The Atlantic, June 12, 2012: “The data we can see [U.S. bank exposure to European debt] is scary, but it’s our blind spots that are truly terrifying. Here’s just one example: Big institutions such as Bank of America have bought and sold hundreds of billions of dollars worth of credit default swaps — the same highly combustible financial derivatives that were at the heart of the 2008 financial collapse — tied to European debt. The banks would argue that all those swaps, which pay off when the underlying asset goes bad, balance out safely…. As the aftermath of Lehman Brothers showed, that sort of delicately calibrated trading strategy can fall apart disastrously if, say, a major bank goes bust and can’t pay everyone else who bought swaps from them. “
The Fall of 2008 marked the beginning of a long continual slide in the value of the U.S. Dollar vs. hard assets as the Fed initiated various forms of direct (and indirect) debt monetization and emergency loans – much of it directed at major financial institutions (both U.S. and foreign). And U.S. taxpayers have been picking up the ‘inflation’ bill (primarily food and energy) ever since.
Excerpts from “The Quiet Coup,” by Simon Johnson, The Atlantic May 2009
In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15 , causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.
But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Of course, this was mostly an illusion. Regulators, legislators, and academics almost all assumed that the managers of these banks knew what they were doing. In retrospect, they didn’t. AIG’s Financial Products division, for instance, made $2.5 billion in pretax profits in 2005, largely by selling underpriced insurance on complex, poorly understood securities. Often described as “picking up nickels in front of a steamroller,” this strategy is profitable in ordinary years, and catastrophic in bad ones. As of last fall , AIG had outstanding insurance on more than $400 billion in securities. To date, the U.S. government, in an effort to rescue the company, has committed about $180 billion in investments and loans to cover losses that AIG’s sophisticated risk modeling had said were virtually impossible.
Stanley O’Neal, the CEO of Merrill Lynch, pushed his firm heavily into the mortgage-backed-securities market at its peak in 2005 and 2006; in October 2007, he acknowledged, “The bottom line is, we—I—got it wrong by being overexposed to subprime, and we suffered as a result of impaired liquidity in that market. No one is more disappointed than I am in that result.” O’Neal took home a $14 million bonus in 2006; in 2007, he walked away from Merrill with a severance package worth $162 million, although it is presumably worth much less today.
In October , John Thain, Merrill Lynch’s final CEO, reportedly lobbied his board of directors for a bonus of $30 million or more, eventually reducing his demand to $10 million in December; he withdrew the request, under a firestorm of protest, only after it was leaked to The Wall Street Journal. Merrill Lynch as a whole was no better: it moved its bonus payments, $4 billion in total, forward to December, presumably to avoid the possibility that they would be reduced by Bank of America, which would own Merrill beginning on January 1. Wall Street paid out $18 billion in year-end bonuses last year  to its New York City employees, after the government disbursed $243 billion in emergency assistance to the financial sector.
In a financial panic, the government must respond with both speed and overwhelming force. The root problem is uncertainty—in our case, uncertainty about whether the major banks have sufficient assets to cover their liabilities. Half measures combined with wishful thinking and a wait-and-see attitude cannot overcome this uncertainty. And the longer the response takes, the longer the uncertainty will stymie the flow of credit, sap consumer confidence, and cripple the economy—ultimately making the problem much harder to solve. Yet the principal characteristics of the government’s response to the financial crisis have been delay, lack of transparency, and an unwillingness to upset the financial sector.
…[TARP] money was used to recapitalize banks, buying shares in them on terms that were grossly favorable to the banks themselves. As the crisis has deepened and financial institutions have needed more help, the government has gotten more and more creative in figuring out ways to provide banks with subsidies that are too complex for the general public to understand….
Full article: http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/307364/
Simon Johnson, a professor at MIT’s Sloan School of Management, was the chief economist at the International Monetary Fund during 2007 and 2008. He blogs about the financial crisis at baselinescenario.com, along with James Kwak, who also contributed to this essay.
Note – The Leviticus 25 Plan, featuring direct credit extensions from the Federal Reserve to American families, would provide for massive debt reduction at the family level.
This ‘ground level’ solution is critical for reducing the scope of Government and re-igniting economic growth.
Any objection that The Leviticus 25 Plan might be unfair to banks ignores the damage that banks have done to themselves and to the economy with their excessive thirst for risk and profits over the past 10 years.
The time has arrived for American families to receive their own just considerations – direct credit extensions from the Federal Reserve.
The Leviticus 25 Plan