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The Friday Night Club
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The Harrowing Escape:
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Shroud of Beckoning
Shadows and Not
America’s Suicidal Statecraft
The End of the 19th Century
Up Close: A Mother’s View
A Case of Wild Justice
What Can We Do Next? The
My Angels Are Come
The Declaration of White Independence: The Founding Documents of Transudationism
Awaken and Arise!
One Time in Paris
The Eye of Icarus
Prodigal of the Pecos
Dolphins Under My Bed
Economic Bubbles, Financial
By Rodrigue Tremblay
It is well enough that people … do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
It seems to me that Europe, especially with the addition of more countries, is becoming ever-more susceptible to any asymmetric shock. Sooner or later, when the global economy hits a real bump, Europe’s internal contradictions will tear it apart.
The normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment and poverty in the middle of what could be virtually universal affluence-in short … financially complex capitalism is inherently flawed.
I have spent some fifty years studying economic cycles and teaching international finance, but I had never seen the likes of what we witnessed and experienced over the last three years. That’s because such financial crises seem to happen 60 to 75 years apart.
—It is a fact that the outbreak of this severe worldwide financial crisis two years ago was a surprise to many people.
For instance, it was widely thought that financial crises, and the severe economic recessions and sometimes depressions they provoked, were really a thing of the past thanks to the protective net of financial regulations that was designed in the 1930s to prevent a repeat of such financial collapses.
—But here we are again, mired in the most severe economic crisis since the 1930s. We may ask why?
The main reason is that the U.S economy, but also most of the world economy, has been subjected to a financial experiment, over the last some 10 years, which has turned sour. In fact, it has turned into a financial fiasco.
Indeed, it must be understood that a completely new type of banking finance was invented; but all the risks involved had not been properly assessed. For a while, the debt pyramid was allowed to grow, but it collapsed when its shaky and unsound foundation disintegrated.
—Of course, there have been similar financial collapses in the past, (notably in 1873, in 1907 and in 1931) and the overall cause is always the same: the financial sector takes too much risk and becomes overextended, creating in the process a debt load for the economy that is unsustainable.
Let’s consider a striking fact of today financial situation: The debt load imposed on the economy is even higher today than it was in the 1930s when total total debt reached the level of some 300% of the annual production or GDP.
Well, today, the ratio of total debt to the U.S. Gross Domestic Product (GDP) is close to 400 percent.
Keep in mind that it took nearly 20 years to bring this ratio down to about 140, in 1952.
What this means is that today it takes about $4.00 of debt to create one dollar of economic activity while it took only $1.40 of debt in the early 1950s to create one dollar of GDP activity. This shows how complex the financial system has become. The question that remains to be answered is whether it will take 20 years to lower the debt ratio from 400% to, say, 200%!
This all shows how this can be devastating for the real economy when financial flows are disrupted and when credit becomes difficult to obtain.
—Sadly, this is our situation today: Investors and producers have a lot of problems financing their new investment projects. This is a big monkey on the back of the economy and it is an important cause of current, and possibly future, economic stagnation.
But before looking into the future, let’s review quickly the main reasons why financial crises arise. Why, in other words, the financial tail is sometime allowed to wag the economic dog.
1. First, the question of deregulation. Too much optimism, overconfidence or simple naivet� sometimes allow the development of some form of risky Ponzi-scheme finance. And, this is pretty much what we have seen over the last 10 years.
—Under the old traditional financial rules, a bank or a credit union would collect deposits or borrow in the open market, lend this money to investors, keep reserves for contingencies, and would hold onto the loans until maturity.
For big banks, at least, this is no longer the model. With the merging of investment banking and commercial banking after 1999, traditional financial rules were pushed aside and they were replaced with the rules of asset securitization through which large banks ceased being banks to become brokers, that is they ceased being lenders to become sellers of sophisticated new securities. More about that later.
Under these new rules, a bank still accepts deposits or borrows in the open market, but it does not hold on to the loans it makes. Rather, it takes a bunch of heterogeneous loans made by itself or by others, repackages and slices them up, and sells them as investment vehicles to third parties. That’s what is called the “securitization” process; it is a sort of sausage machine that takes one type of securities at one end and transforms it into another type of securities, a more risky one, at the other end. -Large Banks have become large financial sausage makers!
In other words, the financial chain has been made longer, much longer; but, as with all chains, its overall strength is not better than the strength of its weakest link. And the new financial products turned out to be the weakest links. They were toxic financial products.
2. Why were such new banking rules adopted? Why were they so risky and dangerous? And how did they lead to the near complete collapse of the credit system in the fall of 2008? These are fundamental questions.
And, as for most questions, there are short answers and there are long answers.
I have four short answers:
-First, they were very profitable to the mega-banks for a while because the banks raked in large fees on the new financial products.
-Second, the politicians were persuaded to let them “innovate” with the new leverage finance by removing most regulation that would have prevented the banks from doing what they were doing.
-Third, it led to irresponsible lending because the lenders were no longer risking their own money but the money of far away investors.
-And, fourth, the moral dimension cannot be neglected. Indeed, it took a lot of corruption and a lot of greed to create such a mammoth crisis. -[Greed was even glorified in the 1987 movie “Wall St.” in which Michael Douglas-playing the character of financier Gordon Gekko-says: “Greed is good, Greed is right. Greed Works.” This was the prevailing ideology at the time.]
(This is an issue that I explain more fully in my new book The Code for Global Ethics.)
For a financial crisis of this magnitude to occur, it takes two kinds of corruption or fraud. -(I don’t delve here into the kind of intellectual corruption that supported the ideology that markets can do no wrong or that they are always “efficient”. In fact, markets are very imperfect; they are often under the control of monopolies or cartels, and sometimes, they do not function at all.)
In the first place, politicians have either to make mistakes or worse, to be in the banks’ pockets and do what people with money (who want more money) tell them what to do.
For instance, as far back as 1977, the Carter administration and the U.S. Congress prepared the ground for the future crisis: It passed the Community Reinvestment Act, by which the Federal Housing Administration loosened down-payment standards for marginal borrowers. -Twenty-five years later, in 2003, President George W. Bush also signed “The American Dream Downpayment Act” into law. This reinforced the pressure on large banks to provide subprime mortgages to needy borrowers incapable of making down payments.
The public financial deregulation stampede that took place between 1999 and 2007 was therefore an extension of this philosophy that special lending rules could and should apply to housing finance.
The string of specific financial deregulation steps taken by the politicians that have paved the way for the current era of irresponsible Ponzi-scheme finance and casino-like leverage banking practices is very long, and I don’t want to burden you with too many details. Read More
A bone-chilling political
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March 20, 2017