Dr. Susmit Kumar, Ph.D.
After the $2 billion Punjab National Bank (PNB) scam has come to light, Arvind Subramanian, the Chief Economic Advisor (CEA), is forcefully advocating the majority privatization of public sector banks (PSBs) (Time to study PSU bank privatisation: Chief economic advisor, The Times of India, February 18, 2018). It is worth noting that Mr. Subramanian is also vociferously advocating consolidation of banks in India (CEA bats for bank consolidation, The Tribune, October 26, 2017).
In US, banks and financial institutions, including the US Federal Reserve Bank (US equivalent of the Reserve Bank of India) are in private hands. As we will see in this paper, the bank officials and Wall Street bankers were responsible of the 2008 Banking Crisis in the US, which created the 2008 Great Recession in the US and world-wide recession, but as the US banks are “too big to jail/fail,” not a single bank official was prosecuted despite having documentary proofs of illegal means (which can be termed as day-light robberies), used by the bank officials and the Wall Street bankers. These bankers made hundreds of billions of dollars by using illegal practices. Since early 2000s, bank officials in US started creating shading mortgages and the Wall Street bankers created shady derivatives on the top of these mortgages. The ultimate losers were the ordinary Americans, who were tricked into purchasing these shady mortgages, and also people, both in US and throughout the globe, who were tricked into purchasing these shady derivatives. The US government had to spend trillions of dollars (several thousand times the $2 billion PNB Scam) to overcome the 2008 banking crisis created by these corrupt bankers. Just a decade ago before the US bankers started creating shady mortgages in early 2000s, the US had to spend taxpayers’ $132 billion (trillions of dollars in current US dollars) to overcome the 1990s Savings and Loan Crisis, caused by the US bankers. It is worth noting that nearly 1,000 bank officials were sent to jail for their parts in the Savings and Loan Crisis. The Savings and Loan crisis was one of reason for the early 1990s recession in the US. There have been similar bank scams in other Western countries also.
The present PNB scam happened because the bank's failure to integrate SWIFT (Society for Worldwide Interbank Financial Telecommunication) and the PNB's internal software system. The SWIFT provides a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized and reliable environment. PNB employees were expected to manually log SWIFT activity. If that was not done, the transactions did not show up on the bank's books. The rogue bank officials issued a series of fraudulent Letters of Undertaking - essentially guarantees sent to other banks so that they would provide loans to a customer, in this case a group of Indian jewelry companies. These letters were sent to overseas branches of banks, thought to be almost all Indians, that would then lend money to the jewelry firms.
A private bank also is not immune to similar frauds because rogue people are there everywhere. If you leave loopholes, like the one which has resulted in nearly $2 billion PNB scam, bankers, in connivance of fraud businessmen, are going to make money. We need checks and balances to close loop-holes.
These US-based economists are in India for just 3 or 5 years tenure and thereafter, they go back to the US and hence their ultimate allegiance is to the US (and its failed economic policy) and not to India. There is no doubt that economists like Mr. Subramanian are brilliant people. They know that the defective “Reaganomics”, followed and preached by nearly all US economists, is indeed responsible for the creation of the Frankenstein China and for the bankruptcy of the US, too. If they would deviate from the tenets of “Reaganomics”, their career in US is finished. India needs to implement an “Indian” economic system and not the failed US economic policy.
India should never go for consolidation of banks. Right now Government of India controls the banks, but if we have only 5 to 7 large banks, then these bankers would control the Government of India. The reason, that none of the bankers went to jail for 2008 banking crisis, is that now bankers control the US government. Banks like JP Morgan Chase, Bank of America, Citibank, and Wells Fargo are “too big to jail/fail.” At least right now the CBI (Central Bureau of Investigation) and the ED (Enforcement Directorate) have been prosecuting the rogue bank officials and fraud businessmen. India needs robust legal system to prosecute the erring bankers and fraud businessmen to deter similar future scams.
Let us first discuss two bank scams in US which inflicted heavy damage to the US economy, resulting in loss of trillions of dollars of taxpayer money as well as many more trillions of dollars in US economy, as these resulted into the early 1990s recession and the 2008 Great Recession.
Then we are going to discuss how the Soviet Union collapsed due to not getting few tens of billions of dollars of loan from overseas banks. On the other hand, the US has been getting trillions of dollars from other countries as investment. Had the US dollar not being the global currency, the US economy would have collapsed in 1980s, i.e. much before the collapse of the Soviet Union. Hence the US-based “Imported” economists like Mr. Subramanian should not preach the failed US economic policy in India.
Finally, we are going to discuss why Mr. Subramanian and other US-based “Imported” economists should stop preaching privatization to be the panacea for all the ills in economy. As discussed in my latest book "India is a Country, not a Company - How Anglo-US 'Imported' Economists Misled and Mismanaged the Indian Economy" (Munshiram Manoharlal Publishers Pvt. Ltd., New Delhi, Price: Rupee 350, 212 Pages, 2018), he along with his fellow US-based “Imported” economists have done considerable damage to the Indian economy and their economic policy of unrestricted privatization in India is behind the Modi administration’s dismal job growth. Their unrestricted privatization policy is responsible for the bankruptcy of the US and also the creation of the Frankenstein China,
(1) Savings and Loan Fraud (Trillions of Dollars Fraud in Current US Dollars)
The savings and loan crisis of the 1980s and 1990s (commonly dubbed the S&L crisis) in the US was the failure of 1,043 out of the 3,234 savings and loan associations in the United States from 1986 to 1995: the US Federal Savings and Loan Insurance Corporation (FSLIC) closed or otherwise resolved 296 institutions from 1986 to 1989 and the Resolution Trust Corporation (RTC), created by the US government to resolve the S&L crisis, closed or otherwise resolved 747 institutions from 1989 to 1995. By 1995, the RTC had closed 747 failed institutions nationwide, worth a total possible book value of between $402 and $407 billion. In 1996, the General Accounting Office estimated the total cost to be $160 billion, including $132.1 billion taken from taxpayers.
After investigation in the S&L Crisis, FBI filed criminal prosecutions against 1,100 and 839 people were convicted – even one senior senator Charles Keating went to prison. The so-called maverick senator John McCain barely survived in politics. On the other hand, for the 2008 banking crisis Justice Department of Justice (DOJ)/FBI did not file any criminal case against any banker. It is worth noting that 2008 banking crisis was much more severe than the 1980s Savings and Loan Crisis as 2008 banking crisis nearly brought down the US economy – US government had to spend nearly $2 trillion (first in bank rescue fund of Bush administration and then Obama administration stimulus) and was responsible for the 2008 Great Recession.
Following New York Times article compared the details of prosecutions in these two crises.
“Two Financial Crises Compared: The Savings and Loan Debacle and the Mortgage Mess” – New York Times, April 13, 2011
http://www.nytimes.com/interactive/2011/04/14/business/20110414-prosecute.html
“Savings and loan crisis” - wikipedia
https://en.wikipedia.org/wiki/Savings_and_loan_crisis
(2) 2008 US Banking Fraud - (Another Trillions of Dollars Fraud Caused by Corrupt Bankers)
The 2008 US Great Recession was triggered by the defaults of record numbers of subprime mortgages. Investment banks were securitizing the mortgages, including the subprime mortgages, and selling them all over the world (i.e., the mortgages were sold as securities to investors). Typically, a bundle of say one hundred home mortgages was sold as securities to investors.
In finance, a security is an instrument representing financial value. When the subprime mortgage market started to collapse in 2007, the investment banks, that had sold these securities, started to lose money. Although the ¬mortgage-based securities affected by the subprime crisis was said to be less than $2 trillion, the collapse of the US housing sector affected non-subprime mortgages too, leading to further losses in mortgage-based securities. Bank officials were under pressure from their higher-ups to give mortgages, and, in turn, they as well as the top officials were getting huge year-end bonuses. At investment banks also, officials were putting pressure on workers to churn out securities that packaged mortgages and other forms of debt into bundles for resale to investors all over the world. The officials, including the CEOs at these investment banks, were making millions of dollars in bonuses due to the profit related to the sale of these securities. These officials were taking huge risks for their bonuses to show short-term gains for their financial institutions, and many of those gains turned out to be huge losses.
During the 1990s and early 2000s, low interest rates and large foreign investments created a housing sector boom in the United States. During this housing boom period, banks were giving housing loans to people whose income was not sufficient to pay the monthly mortgage. However, as home prices were rising every year at a record pace, people were making money by selling homes to each other. When home prices started to collapse, not only people having subprime mortgages but people with prime mortgages found it difficult to pay their mortgages too.
According to a Brookings Institution study, prime mortgages dropped to 64 percent of the total in 2004, 56 percent in 2005, and 52 percent in 2006 (Manav Tanneeru, “How a ‘perfect storm’ led to the economic crisis,” CNN.com, January 1, 2009). According to Credit Suisse, 29 percent of new mortgages in 2005 allowed borrowers to pay interest only—not principal—or pay less than the interest due and add the cost to the principal. It was up from 1 percent in 2001. In 2006, half of new mortgages required no or minimal documentation of household income. According to the National Association of Realtors, the average down payment for the first-time home buyers was 10 percent, whereas in 2007, it was only 2 percent. Suppose you have $20,000 cash. In 2006, you could get a 5 percent down mortgage to buy a $400,000 home whereas a 10 percent mortgage will limit you to buy only a $200,000 home.
According to John D. Parsons, a supervisor at a Washington Mutual mortgage processing center, almost all were granted mortgage loans irrespective of their real incomes. Parsons said that it was normal to see babysitters claiming salaries worthy of college presidents, and school teachers with incomes rivaling stockbrokers. Interviews with two dozen employees, mortgage brokers, real estate agents, and appraisers revealed the relentless pressure to churn out loans (Peter S. Goodman and Gretchen Morgenson, “Saying Yes, WaMu Built Empire on Shaky Loans,” New York Times, December 28, 2008).
Credit Rating Agencies like Moody’s and Standard & Poor’s also played dubious roles by first assigning investment-grade ratings to these subprime mortgage-related securities. Both these agencies were getting substantial amounts of money by grading these products. But when subprime mortgages started to collapse, they suddenly downgraded the mortgage-related securities to junk ratings. According to the Nobel Prize economist Joseph Stiglitz, “I view the ratings agencies as one of the key culprits. They were the party that performed that alchemy that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the ratings agencies (Elliot Blair Smith, “Bringing Down Wall Street as Ratings Let Loose Subprime Scourge,” Bloomberg.com, September 24, 2008).”
Despite having mortgage-related losses, top executives at Wall Street were getting huge bonuses. In 2007, Wall Street firms paid $33.2 billion in bonuses. Seven of Wall Street’s biggest firms (Merrill Lynch, Citigroup, Bear Stearns, Morgan Stanley, JPMorgan Chase, Lehman Brothers, and Goldman Sachs) paid a combined total of $122 billion in total compensation and benefits, up 10 percent since 2006, despite seeing their net revenue collectively fall 6 percent. On the other hand, in the same year mortgage-related losses reported by the seven firms totaled $55 billion and wiped out more than $200 billion in shareholder value, which was nearly half the value of their holdings. Three of those firms suffered their biggest losses ever in the final months of 2007. Employee compensation at those firms was equal to 47 percent of net revenue in 2007, compared with 40 percent the year before (Tomoeh Murakami Tse and Renae Merle, “The Bonuses Keep Coming,” Washington Post, January 29, 2008).
In 2006, Merrill Lynch had record earnings of $7.5 billion, and the firm gave $5 billion to $6 billion in bonuses in that year. A twenty-something analyst with a base salary of $130,000 received a bonus of $250,000, and a thirty-something trader with a $180,000 salary got $5 million. Dow Kim, executive vice president, received a $35 million bonus, whereas his salary was only $350,000. Since then, the company lost three times the money in mortgage-related investments, leading to the company, founded in 1914, being sold to Bank of America in late 2008. In 2006, more than fifty people at Goldman Sachs were paid more than $20 million in bonuses. At Wall Street firms, bonuses are based on short-term profits, which encourage people to take risks like gamblers in a casino (Louise Story, “On Wall Street, Bonuses, Not Profits, Were Real,” New York Times, December 18, 2008).
When home prices started to collapse, not only did people with subprime mortgages find it difficult to make their mortgage payments, people with prime mortgages had difficulties too. Bear Stearns, founded in 1923 and one of the largest global investment banks and securities trading and brokerage firms, collapsed in early 2008 because of the subprime mortgage crisis and was sold to JP Morgan Chase for as low as ten dollars per share, a price far below the fifty-two-week high of $133.20 per share, traded before the crisis. The federal takeover of Fannie Mae and Freddie Mac in September 2008 cost taxpayers about $400 billion. By the first half of 2008, the value of bad loans of Washington Mutual had reached $11.5 billion (Peter S. Goodman and Gretchen Morgenson, “Saying Yes WaMu Built Empire on Shaky Loans,” New York Times, December 27, 2008). Due to its mortgage-related crisis and subsequent withdrawal of $16.4 billion in deposits, during a ten-day bank run in June 2008, Washington Mutual, a hundred-year-old bank, was seized by the FDIC and finally sold to JP Morgan Chase for $1.9 billion in September 2008.
In September 2008, after the failure of Lehman Brothers and the emergency rescue of AIG, Henry Paulson, then US Treasury secretary, warned of an economic calamity greater than the 1930s Great Depression when President Bush and congressional Democratic leaders agreed to the $700 billion bailout. Government officials have acknowledged difficulties in tracking this $700 billion bailout fund because, apart from providing lending to customers and other banks, banks have leeway to use the money for other things, such as buying other banks, paying dividends to investors, or even bonuses to executives. Most of this money is being paid to the parties who won the bet on the derivatives. AIG, which had a record $62 billion loss in the last quarter of 2008, received about $170 billion as an emergency loan from the Fed until March 2009, and it paid $75 billion of this loan in the final months of 2008 to several domestic and foreign banks (such as Goldman Sachs, Merrill Lynch, Morgan Stanley, Bank of America, Societe Generale, Deutsche Bank, and Barclays), as well as to several US municipalities. Most of this money was paid due to the collapse of mortgage-based securities.
Although banks, investment firms, and a majority of hedge funds lost huge amounts of money due to the collapse of the housing sector and the ensuing stock market collapse, some hedge funds made millions, even billions, by betting on the collapse of the housing sector in 2008. For instance, John Paulson, the New York hedge fund manager, made $3.7 billion in 2007 by placing his bet on the collapse of the mortgage market. George Soros and James Simons made $2.9 billion and $2.8 billion, respectively, in 2007. At the beginning of 2007, Paulson’s hedge fund had $6 billion, and by the end of December 2007, his fund assets were worth $28 billion. A few years ago, individual income reaching into billions of dollars was unfathomable. In 2002, the first year Alpha Magazine tracked hedge fund compensation; the top twenty-five managers earned $2.8 billion combined. Hedge funds are pools of private money, largely generated from wealthy individuals, pension funds, and endowments, used for a wide range of investments. Usually 80 percent of any gains are given to such investors, while the fund manager takes 20 percent, plus an annual fee for his or her services (David Cho, “1 Man, 1 Year: $3.7 Billion Payout,” Washington Post, April 17, 2008.). Apart from this, these hedge fund managers claim their incomes as capital gains and pay only 15 percent federal taxes rather than the regular income tax rates, at least twice as high. On the other hand, several states are running out of money in this economic downturn, laying off school teachers and cutting back on essential services.
In short, banks gave home loans to people based on fictitious paper. Bank officers as well as investment bankers made hundreds of millions of dollars in salaries and bonuses because of them. Later on, common people lost money in shares, but hedge funds made a lot of money bringing down the shares of these banks. It all boils down to the fact that the whole mechanism, or dynamics, if you like, created a domino effect leading taxpayers to pay trillions of dollars for the bankers’ misdeeds and exacerbating the economic recession of the country as well as that of the entire world.
The moneymaking instruments at Wall Street are not the birthrights of the bankers and investors. They simply use these instruments as long as the government permits their use. The government enacted laws to restrict short selling after short sellers were blamed for the 1929 Wall Street crash. Some of these restrictions were in effect until 2007, when the Securities and Exchange Commission (SEC) removed them.
Derivatives exacerbated the 2008 global economic crisis. Derivatives are financial contracts whose values are derived from the value of something else. A derivative is basically a side bet, (i.e., a bet on loans, bonds, commodities, stocks, residential mortgages, commercial real estate, loans, bonds, interest rates, exchange rates, stock market indices, consumer price index, or even on weather conditions) without owning it. It is similar to the bet a person who is not a player or does not own the team makes with someone on the outcome of a baseball game. If a person is certain that mortgage securities would fail, he would place the bet against them without owning them, making millions and even billions of dollars. For example, a credit default swap (CDS) is a credit derivative contract between two parties. CDS was invented by a JPMorgan Chase team in the mid-1990s.
Brooksley E. Born, the then head of the Commodity Futures Trading Commission, was for regulating the derivative market. However, the wishes of Federal Reserve Chairman Alan Greenspan, Treasury Secretary Robert E. Rubin, and Securities and Exchange Commission Chairman Arthur Levitt Jr. prevailed. Ms. Born left the CFTC in June 1999. The Commodity Futures Modernization Act of 2000 made it illegal to regulate the derivative market. Derivatives are modern financial casino games. After the 2008 Wall Street banking crisis, in his congressional testimony Alan Greenspan said that he was wrong in his support of deregulating the derivative market.
Warren Buffett famously described derivatives bought speculatively as “financial weapons of mass destruction.” George Soros avoids using them “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs” (Peter S. Goodman, “Taking Hard Look at a Greenspan Legacy,” New York Times, October 8, 2008.). For instance, in October 2008, trading in Gulf Bank, one of the largest lenders in Kuwait, was halted after a major customer defaulted on a currency derivative contract, a bet on the euro that dived against the dollar in the previous ten days. It was reported that losses were as much as 200 million dinars or nearly $750 million (David Jolly, “Global Financial Troubles Reaching Into Gulf States,” New York Times, October 26, 2008).
American International Group (AIG), the world's largest private insurance company, had sold $440 billion in credit-default swaps tied to mortgage securities. When the housing bubble burst the CDSs tied to mortgage securities began to send shock waves throughout the global market. To prevent a chain reaction, the US government had to rescue AIG. When AIG and several others were running out of money after being downgraded by credit-rating agencies because of mounting losses, a $700 billion fund was established by the US Congress to bail out Wall Street firms. This triggered a clause in its credit-default swap contracts to post billions in collateral. AIG is considered “too big to fail,” so the US government had to save it. The failure of AIG would send a shockwave through the finance industry, as it had insured assets of financial firms all over the world.
Phil Angelides was a Democratic member of Congress and was chairman of the bipartisan commission to examine causes of the biggest downturn since the 1930s Great Depression. He said that Goldman Sachs’s operation was similar to selling a car with faulty brakes and then selling an insurance policy on that car. Goldman Sachs helped hedge fund manager John Paulson to select securities tied to risky subprime mortgages without telling investors that he was betting against them (i.e., betting that they would fail). Paulson made about $2.7 billion in the process. This type of betting was illegal until 2000 when the Republican-led Congress passed the Commodity Futures Modernization Act of 2000 (CFMA) to make it illegal to regulate these side bets (i.e., without owning the item). Under the 2000 CFMA act, I can bet (i.e. buy insurance from an insurance firm by paying few percentage of the house price) that your house, without owning it (and also without your knowledge), would burn down in two years and if your house is burnt in two years, I would get the insured money from the insurance firm. Due to massive Goebbelian propaganda, they try to convince people that these corrupt financial instruments, being used by fraud bankers, are good for the economy. It is an irony that when the government increases the tax on rich, then the same people would claim it to be socialism.
Also, the US government is not printing any special money for the Wall Street bankers and investors. Rather, the outrageous amount of money that these people are making comes from the pockets of common people. John Paulson, a New York hedge fund manager, made $3.7 billion in 2007 by betting against questionable mortgage securities during the collapse of the mortgage market. George Soros and James Simons made $2.9 billion and $2.8 billion, respectively, the same year in similar ways. Almost all of their monies were taxpayers’ money because they received this money from the AIG (American International Group), which had insured those mortgage securities (also termed as derivatives), and AIG needed to be bailed out by the government due to mounting losses. The AIG bailout was a backdoor bailout of financial institutions including Goldman Sachs, JPMorgan Chase, and Morgan Stanley. Instead of getting “haircuts,” they were paid in full. This betting method employed by these hedge fund managers was illegal until 2000, when a Republican-controlled Congress made it illegal to regulate or hinder it by passing the Commodity Futures Modernization Act. In 2008, Alan Greenspan, the Fed chairman when the 2000 act was passed and actually a force behind its enactment, admitted his mistake in opposing the regulation of these kinds of derivatives. Had the government not passed the Commodity Futures Modernization Act of 2000, these hedge fund managers would not have made these outrageous amounts of money.
Even if AIG would not have required taxpayers’ money to be bailed out and the company would have paid these tens of billions of dollars to hedge fund managers from its own account, AIG would have to get this money from somewhere, as government does not money especially for AIG. If you had followed the trail of the money within AIG, the trail would have ended in the pockets of ordinary people—the source of all this money. Moreover, these companies’ income has little social value, as they do not create jobs, except for a few secretaries and a few analysts.
Only when the internal documents (emails, phone records, etc.) of firms are subpoenaed or come out in public, then only we know how they are making money at the expense of common people. The internal document of Goldman Sachs showed that they were selling shaky sub-prime derivatives to their clients – and at the same time they were betting against them!
Losers of the 2008 Banking Crisis:
(i) The US government had to spend taxpayers’ $2 trillion to rescue the Wall Street banks and in the form of stimulus. Apart from this, the 2008 Great Recession, caused by the mortgage crisis, resulted in loss of several trillions of dollars in the general economy in US.
(ii) From the peak value of $9 trillion in 2006, the loss of home values was $1 trillion in 2009 and $1.7 trillion in 2010, an increase of 63 percent over the last year. “Underwater” is a technical term for the phenomenon when a borrower owes more than his house is worth. If your home is underwater, then you will have to pay the bank, which has given you mortgage, to leave the home.
Any drop in house prices increases the number of underwater mortgages. At the end of the last quarter of 2010, 27 percent of all mortgages were underwater as compared to 23.2 percent a quarter earlier (Les Christie, “30% of mortgages are underwater,” CNNMoney.com, February 9, 2011). In the third quarter of 2010, 23.2 percent of single-family homes were underwater as compared to 21.8 percent in 2009 (Blake Ellis, “Home values tumble $1.7 trillion in 2010,” CNNMoney.com, December 9, 2010). According to a Washington Post analysis, the number of prime mortgages in delinquency exceeded the number of subprime loans in danger of default for the first time in October 2008. At that time, one of every five mortgage holders had a home worth less than the mortgage on it (Dina ElBoghdady and Sarah Cohen, “The Growing Foreclosure Crisis,” Washington Post, January 17, 2009). More job losses result in more defaults on mortgage loans, and this in turn further depresses the housing market and further cuts consumption.
After the collapse of the housing sector bubble, as Americans have lost their purchasing power, US firms lost sales, and, hence, they had to lay off employees. Fifty-five percent of Americans lost a job, took a pay cut, or faced cutbacks in paid hours on the job due to the 2008 Great Recession (Mark Trumbull, “Eight ways the Great Recession has changed Americans,” The Christian Science Monitor, June 30, 2010). This led to a severe economic downturn. Due to the crash of home values as well as job losses, the credit scores of people went downhill—and damaged their credit ratings.
(iii) We will discuss the cases of two cities, one in the United States and another in Europe, to see how the lives of common people have been affected for the next several years by the games played at Wall Street’s casinos.
Due to the economic crisis, Jefferson County, Alabama’s largest county with 659,000 residents, was on the verge of bankruptcy because of losing bets on interest rates. Since mid-2008, the county was fighting to stave off what would be the largest municipal bankruptcy in the country over its $3.2 billion debt. JPMorgan Chase persuaded the county to convert its debt from fixed interest rates to adjustable rates. They also recommended that the county use interest-rate swaps that would protect it if interest rates rose. Larry P. Langford, the local official who signed off on the deals, said in a deposition in June 2008, “I still don’t understand 99 percent of it.” The county paid JPMorgan Chase, Bank of America, Bear Sterns, and Lehman Brothers Holdings Inc. $120 million in fees—six times the prevailing fees for the amount of the county’s debt for interest rate swaps. During the last few years, Jefferson County entered into a series of complex transactions, called swaps, worth a staggering $5.4 billion. Of eleven swaps and similar contracts that Jefferson County went into from 2001 to 2003, eight were with JPMorgan Chase. JPMorgan, Bank of America, Bear Stearns, and Lehman Brothers Holdings Inc. charged Jefferson County about $50 million above prevailing prices for eleven of the interest-rate swaps the county bought between 2001 and 2004. None of the fees were disclosed to the commissioners, records show. Porter, White & Co., the Birmingham-based financial advisory firm later hired by the county to analyze its swaps, said the banks raked in as much as $100 million in excessive fees on all seventeen of its swaps. The swaps are contracts in which the county and the banks agreed to exchange periodic payments based on the size of the outstanding debt and changes in prevailing lending rates.
The worst came when Jefferson County’s two bond issuers, Financial Guaranty Insurance Co. and XL Capital Assurance Inc., suffered hundreds of millions of dollars in losses on securities tied to home loans. This led to the downgrading of credit ratings of these two by Standard & Poor’s and Moody’s Investors Service. When a bond insurer is downgraded, so are the bonds it has guaranteed. Hence the interest rate of the $3.2 billion Jefferson County debt increased to 10 percent in February and March 2009 from 3 percent in January 2009. The monthly debt payment increased to $23 million from $10 million. The county was paying this extra money (i.e., taxpayers’ money) to the banks instead of building schools, hospitals, public housing, or hiring police officers. To pay for this ill-fated deal, the residents’ sewer rates were quadrupled. Several cities in Massachusetts state faced situations similar to that of Jefferson County.
The Jefferson County story can be described in this way: the county was recommended to gamble, or bet, on the interest rate rather than get the loan at a fixed rate. They entered into an agreement with banks in which periodically complex mathematical and statistical equations, involving several factors beyond the control of the county, would churn out a number for the interest rate for the massive debt. It can only be likened to the situation where an amateur playing poker in a casino has no idea about the next deck of card.
The second case relates to eight municipalities in Norway who lost almost all their money due to global casino capitalism. Four of these small cities—Narvik, Rana, Hemnes, and Hattfjelldal in the far north of Norway—lost heavily in US credit derivatives in 2008. The funds were sold by Terra Securities, an investment firm owned partially by Terra Group, a union of seventy-eight Norwegian savings banks, while the products were delivered by Citigroup, the world’s largest bank based in the United States.
Narvik is a close-knit community of 18,000. As a consequence of the losses the people of Narvik experienced loss of local services such as kindergartens, nursing homes, and cultural institutions. Town halls in several of the communities lowered the temperature to cut back on heating bills during the frigid Norwegian winter. Streetlights were turned off during the long, dark Arctic night. In the aftermath budgets were scaled back so much that the elderly at a local retirement home were left to sleep in hallways.
The invested money was borrowed on revenue anticipated from electricity sales over the coming decade. Terra Securities told city officials that it was a low-risk investment, tied to municipal bonds but cleverly insulated by several layers of funds to hedge against further losses. In fact, as events showed before the end of the year, the risks were high—far higher than people in these towns understood. It was unclear whether those risks were ever communicated. Some town council members suggested that Terra Securities, in translating the Citigroup material into Norwegian, may have left out the parts that raised doubts. The fact is, they explained, the cities had been working with Terra representatives for several years and felt inclined to accept their advice. It was like buying a Mercedes (car): You don't inspect the new car carefully; you rely on Mercedes’ reputation. Terra, the Norwegian securities firm that was the go-between with Citigroup, was forced into bankruptcy in late 2007.
The Terra brokers probably did not understand the scheme themselves. Citigroup's oral and written descriptions inadequately portrayed the risk, he charged; they had used a faulty mathematical demonstration to prove how one fund would hedge against losses by the other. Moreover, the way the instrument was constructed called on the Norwegian towns to provide additional funds if Citigroup's tactics lost money, in effect insuring Citigroup against losses of its own.
One important point to note was that by investing through the complex system of derivatives, these cities were getting only marginally better return than traditional investments. But in this gamble, they lost almost their entire investments.
These examples show that the multimillion-dollar bonuses of executives at Wall Street and other financial institutions are mostly taxpayers’ money. But nobody on Wall Street or in any financial institution has been prosecuted for the 2008 Great Recession.
Corrupt bankers made trillions of dollars
There is a revolving door between the Wall Street and the financial organs, like Treasury Department, of the US administration, i.e. in nearly all US administrations, Wall Street bankers hold the top positions in the financial organs of the government and after end of the term, they again rejoin the Wall Street and hence, their allegiance is with Wall Street and not with the common people of the US. One major criticism of the $700 billion bailout, at the onset of 2008 Great Recession, by the Bush administration was that all the Wall Street financial institutions were paid in full - Societe Generale received $16.5 billion in payments, Goldman Sachs $14 billion, Deutsche Bank $8.5 billion, and Merrill Lynch received $6.2 billion, and another 12 institutions received a total of $16.9 billion for full value for their credit-default swaps with American International Group (AIG) which was certain to go bankrupt without the bailout. On the other hand, had the AIG was allowed to go bankrupt, the Wall Street bankers would not have had received even a single cent (Watchdog: Fed Used Flawed Strategy in AIG Bailout, abcnews.go.com, November, 16, 2009). Generally, in a bankruptcy the loaners are not paid full amount which they had loaned, i.e. they get haircut. It is worth noting that the then US Treasury Secretary, Henry Paulson blackmailed Bush Jr, then US President and the US Congress for $700 billion bailout by saying then the US might not have any economy a day after. He was the CEO of Goldman Sachs, a Wall Street financial firm, before becoming the US Treasury Secretary.
Here is the quote from an article https://www.rollingstone.com/politics/news/secret-and-lies-of-the-bailout-20130104, Secrets and Lies of the Bailout, The Rolling Stone, January 4, 2013):
“Much as with a declaration of war, a similarly extreme and expensive commitment of public resources, Paulson needed at least a film of congressional approval. And much like the Iraq War resolution, which was only secured after George W. Bush ludicrously warned that Saddam was planning to send drones to spray poison over New York City, the bailouts were pushed through Congress with a series of threats and promises that ranged from the merely ridiculous to the outright deceptive. At one meeting to discuss the original bailout bill – at 11 a.m. on September 18th, 2008 – Paulson actually told members of Congress that $5.5 trillion in wealth would disappear by 2 p.m. that day unless the government took immediate action, and that the world economy would collapse "within 24 hours."
To be fair, Paulson started out by trying to tell the truth in his own ham-headed, narcissistic way. His first TARP proposal was a three-page absurdity pulled straight from a Beavis and Butt-Head episode – it was basically Paulson saying, "Can you, like, give me some money?" Sen. Sherrod Brown, a Democrat from Ohio, remembers a call with Paulson and Federal Reserve chairman Ben Bernanke. "We need $700 billion," they told Brown, "and we need it in three days." What's more, the plan stipulated, Paulson could spend the money however he pleased, without review "by any court of law or any administrative agency."
The White House and leaders of both parties actually agreed to this preposterous document, but it died in the House when 95 Democrats lined up against it. For an all-too-rare moment during the Bush administration, something resembling sanity prevailed in Washington.
So Paulson came up with a more convincing lie. On paper, the Emergency Economic Stabilization Act of 2008 was simple: Treasury would buy $700 billion of troubled mortgages from the banks and then modify them to help struggling homeowners. Section 109 of the act, in fact, specifically empowered the Treasury secretary to "facilitate loan modifications to prevent avoidable foreclosures." With that promise on the table, wary Democrats finally approved the bailout on October 3rd, 2008. "That provision," says Barofsky, "is what got the bill passed."
But within days of passage, the Fed and the Treasury unilaterally decided to abandon the planned purchase of toxic assets in favor of direct injections of billions in cash into companies like Goldman and Citigroup. Overnight, Section 109 was unceremoniously ditched, and what was pitched as a bailout of both banks and homeowners instantly became a bank-only operation – marking the first in a long series of moves in which bailout officials either casually ignored or openly defied their own promises with regard to TARP.
Congress was furious. "We've been lied to," fumed Rep. David Scott, a Democrat from Georgia. Rep. Elijah Cummings, a Democrat from Maryland, raged at transparently douchey TARP administrator (and Goldman banker) Neel Kashkari, calling him a "chump" for the banks. And the anger was bipartisan: Republican senators David Vitter of Louisiana and James Inhofe of Oklahoma were so mad about the unilateral changes and lack of oversight that they sponsored a bill in January 2009 to cancel the remaining $350 billion of TARP.
(3) US Pseudo-Capitalism, based on Dollar Ponzi Scheme and Soviet Union Communism
From the early 1950s to the mid-1960s, the Soviet Bloc’s economic growth was astounding. Its GDP increased at a tremendous rate following the planned economy program of transferring a large amount of manpower from the agricultural sector into industry. In many respects, the region was transformed more than Western Europe during these few decades, although that may have been chiefly due to the fact that it was so much poorer and underdeveloped to begin with. Russia’s steel output, a mere 12.3 million tons in 1945, soared to 65.2 million tons in 1960 and to 148 million tons in 1980, making the U.S.S.R. the world’s largest producer; electricity output rose from 43.2 million kilowatt-hours, to 292 million, and then to 1.294 billion kilowatt-hours during the same periods; and automobile production jumped from 74,000, to 524,000, and then to 2.2 million units. The list of production increases could be added to almost indefinitely. The Soviet Bloc achieved an average of more than 10 percent annual growth in industrial output during this period. Its space program, which including successfully launching the first space vehicle, “Sputnik,” even surpassed the American space program, and the U.S. had to work hard to close the “space gap.”
In the 1970s, however, growth reduced to a rate of three to four percent. The previous high rate of growth had been due primarily to the use of vast, reallocated pools of labor and capital, and these had become utilized to their full extent, unable to provide further dramatic increases in productivity. Japan, by using modern technology like computers, telecommunications, and robotics instead of relying so much on labor, was able to surpass the U.S.S.R. in terms of GNP, as was the West. In comparison, Soviet equipment was outdated.
Premier Mikhail Gorbachev attempted to reform the Soviet economy in the 1980s with “glasnost” (freedom of speech, transparency in government) and “perestroika” (reconstruction of economy, economic reforms), for which he needed money. Western banks, especially German, initially gave the Soviet Union loans, but subsequently stopped, leading to economic crisis in the U.S.S.R. Soviet intervention in Afghanistan in the 1980s also resulted in a financial black hole. Lower crude oil prices during the late 1980s, oil being the primary Soviet export, further exacerbated the situation.
After record-breaking prices in the early 1980s, there was drastic reduction is price of crude oil, the main Soviet export, during late 1980s and early 1990s after the end of Iraq-Iran War (1980-88). Crude oil price dropped from an average of $78.2 a barrel in 1981 to as low as $7 a barrel one time. These two factors led to a rise in Soviet external debt. Oil was the main export and source of hard currency for the U.S.S.R. Insufficient investment and lack of the modern technology needed to harness hard-to-reach oil fields prevented her from expanding production, however, and in fact Soviet oil production began to decline. The government was also borrowing heavily to modernize its economy. These two factors led to a rise in Soviet external debt. In 1985, oil earnings and net debt were $22 billion and $18 billion, respectively; by 1989, these numbers had become $13 billion and $44 billion, respectively. By 1991, when external debt was $57 billion, creditors (many of whom were major German banks) stopped making loans and started demanding repayments, causing the Soviet economy to collapse (The End Of Poverty, Jeffrey Sachs, The Penguin Press, New York, 2005, p. 132).
Because of lack of hard currency Russia's shelves were empty of bread. In 1984-85, the USSR imported 55.5 million tons of both wheat and coarse grain, a record for a single country to take in one year. Beginning with the 1972-73 crop season, the Soviet Union imported more wheat than any nation had ever done. It is an irony that today Russia is the number one exporter of wheat in the world.
Even the CIA had not predicted the Soviet Union’s collapse in 1991. Despite being a military super-power, with significant number of aircraft carriers, submarines, military aircrafts and tanks, second only to the US, the Soviet Union collapsed due to the paucity of some tens of billions of dollars.
Had oil prices increased, like it did during early Putin administration (2000s) or had German banks financed Gorbachev’s Perestroika and Glasnost like Japan and China financed US debts since 1980s, the USSR and communism would not have collapsed in 1991 at all. Both Japan and China have invested more than $1 trillion in the US Treasury Bonds, each. Even countries like India and Russia had significant amount of their FOREX invested in the US financial system. It is just [US] Republican Party propaganda that this collapse was due to Reagan’s military buildup. Had Japan not financed American deficits in the 1980s, the U.S. economy and capitalism would have collapsed before communism.
Under the Bretton Woods Agreement, signed by 44 countries in 1944, the US enticed all other countries by claiming that it would keep its dollar pegged to gold at the rate of $35 for one ounce of gold. The US asked other countries to use the US dollar as reserve currency and also for conducting transactions between countries. As per the agreement, you could have asked the US govt. to give you one ounce of gold for $35. The US had trade surplus from the end of World War II till 1971, but since it has had trade deficit year after year. The reason for it is that Nixon de-linked the dollar from gold in 1971, after which the US could print dollars freely to fund its trade and budget deficits. This has been going on since the Reagan administration. Had the dollar not been the global currency, there would not have been “Reaganomics”, the much-revered economic theory of the Republican Party.
According to economist Allan H. Meltzer at Carnegie Mellon University,
“We [United States] get cheap goods in exchange for pieces of paper, which we can print at a great rate.” (“U.S. Trade Deficit Hangs In a Delicate Imbalance,” Paul Blustein, Washington Post, November 19, 2005).
The US dollar is a Ponzi scheme and is over-valued (please read my article: The US Dollar – A Ponzi Scheme). The US just print its currency, which happens to be the global currency, to fund its trade (and also budget) deficit for last four decades. In return, exporting countries deposit the same paper, i.e. the US dollar, in the US by investing in US Treasury Bills, US real estate and US share markets.
Therefore the US-based “Imported” economists need to stop preaching and enforcing the US economic policy in India and also elsewhere because the US economy is surviving since 1980s because the US can print its currency, which happens to be the global currency, to fund its trade and budget deficits which India and any Third World country cannot do.
Both the US-style Capitalism and Soviet Union-style Communism have serious drawbacks. Therefore, the Indian economists needs to come up with an “Indian Economic Policy” which would create jobs as well as economic growth to propel the country to the economic superpower status.
(4) Privatization – Main Reason for the Dismal Job Growth
At the central level, the government has privatized the departments’ vehicle system. Instead of each department having its own vehicles and drivers on its payroll, now private firms are providing cars to senior officers. A driver of one such private firm was complaining to me that he was getting only 10,000 rupees a month and every month he had difficulty in paying monthly fee of his daughter’s school. His predicament shows the adverse effects of the privatization. Suppose there were 300 drivers on government payroll in a department before the privatization of their services. As government employees, they were getting, say, 30,000 rupees a month (in nearly all cases, government salaries for mid- and low-skill workers are more than what a private firm pays). After privatization, 300 mid-wage (30,000 rupees a month) salaried workers are replaced by the same number of low-wage (i.e. 10,000 rupees a month) workers. It is the owner of the private firm who is making the difference, i.e. he is making a lot of money. This transfer of income, from 300 drivers to one owner, inhibits job growth as one rich person’s economic activity cannot replace the economic activities of 300 mid-wage families. One (rich) family would not eat like 300 middle class people; it would not have 600 children (considering two children in a family) to go to schools/colleges; it would not buy 300 autos/cars; it would not live in 300 apartments/homes; it would not go to 300 doctors/hospitals for medical treatment – this list can go on and on. With 30,000 a month, a driver family can spend extra money on children’s schools/colleges, purchasing scooters, renting a better apartment, medical, hospitals, etc. Thus privatization of government jobs has drastically reduced the purchasing power of the people, who were earlier holding the similar job in the government. If say 5 lac jobs have been privatized, it has eliminated maybe 5 lac jobs due to reduction in purchasing power. This explains the drastic drop in the new job creation during 2015-16 which is mainly due to unrestricted privatization by Niti Aayog. For this very reason, the US also has been witnessing jobless growth.
The US has been experiencing similar job losses due to the privatization as per the “Reaganomics” theory and also for shifting of jobs overseas since 1980s.
Despite the historic loss of millions of middle class jobs during 2000 to 2008 and job losses related to the record increase in its trade deficit since 1990s, the US economy kept on booming, firstly due to the tech stock bubble, and secondly the real estate price bubble. When the real estate bubble burst in 2008, the Bush administration (and later the Obama administration) had to spend trillions of dollars to prop-up banking and real estate sectors. US Fed reduced interest rates during the recession to spur consumer spending. Once low interest rate was able to kick-start the economy, the Fed raises the rate within few years. Prior to the 2008 Great Recession, the US had recessions in early 1990s and again in early 2000s. As shown in Chart below, the Fed reduced the rate to about 3% for about a year and a half at the onset of the early 1990s recession and then again it reduced the rate to about 1% for a year and a half at the onset of next recession which occurred in early 2000s, i.e. the Fed had to lower the bar for its rate in early 2000s recession from the previous recession. After the 2008 Great Recession, the Fed has to go down to 0 (!) percent for nearly 7 to 8 years, a move that has only inflated assets on the stock market, with no job recovery in sight. The reason for the failing of this policy is that banks are not finding enough people, with good credit rating (as they do not have good paying jobs), to provide loans to.
If you have a credit card with unlimited credit limit and with no expiry date, you and your family would live a luxurious life even if you do not work. The US has a similar credit card. But once China put an expiry date on the US credit card, i.e. once China replaces the US dollar with its own currency Yuan as global currency, the US would not have any option other than declaring bankruptcy, i.e. at that time, the US economy would be facing the 1990s Russian economy scenario.
According to Lou Crandall, chief economist at Wrightson ICAP, which analyzes Treasury financing trends (“U.S. Debt Expected To Soar This Year,” Lori Montgomery, Washington Post, January 3, 2009):
“While the current market for [US] Treasuries is booming, it’s unclear whether demand for debt can be sustained. There’s a time bomb somewhere, but we don’t know exactly where on the calendar it’s planted.”
The US dollar is over-valued; on Purchasing Power Parity (PPP) term, one US dollar should be only 11 to 12 Indian rupees only and hence even an hourly wage worker in US has better living standard than a middle class India. But once the US dollar goes down to its PPP level, monthly earning of more than half of US population would be just sufficient for food and nothing left for housing and medical expenses.
In an op-ed article, published in the New York Times, William Grieder, a bestselling author, wrote (“America's Truth Deficit,” New York Times, July 18, 2005):
“For years, elite opinion dismissed the buildup of foreign indebtedness as a trivial issue. Now that it is too large to deny, they concede the trend is "unsustainable." That's an economist's euphemism which means: things cannot go on like this, not without ugly consequences for American living standards. But why alarm the public?”
Therefore, Mr. Arvind Subramanian and other US-based “Imported” economists should stop preaching the unrestricted privatization.
