you can get many answers. But, there is a basic answer that goes to the heart of the financial collapse: your money in a bank is a liability for that bank because it's a debt that must be repaid on demand – in simplest terms, when you make an over-the-counter withdrawal. In that context, the primary function of the bank is to create assets from its debt (your money) by making loans. So banks have always been making margin loans: it's what they do.

The trick, as always, is to make loans as risk free as possible.

Well, we all know what happened over the last twenty years, don't we now? Unhappily, over that period, banks and others kept making risky loans, many of which have now been figuratively and literally bundled into my choice – already - for this year's catch phrase: toxic assets.

So who wants to buy a loan (an asset) that's maybe gonna kill you?

There's the rub with Tim Geithner's plan: nobody can agree on the right pricing for those toxic assets. Banks don't want to sell too cheap; investors don't want to buy too dear. So, Wall St is, at the moment, treating the whole plan, well, almost like snake oil. In a way, I can't blame it. Yes, yes, we know they're the bad guys in the first place – but it takes one to know another. Hence, now we just have a Mexican stand-off, of sorts. Nobody moves because you're damned if you do, and you're damned if you don't.

Catch-22.

So, how can we all escape this idiocy of capitalism? Well, we can't physically, unless we go to a fascist state or dictatorship, somewhere. Even then, it's no guarantee. Anyway, it's a non-starter for most, except for people like Lee Harvey Oswald et al.

Well then: how long before the freeze ends?

Bill Gates let that cat outta the bag over a week ago, in Davos, Switzerland when I heard him, on radio, claiming to a BBC interviewer that, from his perspective, this financial crisis and economic dep…recession will last at least five years, and maybe more. Since Bill Gates was hobnobbing with many finance ministers and economists from many countries, there's no doubt he must have heard some very candid opinions. And Bill's not just a fly on the wall, is he?

So, are these 'toxic assets' the stumbling block, the logjam that nobody seems to be able to untangle?

No, the stumbling block is timidity. From what I've seen and read, Geithner just doesn't cut it as a man of perceived confidence. In politics, perception is everything. And from the latest news reports, he's not doing enough yet to ensure a return to financial confidence. Paul Krugman is right: everybody's scratching their heads.

The real problem? Well, it all started with securitizing bad loans (now aka as 'toxic assets') into bundles and selling them on to suckers. Those suckers then sold them on again. And so on. Hey, presto: Ponzi-like toxic assets (such an ironic term). How else did Bernie Madoff get his ideas, you wonder...

Doesn't it make more sense for banks to hold their mortgages instead of selling them on? Who is responsible for allowing the inadvertent creation of such a Ponzi scam? What measures will be taken to reduce or eliminate such schemes? Why were regulations relaxed so that they could bundle mortgages in such a fashion?

From my perspective – as a prior employee of a large bank – if you make a mortgage, you keep it, period. Might be old-fashioned, but it's not a potential danger to anybody except the bank and the mortgagee. If such a bank does make a lot of bad loans, only one bank becomes insolvent, with absolutely no risk to the global financial system.

Are the banks insolvent as Professor Roubini claims in the quote at the top of the page? According to the article from which I grabbed the quote, many are – even though they're not admitting it. By implication, banks in other countries are facing the same or similar financial crunch. Hence, we'll all just have to wait and see what happens. Right?

Wrong. What's needed is something like the suggestion from Nicholas Kristoff (not the first to make it) in his recent NY Times article, in which he says "giving shares in big banks to all American households would be a terrific way" to build the "ownership society" so grandly suggested by the previous president a few years back. Others simply say that some of the banks should be nationalized. Sweden and Japan both did that back in the nineties, and with success: banks were saved and eventually sold back by the government to private enterprise. As I write, the U.K. government is a major shareholder in Britain's largest banks. Other countries are doing the same.

President Bush, however, wasn't using the term "ownership society" in the manner Kristoff suggests; Bush was simply talking about everybody having a business, a fatuous notion if ever there was one. Can you imagine it: everybody as a business owner and no workers to do the actual work – except the owner?

But Kristoff touches upon the real solution to the internal contradictions of capitalism: the whole structure of capitalism must be changed – not through violent revolution, but with legal measures to fundamentally change the way business enterprises, financial institutions and stock markets operate – if there is to be any permanent control of the means of production by the people.

That, of course, would mean power to the masses. I think that's coming, albeit with the speed and difficulty of pushing molasses uphill. So don't hold your breath.

All that's needed, however, is a way of leveling the hill. I'll set out some thoughts on that in Catch (2).

Copyright © Roger Burke, 2009. All rights reserved.