Sunday, March 15, 2009

The Economic Crisis: So Who's Zooming Who Now?

We're working past the initial shock and surprise of the financial crisis, and are onto the second stage--outrage. The cost of the bailouts and stimuli is running into multiple trillions. Taxpayers, especially those in the middle class who see little apparent benefit from all these bailouts, are baffled and indignant that they should have to pay for the mistakes or recklessness of others. They feel that political and governmental processes have been used to take advantage of them. And they have a point. When you look at what's going on with the bailouts and stimulus measures, there are undeserving winners and undeserving losers. Who's zoomin' who?

AIG takes today's top prize for zooming taxpayers. It's received more than $170 billion of bailout money, and just revealed that it paid $165 million in bonuses and retention payments to executives at AIG Financial Products, the subsidiary that created the bulk of the AIG losses covered by taxpayers. Why pay bonuses to a bunch of executives who created losses? Why pay money to retain them? AIG insisted that these bonuses were required by contract, and they had to pay them. Didn't the contracts also require good performance? Or did AIG agree to pay these people millions simply to show up at the office? If AIG hadn't been bailed out, it would have gone into bankruptcy, and these employees probably would have gotten, at best, pennies on the dollar for their bonus and retention payment claims. However, because the taxpayer stepped in due to AIG Financial Products' horrible performance, these executives got full compensation while many taxpayers' marginal rates are slated for increases. That's zoomin'.

Perhaps shamed by the public outrage over its bonuses, AIG today released the names of the financial institutions and other counterparties that benefited from its $170 billion plus bailout. AIG has been resisting disclosure; but it appears to have belatedly learned that chutzpah isn't always a winning strategy. Billion dollar members of the AIG Wing of the Bailout Hall of Shame (i.e., those that received a billion dollars or more) include Goldman Sachs (recipient of $12.9 billion), Societe Generale (recipient of $11.9 billion), Deutsche Bank (recipient of $11.8 billion), Bank of America (recipient of $12 billion, of which $6.8 billion went to Merrill Lynch and $5.2 billion went to Bank of America exclusive of Merrill), Barclays (recipient of $8.5 billion), UBS (recipient of $5 billion), BNP Paribas (recipient of $4.9 billion), HSBC, a British bank holding company (recipient of $3.5 billion), Dresdner Bank (recipient of $2.6 billion), Citigroup (recipient of $2.3 billion), Calyon, a French bank (recipient of $2.3 billion), DZ Bank, a German bank (recipient of $1.7 billion), Wachovia (recipient of $1.5 billion), ING (recipient of $1.5 billion), Morgan Stanley (recipient of $1.2 billion), and Bank of Montreal (recipient of $1.1 billion). Among these banks alone, foreign institutions received a total of $54.8 billion, with $53.7 billion going over to Europe. Add other less shameful bailout recipients and the totals for foreign bailees reaches over $57 billion (with over $56 billion going to Europe).

Many financially struggling banks are zooming taxpayers—why face reality and write off toxic assets when you can foist your losses on the taxpayers--who will end up buying or financing the purchase of a lot of your toxic assets--and then get a capital infusion from them after you book your losses? Simply hang on long enough (while pressuring Congress and regulators for a break on the mark-to-market accounting rules that would otherwise force you to own up to your losses), until the government comes around and takes the hot tamales off your lap.

The wealthy nations of western European, who have the resources to join with the U.S. in a massive stimulus effort but won't go along, are big time zoomers of the American taxpayer. They may figure the U.S. will provide more stimulus anyway if they stall and delay. They’ll get part of the benefit of U.S. stimulus through exports to America, without having to pay the cost. With the AIG bailout having already funnelled $56 billion plus over the Europe, they probably think the Americans will blink if there's a showdown. Twice in the 20th Century, America fought wars to bring peace to Europe, spending many billions of dollars and losing some 400,000 American lives. America has already demonstrated that it will pay an enormous price to solve Europe's problems. Why wouldn't the Europeans again wait for America to come to the rescue?

Zoomers include some borrowers using HUD insured mortgages, too many of whom are defaulting after only one or maybe no payments. A quick default indicates that fraud was likely involved in the mortgage. So the taxpayers may have not only been zoomed but defrauded as well.

Banks and other mortgage lenders are zooming in their efforts to fight legislation giving bankruptcy judges the power to modify the terms of mortgages. If judges can’t do this, more struggling homeowners will have to seek direct assistance from government programs. Why allow judges to have the power to impose losses on bank shareholders and on investors who bought the mortgages, when the taxpayer can be made to take the loss?

Perhaps many struggling mortgage borrowers will also be zoomers. With the recently announced mortgage assistance program, they now have an incentive to seek taxpayer assistance instead of dealing with the consequences of their own poor judgments.

GM and Chrysler, and their various constituencies--management, employees, creditors, and shareholders--are zooming. Ford, to its credit, is not.

Before you, as a taxpayer, become totally outraged, remember that we're doing a little zooming, too. The U.S. is zooming China. The federal government has borrowed so much from China (over $720 billion) that the Chinese are concerned that more fiscal adventurism by the U.S. government will drive down the value of outstanding U.S. Treasury debt. One ironic aspect of China's situation is that the U.S. nationalized Fannie and Freddie in order to bail out their creditors, which included China. But the U.S. will have to borrow to finance the Fan/Fred bailout, and to whom will the U.S. turn in order to sell the U.S. Treasury debt needed? China, of course. So the Chinese are in the position of having to fund their own bailout. The result is they are at risk again, only as holders of Treasury securities now instead of Fannie Maes and Freddie Macs.

While China would benefit from more U.S. government stimulus and bailout spending (since China exports so much in the way of consumer goods to the U.S.), it oddly is counselling restraint. The Chinese have maintained a continuing civilization for some 4,000 years, and perhaps they're worth listening to, if only because they've demonstrated an ability to survive that no other country begins to approach. China has used paper money for over 1,000 years and has experience going back to the Ming Dynasty (A.D. 1368 to 1644) with government currency manipulations that resulted in hyperinflation. They're not comparing the teachings of John Maynard Keynes to those of Milton Friedman; 20th Century theories from the West have limited influence on their thinking. They're a practical people who are looking back at their own hard experiences. They know that a government that borrows and/or prints enough money will destroy its currency, and that economic distress will quickly ensue. Indeed, monetary profligacy by the Nationalist Chinese government in the 1920s and 1930s made it easier for the Communist Party to establish a foothold; so the Chinese Communists are well aware of the dangers of printing money.

The dollar is the world's reserve currency, and its fall from grace may be slowed by that status. But reserve currencies are not immune from the laws of economics (ask the British about how the pound once was, and then wasn't, the world's reserve currency). If the Chinese think fiscal restraint would be the better part of valor, Americans would be well advised to consider caution before charging down the valley, with cannons on the right, cannons on the left and cannons in front.

The Chinese expression of concern may have been in part to assuage domestic concerns about China's dependency on America. China has a long history of isolation from other nations (which not coincidentally began in the 1400s during an earlier period of financial instability). Its strategy during the last 35 years of opening up to the West was a calculated risk taken by China's erstwhile Communist leaders to produce wealth while breaking its dependency on the Soviet Union. If that gamble doesn't pay off, there's a serious possibility that China will turn inward again. This would not be a good thing for America.

China's huge holdings of dollar denominated assets align its interests with America's. If America goes under, China takes gargantuan financial losses. So they're afraid of being zoomed. And we, too, should be afraid of zooming China, because China is probably the only country left in the world that could take the lead in financing America. If China is zoomed, it will hold back on lending more to America. The rest of the world would take notice, and international finance and trade would be endangered. The U.S. government would have produced the result that it most desperately wants to avoid. Very few Americans contend the government shouldn't act, and we would contend that the government should act vigorously. But, just as there are limits to a government's military power (as demonstrated in Vietnam and Iraq), there are limits to a government's economic power and its political legitimacy. Go beyond those limits, and the Big D could loom. The current taxpayer outrage, and the Chinese nervousness, should be taken as signs from canaries in a coal mine.

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