Post-Finance Capitalism

Today it looks like the Fed and Treasury are not just buying highly-visible crap owned by say AIG, but are buying all the crap in sight. They're also buying a lot of crap they can't see at all, but are only guessing at. The markets went ape all over the world, running up prices on everything they could find.

This is all pretty goddam unbelievable. Watching Bush, a guy whose entire career rests on attacking big government, say that government intervention is not only right but necessary, I thought I'd been teleported to Earth 2 in a parallel universe.

Actually, Republicans specialize in pushing public money into private pockets. Remember Haliburton's cost-plus contracts that have done so well rebuilding Iraq? There are actually more strings on this deal than usual - the public actually owns something - crap debt - rather than giving money away hoping for trickle-down.

The New York Times had a decent editorial today about the situation, driven by anger at the absence of honesty and reality in the official versions of investment banking behavior. It assigns blame to underregulation. As I said yesterday, that's only the beginning.

Politics aside, what kind of crap are we buying today? A lot of Credit Default Swaps, for one, and I found a nice explanation of them on Money Morning's website from last April, when we still weren't worrying about our "$50 trillion problem." CDS's were sold and resold by and to what even mainstream NYT columnists have taken to calling "the shadow banking industry" that rules the world. Actually, that holds the world at gunpoint until we give them the REST of our money.

Here's a frighteningly accurate prediction from the April column (it will make more sense if you first read the definition of CDSs).

There are two sources of likely loss on CDS:

Default by the underlying borrowers, the companies that originally took out the loans.

And default by the banks or other financial firms that bought the credit default swap - counterparties in the endless chain of banks, insurance companies, hedge funds and general riff-raff that have done these deals.

Since the total outstanding balance of the CDS market is $50 trillion, compared with the entire U.S. home mortgage market at about $11 trillion and the subprime part of that market at only $1 trillion, you can see why people are worried.

American International Group Inc. (AIG), the insurance company, lost $7 billion on its CDS portfolio in its fiscal quarter ended November 30, and that was on "super senior" CDS.

A more recent piece by Shah Gilani notes that "Credit default swaps are not standardized instruments. In fact, they technically aren’t true securities in the classic sense of the word in that they’re not transparent, aren’t traded on any exchange, aren’t subject to present securities laws, and aren’t regulated. They are, however, at risk - all $62 trillion (the best guess by the ISDA) of them."

and it continues:

What is happening in both the stock and credit markets is a direct result of what’s playing out in the CDS market. The Fed could not let Bear Stearns enter bankruptcy because - and only because - the trillions of dollars of credit default swaps on its books would be wiped out. All the banks and institutions that had insurance written by Bear would not be able to say that they were insured or hedged anymore and they would have to write-down billions and billions of dollars in losses that they’ve been carrying at higher values because they could say that they were insured for those losses.

The counterparty risk that all Bear’s trading partners were exposed to was so far and wide, and so deep, that if Bear was to enter bankruptcy it would take years to sort out the risk and losses. That was an untenable option.

The Fed had to bail out Bear Stearns.

The same thing has just happened to AIG
Since the insurance companies AIG owns are OK, and the Fed now owns their assets, the Fed - we taxpayers - may do OK on this.

FT's chief economics commentator Martin Wolf, not what you'd call a huge fan of government intervention, said "the whole regulatory regime has to be transformed."

And FT columnist John Pender, in his piece "Toxic Assets Head Towards the Public Balance Sheet," writes

In the space of just two momentous weeks, the landscape of global finance has been dramatically transformed. President George W. Bush’s administration has mounted a multi-billion-dollar rescue of the financial system at the cost of inflicting severe damage on the US model of free- market capitalism.

There are two moments of interest in Pender for the coming era after finance capital:

1. A shift from leverage: "This is what happens when an overleveraged global financial system unwinds. Borrowing is being forcibly reduced across the world after the greatest credit bubble in history. It amounts, says David Roche of Independent Strategy, a research boutique, to a “tectonic shift from leverage to thrift as the means of financing growth and the concomitant dramatic reduction in global imbalances such as the US current account deficit.”'
2. Finance's revealed incompetence on society and the "real" economy: "This inability to handle externalities has again been apparent in the markets over the past two weeks as speculators have engaged in short-selling strategies against AIG and the investment banks in the US and HBOS in the UK."

Let's see what we can do with this.