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Just now I watched how Rick Santellli and Steve Liesman get into it on the CNBC Business Channel and I wonder if there is a way to analyze their strong disagreement to determine the fundamental issues involved.

I believe that the toxic assets produced by the unregulated financial securitization instruments, i.e., the derivatives of the sub-prime mortgages and loans (a $65 trillion market) insured by credit default swaps (introduced by J.P. Morgan in 1997 and by mid-2007 ballooned to $45 trillion market), pretty much brought down the main brokerage houses that were leveraging at $30 to one: Lehman Brothers took the real hit going bankrupt. But Merrill Lynch was a forced purchase by Bank of America and Bear Stearns, forced to sell at $2 a share to A.I.G. by Hank Paulson, who then injected $173 Billion into this obscure deal. Now Paulson had been the CEO of Goldman Sachs before George W. Bush made him the Secretary of the Treasury. (I wonder about what would have happened if he had been the CEO of Lehman Brothers!)

The great investment banks all collapsed into the banks that were, by and large, too large to fail: Goldman Sachs into Citigroup and Morgan Stanley…. The Federal Reserve allowed Morgan Stanley to change from an investment bank into a Bank Holding Company, while 21% of it was purchased for $9 Billion by Mitsubishi UFJ Financial Group, the largest bank of Japan.

That spelled the collapse of four of the great brokerage houses in the wake of the housing bubble and Wall Street’s novel financial instruments that had been so lucrative. Far from their reducing risk, they placed and still place the whole financial system as well as the whole economy at risk.

Now Rick Santelli is asking for the good old days of leveraging and big chunks of GDP for the United States produced by the financial community lost with the loss of the great brokerage houses. (I wonder what kind of a reality these chunks of GDP had and what justified that kind of leveraging for our financial gain?) He seems to blame the government intervention for the financial collapse. (My point in a previous “blogging my thoughts” was that the government is priming the pump to get the markets up and going again.)

Steve Liesman is saying that the government had to step in because of the collapse of the markets. This was not merely a business cycle, but a bubble that burst, destructive enough to bring a total collapse of the market. This is what Steve Liesman’s language about “the end of the world” stands for.

Rick Santelli and Steve Liesman clashed over Bank of America, CEO, Ken Lewis’ decision to comply with Hank Paulson over not disclosing the shape of Merrill Lynch (the trillions in magnitude of the toxic assets in question is the skeleton in the closet, I believe.) Thus for the sake of saving the whole financial system, the independence of the market, was taken away by Hank Paulson, who acted like a CEO of the government in his treasury position.

Now Rick Santelli took a very ethical position: just because Paulson tells you to cover up the liabilities that Merrill Lynch brought to Bank of America was no reason to do so. Be an independent CEO. This is business and the government has no right to interfere and ask for an illegal cover up. That is why he mentioned David Frost and Nixon. Steve Liesman had argued that Paulson felt non-disclosure of Merrill’s situation at that moment could save both Bank of America and Merrill Lynch, and with it the collapse of the financial system. Rick Santelli argued that a crisis situation is not an excuse to break a rule or a law. Now the government is embedded in the financial system and he wishes it were not.

But the collapse of the whole system could spell a great depression that would take a decade or more to get out of. I wonder why Rick Santelli would ask who Steve Liesman voted for? That sounded like a Republican trying to scapegoat a Democrat in a Republican business ethos. If Steve’s position was “dumb,” then Rick’s was completely unrealistic. (Rick sometimes hits below the belt!) How could the issues between Ken Lewis and Hank Paulson have been taken to the Supreme Court?  Although Rick Santelli seemed to take the ethical stance, he seems to think that the market operates in a world of its own and is an autonomous realm independent of government and society. The jury is still out about whether or not government intervention will get the markets up and running again, but I submit that the markets are always running to the government for contracts, hand-outs, and bailouts, meanwhile giving lip-service to free markets. The government representatives are also taking whopping amounts from Wall Street lobbyists to bring huge profits at the expense of the health of the markets and the society. Perhaps there is a difference between healthy free markets and those gone wild in a frenzy for fast capital that does not help real production and meet the needs of the society, for which the economy, as supported by the financial system, is responsible.

Perhaps the real issue involves irrational distortions of the markets that got out of hand, because real risk is involved with production for fulfilling the needs of society and false instruments are sold to insure the purchasers that they will be immune from any risk in the market. But the management of risk should not include the stand that allows the whole system to collapse because of instruments that promised all risk had been overcome.

Markets are filled by those whose values are trust-worthy and those who trust them. It is faith that fills the financial world as well as its investments in the economy with profitability as the needs of society are met. (This is the economic version of justification by faith.) The distortion of the market took place as some really used the market to avoid the risk that the market constitutes. That is why it came to no risk at all versus risking the whole financial system.

I hope Steve Liesman and Rick Santelli keep fighting. But the latter will not get those great chunks of GDP into the US again by leveraging and using the phony derivatives and credit default swap markets. I guess the question remains, do the irrational financial markets spread healthy global markets or end up destroying them and failing the societies for which they should provide?

See the CNBC video, the “Bernanke Re-Cap”: http://www.cnbc.com/id/15840232?video=1114536023&play=1

for viewing their argument on this Business Channel.

OUR FINANCIAL AND ECONOMIC CRISIS

November 25^th 2008

I wrote previously about Anghel Rugina’s critique about the irrational aspects of our economy.[1] He criticized the currency, which had no standard to back it[2]; monetized bank credit, in which banks made loans and charged interest for them (unethically, he maintained) without having the said capital[3]; and the pure speculation of the financial system as opposed to actual investment in production.

Rugina argued that if all capital was invested in production, we would have full employment. Since a portion was used for pure speculation, full employment became impossible. Such irrational speculation also threatened destabilization (or dis-equilibrium) of the economy. In face of the irrational elements distorting an economy, which in and of itself is very complex, a rational monetary policy was impossible. One could not control or measure in any way, for example, the affect an interest rate cut by the Federal Reserve was having on the economy.

According to Rugina, full employment becomes impossible because of speculation. Rick Wolff, an economics professor at the University of Massachusetts at Amherst, approaches our crisis from a very different angle. He argues that the indebtedness of the middle class passed the breaking point, because of wage stagnation and higher expectations. He listed the reasons why real worker wages tended to stagnate after 1974. This stagnation followed wages that rose steadily over the previous 150 years, continually increasing the level of consumption. The middle class interpreted its level of consumption as an increasing level of achievement. Four reasons for wage stagnation were outsourcing of labor, women entering the labor force, low level of wage expectations by immigrants, and highly productive technology that made the replacement of many workers possible. See “Against the Grain,” the National Public Radio program of October 20, 2008.[4]

Along the lines of Rugina, Wolff argued that technology (just think of computers) exploded worker productivity, while employers let wages stagnate, allowing fantastic corporate profit. They placed this profit into the banks, which in turn gave workers easy credit. These borrowed heavily to keep pace with the former steady increase in standard of living and levels of consumption. But now this increase was not due to increased wages in terms of a living wage, but due to taking out loans and making use of credit cards. Somewhat like monetized credit, with banks lending money and charging interest on capital they did not have, corporations gave their profit to financial institutions, which loaned workers money with interest, loaning them money which they had rightfully earned but was withheld from their wages. When credit card loans went to the maximum, the people then took out further loans on the equity of their houses, which seemed unproblematic because of the housing bubble.[5]

Fair wages are thus also crucial to the solution of our financial crisis. According to Wolff regulation and deregulation did not work, thus allow workers representation with voice and vote for the guidance of corporations, in order that they help to find an effective balance and standard of regulation.

Listening to one economist after another, I hear them state that the public sector is the only one functioning in the breakdown of the market system. On the Lehrer Report, NPR, November 24, 2008, one economist argued that tax-payer dollars could buy the whole corporation of Citicorp for the $20 billion of invested capital and the $300 billion insurance for liabilities at risk. Those incredible sums of money should give the tax-payer some say-so, some representation for our public and common interest in this bank, which has become too large to fail. The piece-meal bailouts, (for example, why didn’t they bailout Lehman Brothers?) bring about the moral hazard that other private banks will take advantage of the public sector and its billion dollar bailouts.

Meanwhile the huge discrepancy between the salaries of the financial sector and stagnant wages of regular employees remains. It was reported that Goldman Sachs will have to do without bonuses this year. They will have to make do with their meager $600,000 salaries a year! Working in the financial world is stressful and certainly the CEO’s who make $100 million a year are stressed out, but then what about all the employees whose wages have stagnated while those above have jettisoned into the stratosphere? What about the underemployed, the unemployed, the workers who have been marginalized and left out of the statistics because they have given up seeking employment?

Rugina would agree that free market capitalism spells freedom and a government controlled economy spells a controlled society as well. But why can’t a social economics be devised, where legal institutions and public representation enforces enlightened regulation that safe guards public interests as well as private ones. There should not be a collectivization of costs and a privatization of profits, nor conversely, a collectivization profits and a privatization of costs. Legal institutions and boards safe-guarding public interests should have real representation with voice and vote over the corporations in order to maintain such a balance or equilibrium (to use Rugina’s word). Wolff calls for radically reconstituted boards of directors of corporations in this way. Also see Rugina’s table of mixed economic models from pure private competition to a government controlled economy.[6] I feel that Rugina would argue that we have to be more nuanced in terms of regulation, deregulation, and re-regulation in terms of an institutional and legal framework appropriate to our model of capitalism.

I have not yet integrated into my thoughts above the sociological field theory of Pierre Bourdieu, with its structure, forces, positions, dispositions, and specialized capital. The research of his sociology would investigate many different fields of our economy, providing a more nuanced and closer assessment of economic realities than merely thinking on the level of systems.

One more thought: if proper regulation of business and fair taxation was integral to our branches of government, then such economic boards for safe-guarding the public interest would not be necessary. The government would be doing so. But I sense a conflict of interest when the government should stand for the common interests of the public, but represents financial and corporate interests almost exclusively. A philosophy of government that denigrates its necessary functions of checking injustices, preventing the destruction of the environment, and correcting ethical lapses gets sucked into the very problem it should oppose. To consciously place those with known conflicts of interest at the head of regulating agencies is, of course, to hire the fox to guard the chicken coop. I suppose when government governs well, then self-government develops, so that the government can govern less. Then that government is best which governs least. When the financial institutions and corporations are out of control and even the people themselves, then government must step in again.

Some kind of balance seems to have been lost. Perhaps Rugina’s principle of equilibrium is like that of sustainability. Why did all the investment houses collapse the way they did?

Our Financial and Economic Crisis

I just reread the economics article, “Is there anything new to be said after Adam Smith, Marx, Walrus, and Keynes? Toward a third revolution in economic thinking” by my old inspiring college professor from Northeastern University in Boston, Anghel N. Rugina: International Journal of Social Economics, Vol 26 No. 10/11, 1999, pages 1227-1248.

Anghel Rugina is prescient about the failure of monetary policy in the face of the irrational features of our financial and economic system and predicts something rather similar to what we are now experiencing. He states that a “Great Transformation” is coming because unsolved accumulated basic problems in our financial system and economy cannot go on indefinitely. “Toward the passage into the third millennium or shortly thereafter, whether we like it or not, for better or worse, we are exposed to the Great Transformation, a historic event to clean the house of the errors made during the twentieth century.” (§5 in his paper, p. 1229)

He faults irrational financial mechanisms of disequilibrium, i.e., the paper-dollar, monetized credit of banks, and pure speculation that is detached from actual investment for productivity. These factors make our current financial and economic system unstable.

He couches his critique in a holistic social economic approach, but sees the factors for disequilibrium making rational, really effective economic, monetary policy, and even business decisions impossible.

His description of equilibrium is comprehensive:

§3: How can we realize in real life and maintain over

time (dynamic process) not just maximum profit for entrepreneurs, as customarily assumed, but the optimum allocation of available human and natural resources so that we may have simultaneously price stability (equilibrium prices with simple and finite fluctuations), full employment (with no large pockets of involuntary unemployment), a balanced public budget every legislative period, a normal rate of economic growth to satisfy the effective demand of active population, a normal rate of profit to cover the real cost of management (equal to the opportunity cost), a foreign exchange rate to assure a balance of international payments in order and not less important, a most equitable distribution of national income and taking care of those who are really handicapped.” (p. 1228)

Paper money, he argues, fluctuates too much and he argues for what he calls Numeraire-currency which harks back to some constant magnitude of a certain commodity (gold, silver, etc.) (page 1233).

I would add, the value of the dollar relates to our government, economy, and country’s standing behind our currency. When our standing in the world falls, the faith in the symbolic value of our dollar can fall as well. In these institutional matters believing something to be of value gives it value. Believing it doesn’t (like rubles in Russia a good while ago) can make people use cigarettes as currency.

Rugina argues: “The business of ‘monetized credit’ [by banks] is nothing but a form of pure speculation in lending something you do not have (‘empty figures’ in the books of a bank) which is accepted on the market because we trust that the bank in question possesses the amount in question but in reality the bank does not have it! And this lending of ‘empty figures’ is done for an additional profit by charging regular interest rates! Further, the same opportunity to monetize credit means financial power.” (p. 1232)

He first sees a moral problem in lending what the bank does not have and charging interest to boot. But strictly economically, it again makes currency and credit unstable. I believe he may well be explaining the credit freeze in the banks, because each bank knows that the other does not have the capital behind the loans they have given. In a boom, it can go by unnoticed. In a bust it exposes the insolvency of the bank. Thus the plan has become to inject capital in banks and to guarantee their loans to other banks. This new approach seems to provide evidence for Rugina’s theory of destabilizing monetized bank credit.

He argues that real investment enhances productivity, but the money set aside for pure speculation is actually responsible for our lack of full employment, because it could have brought more production by actually being invested in it. By pure speculation, money is received in a completely irrational way unrelated to real production and service. It gives financial power to a small elite, makes mergers possible that short change the workers, and redistributes money to the top. Financial transactions that go into production bring equilibrium, while those for mergers and pure speculation are disequilibrium transactions and bring about disequilibrium prices (page 1234). (That means wildly fluctuating prices.)

I would ask: What are these disequilibrium prices but pure speculation infecting regular prices? The housing boom here put handy-man specials, houses that you could not live in, at half a million dollars! Speculative irrationality I would argue infected housing and caused that bubble, just the same way that it produced the dot.com bubble, and the Dutch tulip bubble when the “Bourse” was young, to reach into history.

I have heard an opposing argument to Rugina next argument. He uses a distinction between real buying and selling, where the seller is handing the real object in question and where it is make believe, i.e., where no object exists.

The latter are pure speculations or genuine gambling, where the buyer puts an order to buy (future delivery) but with no intention to take possession of the item in question. He just believes that the price will go up and if so on delivery day he will liquidate the contract and reap a differential profit. This is a bullish spectator. Simultaneously a bearish speculator who believes that the price of the same item will go down will put a different order to sell short and if indeed the price goes down then he will be the one to reap the differential profit (page 1233).

For the opposing argument: a farmer needs capital in advance and receives it from futures to plant his crop. I believe Rugina would not call that speculation but actual investment in production. But the whole futures market goes well beyond helping production with advance capital, thus most likely bringing the instability and irrationality that Rugina warns us about.

Rugina insists that there needs to be institutions and a legal framework commensurate with the kind of mixed economy that exists. I remember in class how he would chant that the free enterprise system spelled freedom! Freedom! Freedom! He would actually chant that phrase. But he said the capitalist system needed to monitored and have gauges and dials and instruments (let’s face it, fair regulation) like the cockpit of an airplane for it to give us the smooth flight into the equilibrium he described and I quoted here at first.

Rugina writes a very rich and important article to which I do little justice here, especially because I don’t understand many of the issues involved. Hope I’ve shed some light on our crisis, however.

Now to think about the mortgage default and foreclosure problem:

In terms of the continuing bleeding and hemorrhaging of bank capital, because of mortgage defaults, I imagine that when the prices of the houses go down below the amount of the loan mortgaged, rather than the debtor just walking a way from the house and allowing it to become foreclosed, a deal could be struck with the debtor for a mortgage equal to the market price of the house at an affordable monthly rate. When the price of the house rises again, the equity would be shared by the bank and the debtor up to the amount of the first mortgage with 5% interest. When those holding a mortgage walk away from their house and the foreclosure becomes necessary, the losses to the banks decapitalize them, far beyond the value of all their assets forcing them into merger or bankruptcy.

With defaults, the derivatives developed from these mortgages also lose their value and these derivatives evidently represent a 535 trillion dollar, unregulated market!

When the hemorrhaging is stopped, the derivatives could fluctuate in equal proportion to the percentage of the new mortgage to the first one, making it possible to determine the value of the derivatives, and they too could include recovery of value when housing prices increase again.

I wonder if this could work. Some way has to be found to prevent the vicious circle of downward spiraling housing prices, mortgage loans exceeding the market price of the house, defaults, and foreclosures.