The Pyramid Falls

Neo-liberal Free Market Exposed As Dotishness

By Lester Henry

When Wall Street moguls of high finance find themselves running to Uncle Sam for public assistance you know that we are living in interesting times. Make no mistake about it what they are seeking- and getting- are billions of dollars in “welfare”. This is the exact same thing that they and their rich friends in the Senate and Congress deride against when it is sought after by the poor. But unlike the poor, they ask for handouts of US$700 billion and US$ 85 billion. The population is supposed to go along with this because, they are told, it is necessary to “save the system”. As the lowly rated US President Bush himself said, if they don’t get this money “this sucker is gonna blow”. Those of us looking on remain puzzled as to how an advanced developed country like the US could find itself in such a mess, making it look like a financial banana republic. The answer lies in a combination of greed and skullduggery that was justified under the hubris of neo-liberal free-market fundamentalism.

The Market

The belief that markets work best when left on their own is at the core of the current financial crisis. Even though this should have long been discredited – at least since the Great Depression of the 1930s- policymakers in the US have held on to it, actually believing their own rhetoric! The truth is that free markets always tend to create speculative bubbles, chaos and a concentration of wealth and power into the hands of a few. This is why nowhere in the world are markets ever allowed to be completely free from government intervention. The temptation to take excessive risk, to cheat or to form monopolies is built into the system. As students of economics will know, when there is anything close to a free market – e.g. the case of perfect competition – economic profit goes to zero for all firms. So in order to make any extra normal profits a firm has to engage in some form of risk, non-competitive or rather shady behavior.

What Happened:

The Market Unleashed

This is precisely what happened in the US financial system. Wall Street bankers had been pushing the envelope for more and more deregulation since the late 1970s. During the 1980s they got tremendous leeway under Ronald Reagan and rewarded him with the Savings and Loans crisis that ended up costing American taxpayers some US$600 billion. That bailout helped to push up interest rates around the world and caused many developing countries to fall deeper into the debt crisis. But it was during the 1990s under Bill Clinton that they really hit the jackpot. This came in the form of the repeal of the Glass-Steagall Act of 1933. Among other things, this act had set strict barriers on what commercial banks, merchant (or investment) banks, and mortgage and trust companies could have done. In other words, firms had to choose which one they wanted to be. With that out of the way, there became a financial free for all. So for example, insurance company AIG started acting like an investment bank and dealing in sub-prime junk derivatives. This was chiefly responsible for its rapid demise.

When Alan Greenspan was being warned about the exploding housing bubble he said he had nothing against “wealth creation”.

The Sub-Prime

Base of the Pyramid

The base of the financial pyramid rested upon the sub-prime mortgage market. Since I have previously written about how this financial bubble came about and how it crashed before in the TTR, I will not dwell too much on it here. However, suffice it to say that it started with fraudulent, greedy developers and naïve home buyers over the period of the housing bubble, roughly between 2000 and 2006. Throw in over-eager financial institutions with lots of liquidity on their hands and you have the recipe for what is now called “toxic waste” in the financial markets. That is, many firms ended up with pieces of paper that became completely worthless once the original borrowers began to default en masse. So now Merrill Lynch is part of Bank of America and Lehman Brothers is now part of history.

The Revolving Door

Apart from the removal of laws allowing further deregulation of the financial sector in the US, there was also a revolving door from Wall Street to the government. High ranking Wall Street CEOs like Robert Rubin and Henry Paulson became Treasury Secretaries of the State, the former under Bill Clinton and the latter under George Bush. Were they then supposed to be “regulators” to their own firms?

The Credit Rating Agencies

Furthermore, the complicity of the rating agencies such as Standard and Poors and Moodys helped boost up the size of the pyramid. These agencies were all too eager to stamp AAA ratings on all sort of junk paper called fancy names like SIVs (Structure Investment Vehicles) and CDOs (Collateralized Debt Obligations), all of them based on sub-prime mortgages. These high ratings also contributed to an internationalization of the skullduggery. When European and Asian investors saw such ratings on these instruments they dived in head first or maybe “headless”. Now many of them will go the way of Merrill Lynch or Bear-Sterns unless their governments bail them out.

The Crash

As with all pyramid schemes eventually it had to collapse. It was good for about 5 to 6 years and many Wall Street crooks made fortunes out of the housing bubble. But as one commentator put it, if you jump out of a 100-storey building, for 99 floors, you can really think that you are flying. Many readers may have forgotten that this current financial crisis started to unfold more than a year ago. The first major casualty was Countrywide, the largest mortgage company in the US at the time. This was followed by some small and medium-size bank failures. But from then until now the names just kept getting bigger and bigger, culminating with the likes of Bear-Sterns, Lehman Brothers, Merrill-Lynch, AIG and now Washington Mutual Bank. After losing a fortune in the South Sea bubble of the 1600s, the great Sir Isaac Newton is reported to have mumbled “I can calculate the movement of the stars, but not the madness of men”.

The Lessons

The first lesson is that unregulated financial markets are a disaster waiting to happen. The neo-liberals should be hanging their heads in shame. Partial deregulation resulted in the Savings and Loans crisis in the 1980s. Full deregulation has now caused the worst financial crisis in the world since the Great Depression of the 1930s. Second, continuously appointing financial industry executives as regulators is asking for trouble. How could they be expected to act in the best interest of a nation when they are so closely tied to the industry? A case of who will guard the guards? Third, all of the high finance and complex mathematical modeling of financial markets being pushed by top business schools will have to be debunked as pure obfuscation. It’s just a pyramid! Fourth, we should perhaps not be too hasty to get highly sophisticated in our financial system here in Trinidad and Tobago. Look at what it has brought. As for the Americans, as Nobel Prize winning economist Joseph Stiglitz has suggested “we need to impose a special financial sector tax to pay for the bailouts conducted so far. We also need to create a reserve fund so that poor taxpayers won’t have to be called upon again to finance Wall Street’s foolishness”

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