Monday, October 13, 2008

Rescue for the Few, Debt Slavery for the Many

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We are now entering the financial End Time. Bailout “Plan A” (buy the junk mortgages) has failed, “Plan B” (buy ersatz stocks in the banks to recapitalize them without wiping out current mismanagers) is fizzling, and the debts still can’t be paid. That is the reality Wall Street avoids confronting. “First they ignore you, then they denounce you, and then they say that they knew what you were saying all the time,” said Gandhi. The same might be said of today’s overhang of debts in excess of the economy’s ability to pay. First the policy makers pretend that they can be paid, then they denounce the pessimists as spreading panic, and then they say that of course students have been taught for four thousand years now how the “magic of compound interest” keeps on doubling and redoubling debts faster than the economy can squeeze out an economic surplus to pay.

What has ended is the idea that “the magic of compound interest” can make economies rich without having to work and without industry. I hope we have seen the end of derivatives formulae seeking to make money by playing in a zero-sum game. A debt overhang always ends either in foreclosure of the debtor’s property, or in a debt annulment to preserve the economy’s overall freedom and equity.

This means that the postmodern economy as we know it must end – either in financial polarization and debt peonage to a new oligarchic elite, or in a debt cancellation, a Jubilee Year to rescue society. But when the government says that it is reviewing “all” the options, this reality is not one of them. Treasury Secretary Henry Paulson’s first option was to buy packages of junk mortgages (collateralized debt obligations, CDOs) to save the wealthiest institutional investors from having to take a loss on their bad bets. When this was not enough, he came up with “Plan B,” to give money to banks. But whereas Britain and European countries talked of nationalizing banks or at least taking a controlling interest, Mr. Paulson gave in to his Wall Street cronies and promised that the government’s stock purchases would not be real. There would be no dilution of existing shareholders, and the government’s investment would be non-voting. To cap the giveaway to his cronies, Mr. Paulson even agreed not to ask executives to give up their golden parachutes, exorbitant annual bonuses or salaries.

Plan A (the $700 billion to buy mortgage-backed junk that the private sector will not buy) failed partly because it let financial institutions avoid putting a fair value on the debt packages they were selling. Instead of telling the truth about their financial position by marking assets to market prices), they can “mark to model,” Enron-style. We have seen the result: A solid week of plunging stock market prices. The public media call this a panic, but there is nothing irrational about it. Who in their right mind would buy securities or buy into a bank without knowing what the securities were worth? Faith in junk mathematical models has ended.

So we still await a public response to the problem of how to write down debts. Whose economic interest will have to give: that of debtors, as increasingly has been the case over the past eight centuries; or that of creditors, which have fought back to create a neoliberal economy controlled by the FIRE sector?

It is not too late to decide which road to take, but Wall Street bankers and creditors have taken the lead in positioning themselves. Seeing which way the political winds were blowing, they moved to empty out the Treasury before the November 3 elections much like medieval citizens fleeing a horde of Mongolian raiders under Genghis Khan. “We’re moving. Clean out the cupboards,” much as Lehman Brothers emptied out their foreign bank accounts in Britain and elsewhere just before declaring bankruptcy, taking what they could and steering it to their best friends.

The pretense was that a bailout was needed to restore confidence. But the ensuing week showed that the claims were false. It didn’t turn the stock market around as promised. The Dow Jones Industrial Average fell 2,200 points from Wednesday, October 1 through the following Friday October 10 – eight straight trading days, not even pausing for the usual zigzags. Friday’s plunge was 100 points a minute for the first seven minutes – a 690 point drop to under 8000. Each 100 points was more than a 1 percent drop, which was reflected on the NASDAQ. Nothing could withstand the pressure of so many Americans cashing in their mutual funds overnight and so many foreigners in earlier time zones putting in sell-at-market orders.

Short sellers made one of the largest and quickest fortunes ever, and then covered their positions by buying back the stocks they had pre-sold. This pushed prices up even into positive territory just before 10:30 AM when George Bush began to speak. Half the financial stocks showed gains – a sign that the Plunge Protection Team had jumped in. But Mr. Bush said nothing helpful and stocks went back into freefall, ending down another 128 points despite the upcoming weekend G7 meeting. There was no talk at all of reducing debt levels – only of giving more money to banks, insurance companies and other money managers, as if “pushing on a string” somehow would lead them to lend yet more to an already debt-ridden economy.

If Congress really wanted to restore confidence, here’s what it might have done: First, mark to market, not to model. Investors no longer believe America’s Enron-style accounting, debt rating agencies or monoline risk insurers. They don’t trust U.S. banks to be honest about their financial positions. They worry about the fraud charges brought by attorneys general in eleven states against predatory lenders such as Countrywide and Wachovia that Citibank, JPMorgan Chase and Bank of America were so eager to buy.

So is it too late for Congress to change its mind and repeal the giveaway? If the $700 billion handout didn’t stabilize the unsalvageable for small investors, pension funds and even the financial sector itself, what did it do?

What the Fed has been doing while the media have not been looking?

Let’s put the giveaway in perspective. While Senators and Congressmen subject to voters’ choice were debating $700 billion for the major Wall Street contributors to both parties (admittedly only for starters, Mr. Paulson explained), the Federal Reserve already had given even more, without any public discussion and without the major media noticing. Since Bear Stearns failed in March, the Federal Reserve has used the small print of its charter to go outside its normal customers (which are supposed to be commercial banks), to give investment banks, brokerage houses and now large corporations almost indiscriminately some $875 billion in “cash for trash” swaps. (The statistics are released each week in the Fed’s H41 report.) Like Aladdin offering new lamps for old, the Fed has exchanged Treasury securities for junk mortgages and other securities that brokerage houses and investment banks did not have time to pawn off onto OPEC, Asian sovereign wealth funds or other investors.

The press lauds Mr. Bernanke as “a student of the Great Depression.” If he were, he should know that what led to the 1929 collapse were harsh U.S. Government creditor policies toward its World War I Allied governments. This created a situation where the Federal Reserve had to provide easy credit to hold interest rates artificially low so as to encourage U.S. investors to lend to Britain and Germany, which would use these dollar inflows to pay their Inter-Ally arms and reparations debts. Mr. Bernanke’s predecessor, Alan Greenspan, promoted easy credit simply for ideological reasons, to enrich Wall Street by enabling it to sell more debt.

A student of the Great Depression would understand the conflicts of interest between retail commercial banking and wholesale investment banking and money management that led Congress to pass the Glass-Steagall Act in 1933 – conflicts unleashed once again when Pres. Clinton backed then-Fed Chairman Alan Greenspan and Republican leader (and McCain hero) Senator Phil Gramm in leading the repeal of this act, opening up the floodgates to today’s financial double-dealing that has cost the American economy so much.

If Mr. Bernanke does know this history, his behavior is simply that of an opportunistic student of the art of political self-advancement, toadying to Wall Street in campaigning for one last great rip-off before the Bush Administration goes out of business. The Fed has given Wall Street newly minted Treasury bonds, added to the national debt out of thin air. It has done this without feeling any need to rationalize it by drawing absurd public-relations pictures about how the government may “make a profit for taxpayers.”

The Fed Chairman is not elected democratically. He traditionally is designated by the Wall Street financial sector that the Fed is supposed to regulate, acting as its lobbyist for creditor interests – the top 10 percent of the population – against that of the indebted “bottom 90 percent.” This “independence of the central bank” is trumpeted as a hallmark of democracy. But it is undemocratic, precisely by being isolated from public control.

The Age of Oligarchy

Treasury Secretary Paulson has no such luxury. The Treasury is supposed to represent the national interest, not that of bankers – even though its head these days is drawn from Wall Street and acts as its lobbyist. Mr. Paulson presented his almost totalitarian giveaway gruffly to Congress on a take-it-or-leave it basis, announcing that if Congress did not save Wall Street from taking losses on its mountain of bad loans, the banks were willing to crash the economy out of spite. “Please don’t make us wreck the economy,” he said in effect. As Margaret Thatcher used to say while selling off the British government’s crown jewels in the 1980s, TINA: There is no alternative.

In making this bold threat Mr. Paulson behaved as arrogantly as Lehman’s CEO Richard Fuld did when he tried to bluff Korea and other prospective investors into paying the full, fictitiously high book value for his company. (His bluff failed and Lehman went bankrupt, wiping out its shareholders, including the employees and managers who held 30 percent of its stock.) There turned out to be an alternative after all. Responding to the loudest public condemnation in memory, Congress called Mr. Paulson’s bluff.

What made his $700 billion Troubled Asset Relief Program (TARP) so much more visible to the media than the Fed’s actions is that Congress is involved, and this is an election year. The level of deception and false argument is therefore enormous – along with a few tradeoffs and tax cuts to distract attention. Erstwhile Republican opponent Sen. Jeff Sessions of Alabama came right out and said that “This bill has been packaged with a lot of very popular things to give it even more momentum,” so that (as The New York Times explained), “instead of siding with a $700 billion bailout, lawmakers could now say they voted for increased protection for deposits at the neighborhood bank, income tax relief for middle-class taxpayers and aid for schools in rural areas where the federal government owns much of the land.”

Left behind while Wall Street’s believers in the rapture of free markets were swept up to heaven by “socialism for the rich” have been mortgage debtors, student-loan debtors, the Pension Benefit Guarantee Corporation (PBGC, some $25 billion short), the Federal Deposit Insurance Corporation (FDIC, about $40 billion short), as well as Social Security which, we are warned, may run up a trillion dollar deficit thirty or forty years down the line. Only the wealthiest have been beneficiaries, not voters, homeowners and other debtors.

Still, Congress was panicked into acting on Friday, October 3, because a week earlier, September 26, stocks fell 777 points after Congressmen responded to an unprecedented volume of voter protest against the bailout. “This sucker could go down,” Pres. Bush warned as Wall Street’s lobbyists blamed the market downturn to the failure of Congress to preserve the “monetary system,” and specifically the banks and insurance companies that already had lost their net worth and were plunging deeper into Negative Equity territory. Democratic leaders Barney Frank and House Speaker Nancy Pelosi said, in effect, “Look what you’ve done! You irresponsible politicians are grandstanding on principle, and wiping out peoples’ stock market savings and threatening their pension funds. If you don’t give Wall Street firms enough money to cover their losses so that everyone wins, they’ll kill the economy until they get their way.” Well, they didn’t quite say this, but that was basically their message. It certainly was Wall Street’s message: “Wall Street to Economy: Your money or your life.”

So Congress gave in. Democrats ran like lemmings to “save the economy.” Yet the stock market fell a few hundred points, and kept on plunging all week long, much worse and much faster than had occurred right after Congress had initially defeated the bill.

The “Reality Problem”

What did the “free market” theory underlying the giveaway leave out of account? For starters, “the monetary system” turns out to be a euphemism for the fortunes of financial gamblers using junk mathematics (the Merton-Scholes derivatives formula) based on junk economics (blessed with Nobel Prizes) to buy, speculate and even to insure junk mortgages, junk bonds and junk commercial paper and derivatives based on their relative prices. So what is left out first of all was full knowledge of the value of what is being bought and sold. Mark-to-market models leave the price up to the investment bankers. If trust existed and there really was honor among these thieves, a government bailout would not be necessary, because “the market” could clear.

“Free market” ideology assumes that each party will act in his or her self-interest. If this is so, why should foreign governments accumulate more dollar claims on the U.S. Treasury, which already owes their central banks $4 trillion? When there hardly were enough Treasury securities to go around even as the United States ran unprecedented federal budget deficits, U.S. officials urged these banks and sovereign wealth funds to buy packaged mortgages yielding a higher rate of return. And at least by buying these bonds, foreign governments would not be accused of funding America’s war in Iraq that most of their voters opposed. But investors made a fatal mistake in believing U.S. representations of the value of their junk-mortgage packages. This trust has now been lost, all the more so since the bailout’s permission to keep on “marking to market.”

Congress thought that its $700 billion would distract attention at least until the November 4 election. But to no avail. Markets fell 157 points on Giveaway Friday, and kept on going down another 800 points on Monday, October 6 (to about 9500) before bouncing 500 points off the floor, only to fall even more through Friday. So the giveaway failed in its stated purpose to rescue stock market investors (“peoples’ capitalism”) or their pension funds. But that was not its real purpose. The time simply had come to clear out and take whatever one could.

Making banks and insurers in the zero-sum derivative game whole, so that winners can collect their bets while losers can sell their bad investments to the Treasury, is supposed to re-inflate the credit pyramid. The idea is to solve the debt problem with yet more debt to prop up housing prices once again to unaffordable levels! This is not a long-term solution, but it would give insiders enough time to arrange a do-over and get out of the game more quickly, to sell out their junk mortgages and junk bonds to the proverbial “greater fool” – in this case, the “greater fool of last resort,” the U.S. Treasury, as long as it can be run by Mr. Paulson or, under Mr. Obama, perhaps the former Goldman-Sachs official Robert Rubin.

The banks are to “earn” their way out of their negative equity position by selling more of their product – credit – to increase the economy’s debt levels and hence receive more interest payments. The problem is that most families are already “loaned up.” They have no more discretionary income to pledge to carry more debt. Without writing down their debts, there will be no fresh lending, and hence no source of credit and purchasing power for new autos, appliances, goods and services in general. Debt deflation is being imposed on the “real” economy. Creditors and speculators alone are to be made whole.

If no revenue was available for future Social Security, public health care and repair the nation’s depleted infrastructure before this giveaway, think of how bare the cupboard must be now that the government has run up the recent trillions of dollars in new debt rather than writing off a penny of the bad mortgage debts being blamed for causing the debacle.

We can see where this is leading. The wealthiest 1 percent of the population will come into possession of even more returns to wealth than the 57 percent that they are now taking. In contrast to the Statue of Liberty’s inscription “give me your poor … yearning to breathe free,” the Fed – and now the Treasury, with Congressional blessing – is taking from the public purse and giving to America’s wealthiest investors and insiders. This “Robin Hood in Reverse” program is being done without strings, without asking banks to stop paying dividends, exorbitant executive salaries and golden parachutes, and without taking over banks with negative net worth of the kind that many homeowners are experiencing.

Nobody is talking about a debt write-down or moratorium. The subprime mortgage problem could have been solved by writing down just $1 or $2 trillion of the face value and interest rates of predatory loans. Instead, the $10+ trillion in financial-sector damage in recent weeks reflects Wall Street’s fraudulent packaging and sale of junk mortgages at unrealistically high prices, using junk mathematics to calculate junk derivatives and sell them to gullible investors who believe that the pretenses these mathematics, credit ratings and projected income have a basis in reality.

The amazing feature of today’s crash is how many Wall Street firms actually believed that the game of musical financial chairs could go on before they had to stop dancing and indeed, escape from the room. I remember one day back in the 1970s when I warned Frank Zarb of Lazard Freres about the likelihood of Third World debt defaults, and suggested that the firm should do an ability-to-pay analysis. “We don’t have to do any such thing,” he replied. “We have the schedule of what they owe right here in this IMF report.” It was a thick printout of the scheduled debt service for an African country that soon became insolvent. But Wall Street’s mentalité was that of Herbert Hoover on the eve of the Great Depression: A debt is a debt, and that is that. The response is to blame the victim, as if the irresponsibility lies with debtors rather than creditors.

No reversal of the Bush tax cuts is offered to re-inflate the economy, no move toward more progressive taxation of Wall Street speculators who pay only a 15 percent “capital gains” tax rate instead of the much higher income-tax and FICA withholding rates that wage-earners pay. (Wall Street has its own golden parachute program, so why should it pay for Social Security for the rest of society?) There is to be no reduction in the special tax benefits for real estate, whose tax favoritism led to the crisis by “freeing” more income from the tax collector to be pledged to mortgage bankers as interest. The Bubble Economy is to be re-inflated by Fannie Mae, Freddie Mac and the FHA lending to help buyers bid up housing and commercial office prices once again to a rate that promises to impose debt peonage on homeowners.

The budget deficit will soar, without any prosecution of tax evasion scams by UBS or KPMG. Instead of a fiscal or regulatory comet driving these dinosaurs to extinction, the climate has turned more conducive to their proliferation. Our Age of Deception is to be locked in even more tightly. The Congressional bailout’s suspension of mark-to-market rules to rely on Wall Street’s “self-regulation” should win a prize for Oxymoron of 2008 as investors have no clue as to what financial assets are worth. No wonder lending has dried up, especially to banks themselves.

Just as financial victims fail to vote and support their self-interest, predators also turn out to pursue self-defeating “free market” strategies. The financial sector’s short-termism is the greatest enemy to its survival. It has translated its wealth into a fatal political control of its legal climate, blocking [with the explicit support of Barack Obama, Editors] Congressional efforts to rewrite the oppressive bankruptcy laws that credit-card banks lobbied so hard to pass, [with vital help from Joe Biden, the senior senator from credit card company HQ, the state of Delaware, Editors] crucial. These hard bankruptcy terms prevent the courts from renegotiating homeowner debts to keep property occupied, accelerating the real estate price collapse. The result is today’s negative equity, posing the question of just who is to bear the cost of bring debts back in line with the economy’s ability to pay. Will it be the financial institutions that sponsored asset-price inflation and lobbied for deregulation of lenders? Or, will it be the debtors who thought they were riding the wave to get an inflationary free lunch?

Instead of requiring creditors to absorb losses on the excess of debts over what can be paid, the debts are being kept in place, not scaled back to what the economy can pay. The government is to make creditors and computerized derivatives speculators whole – and will act as collecting agent for the overhead of bad debts the economy has run up.

Today we can see the debt-fueled bubble of asset-price inflation that Alan Greenspan trumpeted as real wealth creation for what it really is – credit creation to bid up real estate, stock market and packaged-debt prices. Tangible capital formation has been left out of account, as if postindustrial economies no longer need it.

Will voters see the asymmetry in Congress’s failure to offer debt relief for homeowners as real estate prices plunge below the mortgages that are owed? Will its members be blamed for not rewriting the nation’s bankruptcy laws to free families from debt peonage – and free housing markets from the price declines that result from today’s proliferation of foreclosure sales? For that matter, will there be no relief for corporations having to cut back investment in order to service their junk bonds and other debts with which Wall Street’s corporate raiders and “shareholder activists” have loaded then down?

Evidently not.

Why the Bailout Scam Is More Likely to Fail than to Succeed

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By Ismael Hossein-zadeh

Leaving the issue of fraud aside, the bail out scam is also doomed to fail because it avoids diagnosis and dodges the heart of the problem: the inability of more than five million homeowners to pay their fraudulently ballooned mortgage obligations.

Instead of trying to salvage the threatened real assets or homes and save their owners from becoming homeless, the bailout scheme is trying to salvage the phony or fictitious assets of the Wall Street gambler and reward their sins by sending taxpayers’ good money after gamblers bad money. It focuses on the wrong end of the problem.

The apparent rationale for the bailout plan is that while the injection of tax payers’ money into the Wall Street casino may not be fair, it is a necessary evil that will free the “troubled assets” and create liquidity in the financial markets, thereby triggering a much-needed wave of lending, borrowing and expansion.

There are at least five major problems with this argument.

The first major problem is that the current financial disaster is not really a liquidity problem as it is repeatedly portrayed to be. It is a problem of faith and trust, or lack thereof, which in turn stems from the disproportionately large amount of junk assets or mortgages relative to real assets. It is true that lending and credit expansion has almost come to a halt and, in this sense, there is a serious liquidity crisis. But this illiquidity is not really due to a lack of good money or real assets in the system. It is rather because owners of such valuable assets are unwilling to lend their precious possessions to owners of troubled assets, or worthless papers.

As Herman E. Daly, University of Maryland economist, puts it, “The value of present real wealth is no longer sufficient to serve as a lien to guarantee the exploding debt. Consequently the debt is being devalued in terms of existing wealth. No one any longer is eager to trade real present wealth for debt even at high interest rates. This is because the debt is worth much less, not because there is not enough money or credit.”

The second major problem with the bailout scheme is that it is simply unfeasible and ineffectual because there is just not enough good money to redeem all the bad money that has ballooned or bubbled to a multiple of the good money and/or real assets.

The initial $700 billion bailout money falls way short of what is needed to rescue the Wall Street gamblers, as it is only a fraction of their accumulated bad debt. According to a September 29 Washington Post report:

“Twenty of the nation's largest financial institutions owned a combined total of $2.3 trillion in mortgages as of June 30. They owned another $1.2 trillion of mortgage-backed securities. And they reported selling another $1.2 trillion in mortgage-related investments on which they retained hundreds of billions of dollars in potential liability, according to filings the firms made with regulatory agencies. The numbers do not include investments derived from mortgages in more complicated ways, such as collateralized debt obligations.”

These three categories of mortgage-related financial instruments add up to a $4.7 trillion obligation for the twenty largest financial institutions. This is nearly seven times as large as the initial Paulson/Bernanke bailout plan of $700 billion, which means the plan is destined to be ineffectual.

Nationwide, the ratio of bad to good money is much higher. According to Herman E. Daly, “Financial assets have grown by a large multiple of the real economy—paper exchanging for paper is now 20 times greater than exchanges of paper for real commodities.” This means that the initial $700 billion bailout fund is simply a drop in the sea of bad debt, and that, therefore, there is not enough good money to pay for the mountain of junk assets accumulated by the gambling financial institutions.

The third major flaw of the bailout plan is that, as mentioned earlier, it does not address the real problem: the problem of rescuing the financially-distressed homeowners. As Dr. Paul Craig Roberts points out, “the Paulson bailout does not address the core problem. It only addresses the problem for the financial institutions that hold the troubled assets. Under the bailout plan, the troubled assets move from the banks' books to the Treasury's. But the underlying problem--the continuing diminishment of mortgage and home values--remains and continues to worsen.”

Simply moving soured assets from fraudulent lenders to the Treasury, that is, buying junk mortgages at face value, will neither help the millions of homeowners facing homelessness, nor help mitigate the raging financial crisis. The bailout should, instead, focus on defrauded homeowners and real assets, not fictitious capital and its unscrupulous owners.

Instead of trying to salvage a mountain of soured assets and prop up bankrupt institutions, the government should allow for a market cleansing, or destruction, of such worthless assets by purchasing the threatened mortgages not at their inflated face value but at the current, depreciated, or market value—as the FDR government did in response the Great Depression of the 1930s.

This alternative, homeowner-based solution would have a number of advantages. First, and foremost, it would help citizens facing the specter of homelessness stay in their homes by allowing them to pay affordable mortgage installments based on reduced or realistic home prices.

By the same token, this solution would also allow the government to gradually recover the market-based home prices it would be paying the troubled commercial mortgage holders. Obviously, this means that, instead of the predatory banks and similar financial institutions, the government would now be the title holder of the rescued homes; of course, until such homes are paid for, upon which time the homeowners would take the possession of their home titles.

By cleansing the market of the dead-weight of tons of junk assets, and allowing threatened homeowners to pay affordable mortgage installments, this bottom-up solution would also help restore faith and trust in the financial system, and in the lending and borrowing mechanism—thereby also mitigating the liquidity crisis.

Furthermore, by bailing out homeowners (and real assets) instead of Wall Street gambler, the government would need only a fraction of the money needed to pay for the huge bubble of the junk assets that have ballooned on top of a much narrower base of real assets. Compared with the scandalous Paulson/Bernanke bailout scheme, this means that the government would end up with enough excess money to invest on a long-term, robust stimulus plan a la the New Deal of the 1930s.

And this brings us to the discussion of the fourth major problem of the Paulson/Bernanke bailout scam: lack of any economic stimulus plan, which is badly needed for economic revival. While government substitution for predatory lenders and the resulting institution of realistic or devalued mortgage installments will certainly lighten the financial burdens of the economically-pressed, it will not relieve them from the need to earn an income and make a decent living. Nor would it (by itself) provide the badly needed purchasing power or necessary demand to stimulate the economy.

To achieve such broader socio-economic objectives requires no less than duplicating (and perhaps even going beyond) FDR’s New Deal reform package that proved critical in ending the Great Depression of the 1930s. A comprehensive long-term public investment in both social and physical infrastructure (health, education, roads, bridges, levees, schools, green energy, etc.) is bound to create jobs, inject purchasing power and liquidity into the economy, and revive production and expansion.

Of course, such an urgently needed comprehensive investment in the future of our society requires extensive public financing, which, in turn, requires a careful and socially-responsible fiscal policy. And this brings us to the fifth major problem of the Paulson/Bernanke bail out scheme: absence of any mention, let alone change, of our warped or lop-sided fiscal policies and priorities.

The sad and sick status of our public finance (the rising budget deficits, the soaring national debt, the curtailment of crucially important social spending, and the resulting neglect of both social and physical infrastructure) is a direct consequence of our warped fiscal policies that give priority to the interests of the super rich at the expense of everybody else. It is a direct result of the looting of our public money through a combination of (a) huge “supply-side” tax cuts for the wealthy, and (b) drastic increases in the share of military spending at the expense of non-military public spending.

In a real sense, even the current financial meltdown is a logical outcome of an economic philosophy that promotes extreme social inequality. Contrary to “expert” punditry and popular perceptions, it is not simply due to personal greed; more importantly, it is the result of a systemic failure, or the outcome of the diverging and conflicting class interests.

Progressive taxation, social spending, New Deal reforms, and the War on Poverty were designed not only to protect the poor and working people against the woes and vagaries of market mechanism, but also to save capitalism from itself. Instead of viewing public spending on social safety net programs as long-term investment in the future of the nation, trickle-down economic philosophy views such expenditures as overheads that need to be cut as much as possible.

To this effect, proponents of this philosophy have since the early 1980s been working very hard to cut taxes for the wealthy, to cut non-military public spending, and to reverse most of the social safety net programs that were put in place by FDR’s New Deal and LBJ’s War on Poverty.

Not surprisingly, the result has been an extreme concentration of national riches and resources in fewer and fewer hands, side-by-side with a steady deterioration of the living conditions of the overwhelming majority of our citizens. Unable to make ends meet, most of our citizens exceedingly resorted to borrowing.

Predatory lenders proved to be both creative and merciless in taking advantage of the economically vulnerable, or the legitimate aspirations and dreams of homeownership. Unfettered by the irresponsible government deregulation policies, these rapacious lenders pushed loans, engaged in deceitful or fraudulent lending practices, and unscrupulously invented many shady financial instruments that resulted in the accumulation of massive amounts of fictitious assets that proved unviable, and eventually collapsed under their own dead weight.

Unless the lopsided national priorities and perverse fiscal policies, known as trickle down or neoliberal economics, which began under Ronald Reagan, are somewhat rectified or mitigated, and the resulting financial resources are invested through a broad and carefully-crafted plan of social and economic recovery, no bailout plan of the plutocrats, by the plutocrats, for the plutocrats can succeed in reversing the current cycle of economic decline.

'The United States Has Essentially a One-Party System'

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The linguist and public intellectual Noam Chomsky has long been a critic of American consumerism and imperialism. SPIEGEL spoke to him about the current crisis of capitalism, Barack Obama's rhetoric and the compliance of the intellectual class.

SPIEGEL: Professor Chomsky, cathedrals of capitalism have collapsed, the conservative government is spending its final weeks in office with nationalization plans. How does that make you feel?

'The United States Has Essentially a One-Party System'

The linguist and public intellectual Noam Chomsky has long been a critic of American consumerism and imperialism. SPIEGEL spoke to him about the current crisis of capitalism, Barack Obama's rhetoric and the compliance of the intellectual class.

SPIEGEL: Professor Chomsky, cathedrals of capitalism have collapsed, the conservative government is spending its final weeks in office with nationalization plans. How does that make you feel?

SPIEGEL: Do you prefer the team on the other side: the 72 year old Vietnam veteran McCain and Sarah Palin, former Alaskan beauty queen?

Chomsky: This Sarah Palin phenomenon is very curious. I think somebody watching us from Mars, they would think the country has gone insane.

SPIEGEL: Arch conservatives and religious voters seem to be thrilled.

Chomsky: One must not forget that this country was founded by religious fanatics. Since Jimmy Carter, religious fundamentalists play a major role in elections. He was the first president who made a point of exhibiting himself as a born again Christian. That sparked a little light in the minds of political campaign managers: Pretend to be a religious fanatic and you can pick up a third of the vote right away. Nobody asked whether Lyndon Johnson went to church every day. Bill Clinton is probably about as religious as I am, meaning zero, but his managers made a point of making sure that every Sunday morning he was in the Baptist church singing hymns.

SPIEGEL: Is there nothing about McCain that appeals to you?

Chomsky: In one aspect he is more honest than his opponent. He explicitly states that this election is not about issues but about personalities. The Democrats are not quite as honest even though they see it the same way.

SPIEGEL: So for you, Republicans and Democrats represent just slight variations of the same political platform?

Chomsky: Of course there are differences, but they are not fundamental. Nobody should have any illusions. The United States has essentially a one-party system and the ruling party is the business party.

SPIEGEL: You exaggerate. In almost all vital questions -- from the taxation of the rich to nuclear energy -- there are different positions. At least on the issues of war and peace, the parties differ considerably. The Republicans want to fight in Iraq until victory, even if that takes a 100 years, according to McCain. The Democrats demand a withdrawal plan.

Chomsky: Let us look at the .differences. more closely, and we recognize how limited and cynical they are. The hawks say, if we continue we can win. The doves say, it is costing us too much. But try to find an American politician who says frankly that this aggression is a crime: the issue is not whether we win or not, whether it is expensive or not. Remember the Russian invasion of Afghanistan? Did we have a debate whether the Russians can win the war or whether it is too expensive? This may have been the debate at the Kremlin, or in Pravda. But this is the kind of debate you would expect in a totalitarian society. If General Petraeus could achieve in Iraq what Putin achieved in Chechnya, he would be crowned king. The key question here is whether we apply the same standards to ourselves that we apply to others.

SPIEGEL: Who prevents intellectuals from asking and critically answering these questions? You praised the freedom of speech in the United States.

Chomsky: The intellectual world is deeply conformist. Hans Morgenthau, who was a founder of realist international relations theory, once condemned what he called .the conformist subservience to power. on the part of the intellectuals. George Orwell wrote that nationalists, who are practically the whole intellectual class of a country, not only do not disapprove of the crimes of their own state, but have the remarkable capacity not even to see them. That is correct. We talk a lot about the crimes of others. When it comes to our own crimes, we are nationalists in the Orwellian sense.

SPIEGEL: Was there not, and is there not -- in the United States and worldwide -- loud protest against the Iraq war?

Chomsky: The protest against the war in Iraq is far higher than against the war in Vietnam. When there were 4,000 American deaths in Vietnam and 150,000 troops deployed, nobody cared. When Kennedy invaded Vietnam in 1962, there was just a yawn.

SPIEGEL: To conclude, perhaps you can offer a conciliatory word about the state of the nation?

Chomsky: The American society has become more civilized, largely as a result of the activism of the 1960s. Our society, and also Europe's, became freer, more open, more democratic, and for many quite scary. This generation was condemned for that. But it had an effect.

SPIEGEL: Professor Chomsky, we thank you for this interview.

Interview conducted by Gabor Steingart

US surrenders power to appoint World Bank president

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By Heather Stewart and Larry Elliott

The US is to lose its power to appoint the president of the World Bank after the UK's development secretary, Douglas Alexander, brokered a deal to throw open the post to candidates from any country.

Backed by European governments and developing countries, Alexander overcame resistance from the US and Japan to secure a reform he described last night as "a significant step forward".

Washington has had the right to hand-pick the president of the World Bank since the institution was founded after the second world war, with Europe choosing the managing director of the International Monetary Fund.

Alexander said: "The agreement provides the opportunity for candidates to be nominated regardless of nationality. It will ensure that the best-qualified candidate is selected."

Developing countries have grown increasingly frustrated at the stranglehold of rich nations on the two Washington-based multilateral bodies, with pressure for change accelerating after the controversial presidency of Paul Wolfowitz, who was forced to step down after a scandal involving his partner's promotion.

Alexander said that more changes were needed: "It is a significant step forward, albeit on a much longer journey."

The bank's development committee yesterday was dominated by concerns that poor countries would fall victim to the global financial crisis. It backed proposals that will give countries from sub-Saharan Africa a third seat on its 25-strong governing board.

The bank's president, Robert Zoellick, urged rich countries not to forget their pledges of financial support to the developing world. The bank believes the number of malnourished will increase by 44 million this year.

Donor countries were also discussing whether to release a multibillion-dollar reconstruction package to Zimbabwe. Alexander said the tests a new Zimbabwean government would have to meet included respecting human rights and allowing charities into the country to deliver aid.

The Fannie/Freddie Flat Earth Theory

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By Dean Baker

For the last month, most of the world has been watching the Wall Street gang drowning in their own greed as they threaten to pull the rest of us down with them. However, while we have been distracted, the Flat Earth Society has developed its narrative to explain the crisis.

In the Flat Earth version, the real villains in the story were the public/private mortgage giants Fannie Mae and Freddie Mac. Prominent Congressional Democrats like Senators Charles Schumer and Chris Dodd, and Representative Barney Frank, are cited as accomplices. According to the Flat-Earthers, the problem wasn't sleaze bag bankers pulling down tens of millions a year pushing predatory loans to people who didn't understand them; the real problem was Congressional Democrats, who wanted the government to help the poor and minorities buy homes.

Before addressing the Flat Earth argument, I should be very clear that I have long been a harsh critic of Fannie and Freddie. They committed a colossal mistake by failing to recognize the housing bubble. It is understandable that you could miss an $8 trillion housing bubble if you drive a bus or sell shoes for a living. It's a little harder to accept this sort of mistake from companies that own or guarantee trillions of dollars of mortgage debt.

I first warned that the collapse of the housing bubble would lead to serious problems for Fannie and Freddie in the fall of 2002 , before they began to move into the risky mortgages that were the immediate cause of their collapse. When almost all you own is mortgage debt, and the mortgage default rate rises to several times its normal level, it is virtually guaranteed that you're going to face serious problems. Obviously, Fannie and Freddie's venture into more risky mortgages in the years 2005 to 2007 worsened the problem.

While no one should shed any tears over the collapse of these two giants - the top management and shareholders got what they deserved - it is equally ridiculous to lay the blame for the financial crisis on the shoulders of Fannie and Freddie.

The underlying problem was the housing bubble, which Alan Greenspan allowed to grow unchecked and, arguably, actively promoted. The bubble was accentuated by the willingness of banks to ignore normal prudential standards in issuing mortgages and to make loans that they knew could not be paid off by the borrowers. And, of course, leveraging themselves to the sky guaranteed full-fledged disaster

Banks would issue these loans because they knew they could dump them into the secondary market where securitizers would peddle them off to suckers all round the world. This is where Fannie and Freddie came in. They purchased many of the junk mortgages issued by banks in the years 2005 to 2007. According to the Flat-Earthers, this makes Fannie and Freddie the cause of the current crisis.

There is one basic problem with the Flat Earth story: Fannie and Freddie jumped into the junk mortgage market because they were trying to keep pace with the private issuers of mortgage-backed securities. Fannie and Freddie made a conscious decision to dive into the junk in order to protect their market share, which was being seriously eroded by the aggressive tactics of private giants like Citigroup and Merrill Lynch.

The market share of Fannie and Freddie. in the years 2004 to 2007, never came close to its level before the junk market took off. According to data from the Federal Reserve Board, Fannie and Freddie securitized $315.2 billion worth of mortgages in 2002, accounting for 50.1 percent of the new mortgage debt that year. In 2006, they securitized $276.0 billion in mortgages, giving them a market share of just 34.8 percent.

Fannie and Freddie's conduct was despicable. Their decision to dive into the junk certainly contributed to the further expansion of the bubble and worsened the pain from its eventual collapse. However, they were followers, not leaders. They didn't cause the bubble and the subprime craziness. This train had already left the station. Fannie and Freddie's crime was going along for the ride.

Fannie and Freddie could have instead played a positive role in this crisis. Suppose in 2004 or 2005 one of these mortgage giants issued a statement warning of the dangerous over-valuation in many housing markets across the country. Instead of easing mortgage standards, imagine that Fannie or Freddie announced that it was tightening its rules for mortgages in the most over-valued markets, requiring nonborrowed down payments of 20 percent, or even 30 percent, in order to protect against anticipated price declines.

This action would have produced howls of outrage from builders, realtors, and other big beneficiaries of the housing bubble. It also would have led to headlines and possibly some serious analysis of the evidence for a housing bubble. It may have saved the country from much of the pain it is now suffering.

But this sort of step would have required real courage and leadership, traits rarely found in high positions in Washington, or on Wall Street. Fannie and Freddie should be blamed for following the herd off the cliff. They stand out as especially big sheep. But only the Flat-Earthers could make them the main villains in this story.

Iraqi government fuels 'war for oil' theories by putting reserves up for biggest ever sale

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By Terry Macalister and Nicholas Watt

· BP, Shell and Exxon in meeting with minister
· Unprecedented 40bn barrels up for grabs

The biggest ever sale of oil assets will take place today, when the Iraqi government puts 40bn barrels of recoverable reserves up for offer in London.

BP, Shell and ExxonMobil are all expected to attend a meeting at the Park Lane Hotel in Mayfair with the Iraqi oil minister, Hussein al-Shahristani.

Access is being given to eight fields, representing about 40% of the Middle Eastern nation's reserves, at a time when the country remains under occupation by US and British forces.

Two smaller agreements have already been signed with Shell and the China National Petroleum Corporation, but today's sale will ignite arguments over whether the overthrow of Saddam Hussein was a "war for oil" that is now to be consummated by western multinationals seizing control of strategic Iraqi reserves.

Al-Shahristani is expected to reveal some kind of "risk service agreements" that could run for up to 20 years, with formal offers to be submitted by next spring and agreements signed in the summer.

Gregg Muttitt, from the UK-based social and ecological justice group Platform, says he is alarmed that the government is pushing ahead with its plans without the support of many in Iraq.

"Most of the terms of what is being offered have not been disclosed. There are security, political and reputational risks here for oil companies but none of them will want to see one of their competitors gain an advantage," he said.

Heinrich Matthee, a senior Middle East analyst at the specialist risk consultant Control Risks Group, also believes there are many pitfalls for those considering whether to make an offer.

"Currently it is unclear which party in Iraq is authorised to award a contract and at the same time to deliver its side of the bargain," he said. "Any contract with an independent oil company will be subjected to opposition and possible revision after pressure by resource nationalists."

Oil companies will find their reputations at risk from the actions of their Iraqi counterparties, such as joint venture partners, suppliers and agents. They will also have to contend with oil smuggling and the possibility that the ruling alliance could collapse, Matthee said.

He said that if the conspiracy theory that western oil companies egged on US and British governments to invade Iraq were true, the plan could backfire on them and benefit rivals in Asia instead. "It is possible the American army has provided the economic stability that will encourage Malaysian, Chinese and other Asian companies to become involved," he said.

There is no precedent for proven oil reserves of this magnitude being offered up for sale, said Muttitt. "The nearest thing would be the post-Soviet sale of the Kashagan field [in the Caspian Sea], which had 7bn or 8bn barrels."

China's state-owned oil group, CNPC, has already agreed a $3bn (£1.78bn) oil services contract with the government of Iraq to pump oil from the Ahdab oil field.

The deal is the first major oil contract with a foreign firm since the US-led war and was followed up by an agreement with Shell, potentially worth $4bn, to develop a joint venture with the South Gas Company in Basra.

This deal has also triggered controversy. Issam al-Chalabi, Iraq's oil minister between 1987 and 1990, questioned why there had been no competitive tendering for the gas-gathering contract and claimed it had gone to Shell as the spoils of war.

"Why choose Shell when you could have chosen ExxonMobil, Chevron, BG or Gazprom?" he asked. "Shell appears to be paying $4bn to get hold of assets that in 20 years could be worth $40bn. Iraq is giving away half its gas wealth and yet this work could have been done by Iraq itself."

The Baghdad government says it aims to increase crude oil production from 2.5m barrels a day to 4.5m by 2013, but faces internal opposition from regional governors and political opponents.

The sale today comes as oil prices have plummeted after stockmarket turmoil on Friday. The price of crude fell by more than $4 at one point to $75 a barrel - the lowest point since September last year and a sharp drop from its peak of $147 in July. Opec, the oil producers' cartel, has called an emergency meeting to agree a cut in output to bolster prices in spite of protestations from politicians including Gordon Brown. Brown said on Friday: "We've had some success in getting the price of oil down: the price this morning is roughly $80, about half what it was a few months ago. I want these price cuts passed on to the consumer as quickly as possible.

"I'm concerned when I hear that the Opec countries are meeting, or are about to meet, to discuss cutting production - in other words, making the price potentially higher than it should be.

"I'm making it clear to Opec it would be wrong for the world economy and wrong for British people who are paying high petrol prices and high fuel prices to cut production and therefore keep prices high."

A government source said: "The one chink of light has been the fall in the price of oil. The last thing we want is to head into a difficult period with a return to high oil prices. People need to act responsibly."

International financial crisis exposes vulnerability of Indian economy

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By K. Ratnayake

The global financial crisis and looming recession have quickly exposed the weakness of the Indian economy and shattered illusions in the country’s so-called economic miracle. In the course of last week, the Sensex index on Bombay Stock Exchange (BSE) plunged by almost 16 percent and the rupee devalued further against the US dollar amid fears of a marked economic slowdown.

The BSE Sensex dropped by nearly 10 percent on Friday before the Reserve Bank of India (RBI) intervened for the second time that week to cut the cash reserve ratio by 1 percent to 7.5 percent, injecting 600 billion rupees (about $US13 billion) into the financial system. The BSE Sensex ended the day at 10,527.85, down 7.1 percent and the broader National Stock Exchange (NSE) Nifty index lost 6.65 percent.

India’s largest private sector financial group, ICICI Bank, dropped by as much as 28 percent, before ending the day down 20 percent. Its shares have dropped by 46 percent since the end of September amid concerns about the group’s extensive operations in the global financial markets. India’s second largest mobile phone company, Reliance Communications, fell 21 percent, while the biggest real estate developer DLF Ltd fell 8.8 percent and top engineering firm Larsen & Toubro lost 8 percent.

The RBI had already cut the cash reserve ratio, or the proportion of deposits held by the central bank, by 0.5 percent on Monday when the BSE Sensex fell by 725. On the same day, the Stock Exchange Board of India lifted restrictions on foreign institutional investors imposed in October last year to defend the weakening rupee. The rupee fell to 49 to the US dollar on Friday, down from 39 in January.

Share values plunged on Friday despite government reassurances. Emerging from the weekly cabinet meeting on Thursday, Finance Minister P. Chidambaram declared that there was no need for panic. “Indian banks are well capitalised and financially strong,” he said. Behind closed doors, however, the cabinet had decided to set up an emergency finance committee and discussed whether Prime Minister Manmohan Singh should address the nation.

The Times of India reported on Saturday that the Federation of Indian Air Lines (FIA) had requested $1 billion in interest free loans as well as other concessions to bail out the airlines. In a presentation to the prime minister’s office, FIA officials expressed concerns about the impact of the international credit crunch, tough global competition and declining passenger numbers.

The BSE Sensex has fallen by almost 50 percent in the course of the year, from a high peak of 20,873 on January 8 to last Friday’s close of 10,528. The cumulative market capitalisation of Indian shares, which was $1.8 trillion in January, has slumped even more dramatically to $760 billion as the rupee has devalued.

Foreign investors have left the Indian market in droves, selling off $9.6 billion worth of shares in the first nine months of this year. This is a sharp reversal of last year’s record inflow of $17.2 billion into the Indian capital market. Some analysts predict that the final outflow for 2008 could reach $13.5 billion.

Economic statistics for August released last Friday reveal that the economy is already slowing. Infrastructure sector output for the month grew by only 2.3 percent, compared to 9.5 percent in August last year. Industrial growth for August slowed to just 1.3 percent as against 10.9 percent last year.

M. Govinda Rao, a member of the prime minister’s Economic Advisory Council, acknowledged that the figures pointed to “industrial recession.” He admitted that the Gross Domestic Product (GDP) growth rate could fall to 7 percent next year, adding: “We are going to have a much more serious problem.” Since 2003, the Indian economy has grown at an average of 8.7 percent and the government had previously predicted 9 percent this year, rising to 10 percent by 2012.

India is vulnerable to a global downturn. Over the past two decades, successive governments have transformed the country into a huge cheap labour platform, particularly for hi-tech information technology (IT) and related business services. Prime Minister Singh and Finance Minister Chidambaram both played a central role in initiating the sweeping restructuring measures in the early 1990s.

In an interview with Figaro this month, Singh admitted that a global slowdown would “compromise India’s export markets.” North America and the European Union, which are both heading for recession, accounted for 16 percent and 21 percent respectively of India’s exports. The fastest-growing sector—IT and services known as Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO)—is likely to be seriously affected.

India is sometimes dubbed the “office of the world” because major corporations from around the globe have exploited its large supply of highly-trained, English-speaking graduates to cut business service costs. In 2003-2004, BPO and KPO services earned $ 3.1 billion in export revenues, rising to $8.4 billion in 2006-2007. Nasscom reported that the number of jobs in this sector rose from 216,000 to 553,000 over the same period, and was expected to reach 700,000 this financial year.

Last year 61 percent of India’s BPO and KPO exports were to the US. About 40 percent of Fortune 500 companies in the US favour India for outsourcing their business services. IDBI Capital Market services research head Shahina Mukadam warned: “The slowdown is going to impact on the BPO firms in India. This will eventually result in an overall slowdown of the BPO industry.”

The Economic Times explained: “In India, around 60 percent of the companies operating in the IT-BPO sector have been working for American financial corporations like Goldman Sachs, Washington Mutual, Citigroup, Bank of America, Morgan Stanley and Lehman Brothers. Tata Consultancy Services and Satyam Computers have been working for Merrill Lynch, and Wipro has a number of American corporations as its clients that are bruised by the present collapse.”

The article added: “It is anybody’s guess that layoffs are certain to take place in Bangalore, Hyderabad, Chennai, Gurgaon, Noida, etc.” It predicted that 2.3 million young employees working in BPO and other IT sectors would be affected by the financial crisis.

Hardest hit by the economic crisis will be the poorest layers of Indian society whose living standards have already declined as a result of nearly two decades of economic restructuring. The social gulf between rich and poor in India is immense. In March, Forbes magazine reported that the number of billionaires had increased to 53 and their combined wealth was equal to 31 percent of the country’s GDP. At the same time, a recent World Bank report found that 42 percent of the population or 456 million people are living below the official poverty line of $1.25 a day.

A global recession will undermine other major export sectors of the Indian economy, including textile and clothing, and lead to mass layoffs. At present, 14 million young people enter the labour market every year but only 10 million get jobs, most on very low wages. Price rises are already eroding living standards. India’s inflation rate reached a 13-year high in August of 12.63 percent and is still hovering around 12 percent. A weakening rupee will drive prices up further.

While billions of dollars are being channelled into the financial system to prop it up, the Congress-led coalition government has no plans to alleviate the suffering of the urban and rural poor. Congress won office in 2004 as a result of widespread anger over the social impact of the economic reforms of the previous Bharathiya Janatha Party (BJP)-led government, but implemented only limited social measures, including a national rural employment guarantee scheme.

Inevitably, as the Singh government moves to protect the wealthy elite in the finance and business sectors, those who will pay the price will be hundreds of millions of ordinary working people who are already struggling to survive from one day to the next.

Washington’s “shock” over AIG’s post-bailout junket

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By Sandy English

It was revealed last Tuesday at a congressional hearing that a week after the government bailed out insurance giant AIG to the tune of $85 billion, the company hosted its top life insurance agents at the luxury St. Regis Resort in Monarch Beach, California. There they ran up a bill of over $443,000 that included $200,000 for rooms, $150,000 for catered banquets, $23,000 for the spa and nearly $7,000 in golfing fees.

Because of the public outcry, AIG on Thursday called off a second retreat that was to be held at the Ritz Carlton Resort in Half Moon Bay, California, although not without complaints from AIG executives that the cancellation was producing “demoralization.”

Politicians from both parities, including President Bush and Democratic presidential candidate Barack Obama, expressed indignation over the AIG affair.

Typical were the remarks of Max Baucus, the Montana Democrat and chairman of the Senate Finance Committee, who sent a letter to Federal Reserve Chairman Ben Bernanke declaring, “This kind of behavior is an insult to taxpayers whose dollars are used to protect and preserve private companies. Provisions must be in place to end frivolous expenses, limit executive compensation and protect taxpayers from unnecessary risks.”

Obama condemned the AIG junket during last Tuesday night’s presidential debate. “The Treasury should demand that money back and those executives should be fired,” he said.

The final voice of moral authority came from the White House. Bush’s press secretary, Dana Perino, pronounced the junket “pretty despicable” and informed the world, “The president did not want to move forward on this rescue package to help anybody in the top positions on Wall Street. He was concerned about everyday people like you and me.”

What hypocrisy! If ever the phrase “strain at a gnat and swallow a camel” applied, it applied in spades to the supposed outrage of official Washington over AIG’s doling out some half a million dollars for a luxury retreat. The flurry of condemnation was an exercise in play-acting intended for public consumption on the part of those who are bailing out the financial aristocracy while refusing to lift a finger for ordinary Americans who face layoffs, the loss of their retirement savings and foreclosure as a result of the financial meltdown.

Just two days after the Capitol Hill fulminations over the corporate junket, the Federal Reserve Board loaned AIG another $37.5 billion on top of the original $85 billion handout.

There is nothing strange, or, from the privileged perspective of the political elite in Washington, exceptional about the sort of lifestyle exhibited by AIG. The Los Angeles Times reported on Thursday that Wachovia, soon to be acquired by Well Fargo for over $11 billon, is sending 75 executives and their spouses on a cruise to the Greek Islands.

All of the politicians of the two parties that monopolize political power in America are tied to the financial elite by financial, political and personal connections. They are its representatives. Not a few have participated in lavish bashes thrown by the barons of Wall Street.

Max Baucus, for example, counts AIG among his top five campaign contributors. According to the Center for Responsive Politics, he has raised nearly $11 million for his reelection campaign, of which $46,750 has come from AIG. Another top contributor is Goldman Sachs, formerly headed by Treasury Secretary Henry Paulson, which has paid out $48,900. In all, the securities and investment industry has donated $768,518 to Baucus’s campaign.

Baucus’s support from the financial sector is typical for a ranking Democrat in the Senate or the House of Representatives. Charles Schumer, the senior senator from New York who chairs the Joint Economic Committee, has already raised $12 million for his 2012 campaign, including $80,000 from Citigroup and over $79,000 from UBS. Altogether, securities and investments companies have given Schumer $1,370,390.

Obama has received over $22 million from the financial sector—50 percent more than his Republican rival John McCain—with nearly $10 million of it coming from the Wall Street finance houses and another $1.6 million from insurance firms. The rest has come from commercial banks, real estate investors and various other financial operations.

AIG itself has spent over $6 million dollars this year to lobby Congress. It has 16 major lobbyists on its payroll.

The pattern is the same for the top executives of other companies that are being rescued with public funds. In July, the Center for Responsive Politics revealed the wide-ranging influence in Congress of mortgage giants Fannie Mae and Freddie Mac:

“Freddie Mac has given so much money to federal candidates, parties and PACs, in fact, that the Center for Responsive Politics ranks it among the top 100 donors of all time. So far this year [2008] the company’s PAC and employees have contributed $478,300, 54 percent of which went to Democrats. Although Fannie Mae is not among the top 100 donors, it has given more in this election cycle than its counterpart—nearly $1 million, with 62 percent going to Democrats. Together, Fannie Mae and Freddie Mac are the #1 and #3 contributors in the mortgage banking industry. (The Mortgage Bankers Association is #2).”

As for vacations at fine resorts, a 2006 study by the Center for Public Integrity found that over the previous five-and-a-half years members of Congress and their staffs had over $50 million worth of services lavished upon them in the course of at least 23,000 such trips.

One reader of the Washington Post commented on Tuesday’s report of the AIG junket. The reader’s views express a broad and growing sentiment in the American population.

“Why [does AIG] think they are above the law? Simple. They are. They have the means to purchase a $10,000-a-plate dinner at BOTH RNC [Republican National Committee] and DNC [Democratic National Committee] fundraisers. And yes, they will do both, so they cover all the bases. So if you have the means, give to the RNC and DNC and you’ll have complete immunity to just about everything. I’m personally shocked that people are surprised that this happened.”

To divert public attention from their longstanding and corrupt relationship with Wall Street, even as they transfer hundreds of billions of dollars of taxpayer funds to their corporate sponsors, the politicians feign outrage. This theatrical exercise is an attempt to mask the obvious: that both major parties are controlled by the financial oligarchy and work to defend its interests against those of the working class, the vast majority of the population.

Wall Street demands free hand with funding from US Treasury

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By Patrick Martin

US Treasury Secretary Henry Paulson signaled a significant shift in the plan to turn over hundreds of billions of taxpayer dollars to Wall Street, announcing Friday that the Bush administration will invest funds directly in financial institutions, rather than buying mortgage-backed securities.

The change is driven in part by the rapid deterioration of global financial markets, which makes the bailout as initially proposed by Paulson—a complicated process in which banks will offer their toxic securities for purchase by the Treasury in reverse auctions—far too slow to funnel vast amounts of cash into the financial system.

There was a widespread clamor in the financial press insisting that the bailout proposed by British Prime Minister Gordon Brown was more effective and faster than the Paulson plan. Brown said that his plan to inject capital directly into major British banks would start delivering hundreds of billions in public funds as early as Monday.

In an additional effort to speed up the bailout, Paulson directed Fannie Mae and Freddie Mac, the government-chartered mortgage giants that were taken over by federal authorities last month, to begin immediate purchases of mortgage-backed securities using the $100 billion apiece appropriated by Congress in July—a sum on top of the $700 billion authorized in the bank bailout legislation passed by Congress October 3.

There was also concern that the overall size of the bailout was now inadequate for the scale of the catastrophe, following the worst week on global stock markets in history. According to a report in the New York Times Sunday, “Treasury Secretary Henry M. Paulson Jr. has refused to say whether the capital infusion program for banks would be bigger than the original plan to buy troubled assets.”

The Times noted opinion on Wall Street that Paulson’s initial proposal has simply been overtaken by events. “Even if it was adequate before, it’s not adequate now,” former Federal Reserve governor Frederic Mishkin told the newspaper.

According to the Times account of internal Bush administration and Federal Reserve discussions, the Treasury initially opposed suggestions by Fed Chairman Ben Bernanke that capital should be injected directly into the banks “in part because they were ideologically opposed to direct government involvement in business.”

During the past ten days, however, important financial institutions, including Goldman Sachs and Morgan Stanley, demanded action urgently. Both Paulson and the Treasury official he selected as the interim administrator of the bailout, Neel Kashkari, are veterans of Goldman Sachs.

When Paulson indicated that he was now in favor of the Treasury buying either common or preferred shares of stock, the Times reported, “Industry executives quickly told Mr. Paulson that they liked the idea, though they warned that the Treasury should not try to squeeze out existing shareholders. They also begged Mr. Paulson not to impose tough restrictions on executive pay and golden-parachute deals for executives who are fired. Mr. Paulson heeded those pleas.”

The picture presented here is remarkable: US government officials are engaged in high-level consultations with top bankers and with officials of other G-7 countries, as well as China, in an effort to halt the chain-reaction collapse of the world financial system. Despite lip service to the impact that a financial market meltdown will have on “Main Street,” the real concern in these talks is how to safeguard the wealth of the CEOs and other top executives whose speculative financial manipulations have produced the market disaster.

Paulson, the former CEO of Goldman Sachs—himself a near-billionaire when he joined the Bush administration in 2006—is fully in sympathy with the demands of his former peers. In his statement Friday, he assured banks that the government would acquire only “nonvoting” shares. In other words, Wall Street is to be given virtually unlimited access to federal cash without any restrictions on how the money is used, including how big a share will go directly into the pockets of those responsible for the crisis in the first place.

The entire world economy, and the livelihoods of billions of people, are thus being held hostage to the demands of a handful of Wall Street bankers and speculators to guarantee their gargantuan personal incomes and assets. There is not the slightest suggestion in the official “debate” over economic policy that those responsible for the financial collapse should be made to pay for it.

The revised Paulson plan is an even more brazen effort to bail out the richest people in America at the expense of the people. That is why it is being hailed by the pillars of the capitalist press in the United States. The Wall Street Journal, in an editorial October 9, endorsed the decision by Gordon Brown to inject capital into British banks as well as Paulson’s hints that he might do something similar.

“We take—and hope—that this means Mr. Paulson is willing to use some of his new $700 billion Troubled Asset Relief Program (Tarp) to inject capital into individual banks if needed to prevent failures,” the Journal wrote.

The Washington Post, in an editorial October 11, praised Paulson’s decision to follow the British example, declaring: “This would involve a direct infusion of funds into banks through the purchase of equity stakes. In contrast to the earlier plan to use most of the $700 billion to buy ‘toxic’ mortgage securities, the new strategy could more directly address the problem of the banks’ solvency, and it might have a quicker effect.”

The Times itself echoed this view the same day, editorializing that a new global approach to the crisis should include “some temporary government guarantee for deposits and loans to unlock interbank lending and gain some time to figure out which banks can be saved and which cannot. It should provide for governments to quickly inject equity capital into banks.”

Bringing up the rear were the congressional Democrats and Democratic presidential candidate Barack Obama, who will embrace whatever measures are proposed by the Bush administration and backed by Wall Street. Senator Charles Schumer (Democrat of New York), the chairman of the Joint Economic Committee, said Paulson’s proposal to inject federal money into selected banks “is gaining steam.” He added, “I am hopeful that tomorrow the Treasury will announce that they’re doing it. And they have to do it quickly... markets are waiting.”

This process of capital injection is frequently described by the media as “partial nationalization” of the American banking system, as though it represented some sort of inroad into private property. On the contrary, it would be better described as the “partial privatization” or, more properly, the outright looting of the US Treasury by Wall Street executives and big investors who are now demanding that the American people pay off their bad debts.

Any such arrangement would be the opposite of genuine, i.e., socialist, nationalization, in which the financial system would be taken under public ownership and reorganized to serve the needs of the working class—the vast majority of the population—rather than the financial aristocracy.

Ohio Shooting Puts Face on Foreclosure Crisis

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By the time deputies came to escort Addie Polk out of her home of 38 years, the 90-year-old had taken out her life insurance policy and placed it next to her pocketbook and keys in the neatly kept house.

She shot herself in the chest Oct. 1 before she could be taken away from the foreclosed house, which was worth less than its mortgage from the day she took out the loan.

A congressman called her the face of a national tragedy, the housing crisis that has affected millions of Americans. Neighbors were stunned and said they had no idea the widow had been about to lose her two-story, white vinyl home.

And Polk, as she recovered, sounded a bit regretful.

''She said that was a crazy thing to do,'' said neighbor Robert Dillon, 62, who visited her at the hospital.

He said he told her, ''That's crazy to you. The good Lord could have been in control.''

Polk's cause was taken up by U.S. Rep. Dennis Kucinich and fueled blogs on reckless lending practices rampant during the housing boom. Mortgage finance company Fannie Mae dropped the foreclosure, forgave her mortgage and said she could remain in the home.

''You have to shoot yourself to get help,'' lamented a neighbor, Hannah Garrett, 76.

The Summit County Sheriff's Department concluded that Polk shot herself over the foreclosure, Lt. Kandy Fatheree said. A revolver was inches from her, and the house was locked.

Dillon heard the gunfire Oct. 1, climbed through Polk's upstairs bathroom window and found her lying in bed bleeding.

Polk was recovering at Akron General Medical Center, and did not immediately respond to a mailed Associated Press request for an interview. The hospital would not release information about her condition.

Dillon hadn't been aware of Polk's financial situation but said she had indicated she couldn't afford roof or porch repairs.

Polk's blue-collar neighborhood, overlooking a duck pond and a noisy highway near Goodyear Tire & Rubber Co.'s world headquarters, is a mix of renovated and worn-out houses. Unlike some hard-hit areas, there were no for-sale signs on the brick street on a recent day.

Polk's home gives no outward sign of financial turmoil. Rows of hosta plants line her front yard and a neighbor keeps the grass trimmed. Neighbors said Polk, who has no children, drives herself to church services and goes out to dinner with friends on Sundays.

''She didn't act like she was under stress,'' Garrett said. ''It was really sad. I was shocked. When you saw her, she was happy-go-lucky.''

Polk took out a mortgage in 1997 and refinanced several times after that, court and property records showed.

She took out a 30-year, 6.375 percent mortgage for $45,620 four years ago when the house was appraised at $31,230.

That move put her in a position that, according to Deutsche Bank, up to 40 percent of borrowers, or 20 million households nationwide, could face within 12 to 18 months: Suddenly Polk owed more on her house than it was worth.

While many households ran into that problem when once-soaring house prices declined, there was no bubble on LaCroix Avenue, located in a city whose population dropped 4 percent since 2000 amid declining manufacturing.

In the midst of the House debate on the economic rescue package, Kucinich made some calls about Polk's plight and rushed to the House floor to denounce the foreclosure action against her.

The Cleveland Democrat and two-time presidential candidate said anyone could have known that offering a mortgage more than the home's value to a woman in her 80s was setting her up to fail.

Fannie Mae, which had assumed the Countrywide Home Loan mortgage on Polk's home, believes a reversal of the foreclosure was appropriate given the circumstances, a Fannie Mae spokesman said. Fannie Mae filed the foreclosure Sept. 6, 2007.

Garrett said Polk's story would make older people worry.

''The same thing could happen to us,'' said her husband, Elisha Garrett, 74, a retired tractor factory worker.

Guantanamo prosecutor who quit had 'grave misgivings' about fairness

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By Josh Meyer

Convinced that key evidence was being withheld from the defense, Lt. Col. Darrel J. Vandeveld went from being a 'true believer to someone who felt truly deceived' by the tribunals.

Darrel J. Vandeveld was in despair. The hard-nosed lieutenant colonel in the Army Reserve, a self-described conformist praised by his superiors for his bravery in Iraq, had lost faith in the Guantanamo Bay war crimes tribunals in which he was a prosecutor.

His work was top secret, making it impossible to talk to family or friends. So the devout Catholic -- working away from home -- contacted a priest online.

Even if he had no doubt about the guilt of the accused, he wrote in an August e-mail, "I am beginning to have grave misgivings about what I am doing, and what we are doing as a country. . . .

"I no longer want to participate in the system, but I lack the courage to quit. I am married, with children, and not only will they suffer, I'll lose a lot of friends."

Two days later, he took the unusual step of reaching out for advice from his opposing counsel, a military defense lawyer.

"How do I get myself out of this office?" Vandeveld asked Major David J.R. Frakt of the Air Force Reserve, who represented the young Afghan Vandeveld was prosecuting for an attack on U.S. soldiers -- despite Vandeveld's doubts about whether Mohammed Jawad would get a fair trial. Vandeveld said he was seeking a "practical way of extricating myself from this mess."

Last month, Vandeveld did just that, resigning from the Jawad case, the military commissions overall and, ultimately, active military duty. In doing so, he has become even more of a central figure in the "mess" he considers Guantanamo to be.

Vandeveld is at least the fourth prosecutor to resign under protest. Questions about the fairness of the tribunals have been raised by the very people charged with conducting them, according to legal experts, human rights observers and current and former military officials.

Vandeveld's claims are particularly explosive.

In a declaration and subsequent testimony, he said the U.S. government was not providing defense lawyers with the evidence it had against their clients, including exculpatory information -- material considered helpful to the defense.

Saying that the accused enemy combatants were more likely to be wrongly convicted without that evidence, Vandeveld testified that he went from being a "true believer to someone who felt truly deceived" by the tribunals. The system in place at the U.S. military facility in Cuba, he wrote in his declaration, was so dysfunctional that it deprived "the accused of basic due process and subject[ed] the well-intentioned prosecutor to claims of ethical misconduct."

Army Col. Lawrence J. Morris, the chief prosecutor and Vandeveld's boss, said the Office of Military Commissions provides "every scrap of paper and information" to the defense. Morris said that Vandeveld was disgruntled because his commanding officers disagreed with some of his legal tactics and that he "never once" raised substantive concerns.

Morris said last week that he had no idea why Vandeveld had become so antagonistic toward the tribunal process, adding that the lieutenant colonel's outspokenness angered him because it was unfair and was a "broad blast at some very ethical and hardworking people whose performances are being smudged groundlessly."

Vandeveld, who was prosecuting seven tribunal cases -- nearly a third of pending cases -- has declined to be interviewed about the particulars of the Jawad case. But he did engage in a series of e-mails with The Times about his general concerns, before being "reminded" last week that he could not talk to the press until his release from active duty was final. In the future, he said, he plans to speak out.

"I don't know how else the creeping rot of the commissions and the politics that fostered and continued to surround them could be exposed to the curative powers of the sunlight," he said. "I care not for myself; our enemies deserve nothing less than what we would expect from them were the situations reversed. More than anything, I hope we can rediscover some of our American values."

Some tribunal defense lawyers are preparing to call Vandeveld as a witness, saying that his claims of systemic problems at Guantanamo, if true, could alter the outcome of every pending case there -- and force the turnover of long-sought information on coercive interrogation tactics and other controversial measures used against their clients in the war on terrorism.

For years, defense lawyers and human rights organizations have raised similar concerns in individual cases. "But we never had anyone on the inside who could validate those claims," said Michael J. Berrigan, the deputy chief defense counsel for the commissions.

Before the Sept. 11 terrorist attacks, Vandeveld led a relatively placid life outside Erie, Pa., with his wife and four children. He worked as a senior deputy state attorney general in charge of consumer protection in the region, and he served on his local school board in Millcreek Township.

Anyone who knows him, Vandeveld, 48, told The Times, "will probably tell you that I've been a conformist my entire life, and [that] to speak out against the injustice wrought upon our worst enemies entailed a weather shift in my worldview."

Mark Tanenbaum, an English teacher whose children are friends with Vandeveld's, remembers talking to him while sitting around campfires at high school gatherings. "We talked a lot about religion. I'm Jewish. We'd talk about faith, value-based philosophy. We were kindred spirits in this.

"With him, it is all about doing the right thing."

Vandeveld, called to active duty after 9/11, received glowing evaluations as a Pentagon legal advisor and judge advocate in Bosnia, the Horn of Africa and Iraq. "An absolutely outstanding, first-class performance by an extraordinarily gifted, intelligent, knowledgeable and experienced judge advocate, whose potential is utterly unlimited," his commanding officer, Gen. Charles J. Barr, wrote in his June 2006 evaluation. "One of the corps' best and brightest. Save the very toughest jobs in the corps for him."

From his Iraq assignment, Vandeveld went to Guantanamo, where he began locking horns over the Jawad case with Frakt -- a law professor at Western State University in Fullerton and a former active-duty Air Force lawyer who volunteered for the tribunals.

Frakt believed that his Afghan client was, at worst, a confused teen who had been brainwashed and drugged by militant extremists who coerced him into participating in a grenade-throwing incident with other older -- and more guilty -- men. He insisted that the prosecution was withholding key information or not obtaining it from those at the Pentagon, CIA and other U.S. agencies that had investigated and interrogated Jawad.

Vandeveld believed that Jawad was a war criminal who had been taught by an Al Qaeda-linked group to kill American troops and, if caught, to make up claims he had been tortured and was underage. Vandeveld insisted that he had been providing all evidence to the defense.

But by July, Vandeveld told The Times, he had grown increasingly troubled. He kept finding sources of information and documents that appeared to bolster Frakt's claims that evidence was being withheld -- including some favorable to the defense, such as information suggesting that Jawad was underage, that he had been drugged before the incident and that he had been abused by U.S. forces afterward.

Vandeveld also was having difficulty obtaining authorization to release documents in his possession to the defense.

On Aug. 5, he e-mailed Father John Dear, a well-known Jesuit peace activist. Dear, who boasts of being arrested 75 times in protests, encouraged him to act, saying he might "save lives and change the direction of the entire policy."

With Frakt pressing for the charges against Jawad to be dismissed due to "outrageous government misconduct," Vandeveld proposed a plea agreement under which Jawad, now thought to be 22, could return to Afghanistan for rehabilitation. But his superiors rejected it, Vandeveld said.

By late August, he had told Frakt that there were other "disquieting" things about Guantanamo and that his superiors were refusing to address them or to let him quietly transfer out, Frakt said in an interview.

"Now might be a good time to take a courageous stand and expose some of the 'disquieting' things that you have alluded to, whatever they may be," Frakt replied in a Sept. 2 e-mail, noting that there would soon be a change of administrations in Washington.

"It wouldn't be a bad idea to distance yourself from a process that has become largely discredited, or at least distinguish yourself as one of the good guys, an ethical prosecutor trying to do the right thing," Frakt wrote.

On Sept. 9, Vandeveld e-mailed Dear to say he had resigned from the Guantanamo military tribunals: "The reaction was the expected outrage and condemnation. I have and will maintain my equanimity and, while scared for me and for my family, know that Christ will watch over me."

That, however, was only the beginning. In late September -- after the military, according to Frakt, initially tried to block it -- Vandeveld testified by video link for the defense, saying he believed that insurmountable problems with the tribunals might make them incapable of meting out justice fairly.

Morris said that Vandeveld is not qualified to speak about systemwide problems at Guantanamo. But Frakt said that he is and that Vandeveld's testimony and declaration only scratched the surface of his concerns, judging by their extensive conversations and hundreds of e-mail exchanges.

"There is a lot more that he knows," Frakt said.

Democrats call for massive U.S. economic stimulus plan

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By David Lawder

The United States needs a new economic stimulus plan that pumps billions of dollars into infrastructure projects and budget relief for cash-strapped state and local governments, Democratic lawmakers said on Sunday.

U.S. Rep. Barney Frank, chairman of the House Financial Services Committee, told ABC television he will put together an economic stimulus bill when Congress returns to Washington after the November 4 elections, while a key Republican said he would support an effort that "makes sense."

Rep. Roy Blunt, the Missouri Republican who serves as House minority leader, said he would support a stimulus plan if it did not include massive public works spending and budget bailouts for states that overspent on health care and other social programs.

"A stimulus plan that makes sense is something that I'll be helpful with," Blunt said, also on ABC television.

U.S. House Speaker Nancy Pelosi last week said a $150 billion economic stimulus plan was needed to help counteract a faltering economy shaken by a paralyzed banking system and steep stock market falls.

On Monday, Pelosi and House Democratic leaders will meet with key economists to discuss a jobs creation and recovery plan that will complement the recently passed $700 billion rescue legislation for financial institutions. Participants will include former U.S. Treasury Secretary Larry Summers, former Securities and Exchange Commission chairman Arthur Levitt and former Federal Reserve vice chairman Alice Rivlin.

The Congress earlier this year passed a $152 billion stimulus package that provided tax rebates of up to $600 per adult to support consumer spending at a time of rising energy and food costs.

Most of that money has already been spent, and many economists say financial turmoil will squeeze the economy into recession in the fourth quarter.

"Not only is Wall Street frozen, but Main Street is in real trouble. A stimulus aimed at Main Street makes sense," New York Sen. Charles Schumer told CNN.

He said the plan should "get into the guts of the economy" by boosting spending on infrastructure such as roads, sewer and water projects.

Former Treasury Secretary Robert Rubin, who served under President Bill Clinton, told CNN that an infrastructure plan that could quickly pump money into the economy was the most important action that U.S. authorities could take to help deal with the current economic crisis.

"I would put in place an infrastructure piece... bridges, water systems roads, highways, but not new projects that are going to take a long time to set up," Rubin said. "There are a lot of existing projects where states and cities are having a hard time finding a lot of financing where you could funnel that money right into existing activities where you would be able to act very very quickly."

Schumer also urged the Treasury to move quickly on its plan to buy equity stakes in banks.

"I am hopeful that tomorrow the Treasury will announce that they're doing it. And they have to do it quickly," said Schumer, a New York Democrat.

"This cannot be two, three, four weeks. The markets are waiting, the country is waiting, and we're beginning a downward spiral, not just in finance ... but in the whole economy. We need quick action," he added.

Anatomy of the American Financial Crisis: How It is Turning into a Worldwide Crisis

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By Prof. Rodrigue Tremblay

"The basis for optimism is sheer terror." Oscar Wilde

[After the March 2008 Bear Stears bailout] "As more firms lost access to funding, the vicious circle of forced selling, increased volatility, and higher haircuts and margin calls that was already well advanced at the time would likely have intensified. The broader economy could hardly have remained immune from such severe financial disruptions."Ben Bernanke, Fed Chairman (March 2008)

“In accounting 101 we learn that high yields equal high risk. We know the CEOs had an incentive to disregard this because they were getting huge bonuses.” David Hartzell, dean of the University of Delaware’s business college and a former vice-president of Salomon Brothers

“Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown.” Dominique Strauss-Kahn, Head of the IMF (October 11, 2008)

The Bush administration’s way of dealing with the ongoing financial crisis has been frantic, but probably less than adequate. In fact, tragic errors may have been made that must be remedied as quickly as possible.

The most damaging error may have been to let the global investment bank Lehman Brothers fail ($691 billion of assets at the end of 2007), on Monday September 15. This fateful date may have to be remembered in the future. This was the largest failure of an investment bank since the collapse of Drexel Burnham Lambert in 1990. In contrast, the Fed and the U.S. Treasury moved quickly in mid-March (2008) to save a similar global investment bank in distress (but half the size of Lehman), Bear Stearns, by quickly lending and guaranteeing $29 billion to the large universal J. P. Morgan Chase bank in order to absorb it. —(N.B.: Let us keep in mind that it was the collapse in June 2007 of two internal Bear Stearns hedge funds that had been heavily invested in mortgage securities that kicked off the full-fledged market panic that unfolded in August 2007, and which today has turned into a full-fledged international financial crisis).

Why was the same treatment not offered to Lehman? Possibly because of a personal lack of empathy between Treasury Secretary Henry M. Paulson Jr. (a former chief executive of rival investment bank Goldman Sacks) and Lehman’s CEO Mr. Richard S. Fuld Jr., or possibly because the Bush administration wanted to make an example that all investment banks, no matter how large, could not count on being rescued by the government. The Bush administration did not even bother to appoint a trustee to supervise Lehman’s liquidation in order to make it orderly.

Such a liquidation of a large international bank, known for its worldwide interconnections and unsound banking practices, was nearly a repeat of the mistake made in letting the large Vienna-based Creditanstalt bank fail, on May 13, 1931. This was a bank that had borrowed large amount of money in London and in New York to finance its activities. Its failure created a domino effect among other international banks that had lent to each other in the international credit chain. So much so that the failure of the Creditanstalt forced them to severely tighten their lending to absorb their sudden losses.

Seventy-seven years later, in 2008, the Bush administration’s decision to let the Lehman Brothers bank fail has produced a similar ripple effect throughout the international financial system. And, perhaps more important politically, it signaled to the markets that the Bush administration was willing to let a dangerous debt deflation and an ominous credit crunch proceed. This may turn out to have been a most tragic mistake.

Indeed, Lehman’s bankruptcy forced the global investment bank to quickly write down its huge portfolio of debt, a fair amount of it in derivative products. But since banks are creditors of each other, especially Lehman which dealt with large institutions, this had the consequence of spreading the American financial disease all over the world, and especially in Europe. Why? Because Lehman’s London office was a huge center of sale and distribution for its more or less toxic derivative products all over Europe. Indeed, many European banks had invested in Lehman’s securitized paper, and when it failed, they were left with large losses. As a consequence, they had to curtail their domestic lending and that’s the reason the credit crunch is now moving to Europe.

The second mistake was to address the “liquidity problem” of American investment and mortgage banks without tackling at the same time their underlying “solvency problem”.

As we wrote right at the very beginning, on August 24, 2007, the financial crisis in the U.S. is not only a classic “liquidity problem”, when banks find themselves short of cash to pay immediate redemptions and withdrawals while their longer term loans are secure, but also and above all a “solvency problem”, because the huge losses that banks had to absorb when they wrote down the value of their toxic assets-backed securitized paper, eroded their capital base to an extent that they became de facto insolvent. Market operators saw that and they sold the banks’ shares short and the price of these shares plummeted.

With many banks’ solvency now in doubt, inter-bank lending has nearly stopped, and because of a ’flight to safety’, the Ted spread [the difference between three-month U.S. Treasury bills yields and yields on three month eurodollar contracts, as represented by the London Inter Bank Offered Rate, called Libor] exploded, and banks cut down their lending. Credit became tight and scarce. Because banks as a whole ordinarily lend between 10 and 12 times their capital base, the most liquid money supply (M1) began to contract in real terms. Even money market funds suffered heavy losses, and a run on them was in full swing when the Treasury stepped in a month ago to offer an emergency $50 billion guarantee.

The U.S. economy may be approaching what can be called a classic “liquidity trap” situation, wherein the Fed is lowering interest rates while lending through its discount window and printing money on a high scale, however the liquid money supply figures, in real terms, are not increasing, but are rather falling. Thus, there is no immediate inflation, but the money supply is contracting as banks reduce their lending and make a rush to T-bills (their yields nearly fell to zero). The short-term result is a net deflationary effect for the overall economy and on the stock market (although the long term bond market sees inflation ahead, and long term rates are rising). —The result is stock market crashes in repetition.

In fact, this is precisely what has happened over the last few weeks, not only in the United States, but also in the U.K and in other European countries. This is a very dangerous development for the real economy, because money data in real terms are a leading indicator of the future course of the economy. Six or nine months down the road, the consequences of the credit crunch will appear in production and employment declines, because the credit crunch has the effect of placing a serious squeeze on most companies. Since the credit contraction really began in June (2008), the early part of 2009 is bound to show severe economic weakness.

On Friday, September 19 (2008), the Bush administration announced its solution to the growing banking crisis. It made public the $700 billion Paulson plan (US Emergency Economic Stabilisation Act, EESA) that primarily focused on creating a government market for some of the bad mortgage-backed securities on the banks’ books. —But this was only half of the problem. The other half of the problem was the need to stop the money supply from declining, by restoring bank credit lending and allowing companies to have access to working capital financing. The goal here is to prevent banking problems from morphing into a general contraction of consumption and capital investment plans, thus slowing down production and raising unemployement in the coming months.

For this to happen, however, banks must be allowed to find badly needed new capital. But in a time of crisis, with stock markets declining, it is doubtful that much private capital can be found. The recent association of Warren Buffett with Goldman Sachs may be more of an exception than a rule.

When private capital is not available, the government has no other choice but to inject equity (by buying the banks’ preferred shares) into the national banking system, while taking steps to safeguard the public interest by obtaining common share warrants that can be resold profitably later, when the situation stabilizes.

In conclusion, we may ask if it is possible to avoid a repetition of the U.S. Great Depression of the 1930s or the more recent Japan’s protracted recession of the 1990s, both the result of a similar severe banking crisis? The answer is yes, if the vicious cycle of asset price decline, banking credit crunch and money supply contraction can be avoided, or, at the very least, stopped and reversed. —In economics, as in medicine, it is never too late to do the right thing.