Submerging Markets™

TRUE UNEMPLOYMENT: 20% AND RISINGSend Geithner Home to Wall Street!His Legacy: 30 MM Underemployed, A Flagging Stimulus, No Bank Reform, Soaring Deficits, a Sinking DollarJames S. Henry

With official US unemployment now at 10.2 percent,  the third highest among the 29 OECD countries,  and unofficial unemployment at least two times  higher, more than 30 million American workers and their families are now being forcefully reminded  every day that "the reserve army of the unemployed" is not just pure Marxist rhetoric.  

While China and most developing countries are already recovering nicely from this First World-made debt crisis, all indications are that US unemployment is still rising, and that we will soon see a new postwar record -- -- two years after the "Great Recession," the longest and deepest since the 1930s,  began in December 2007. 

UNEMPLOYMENT:  GET REAL

To get the real unemployment picture, we need to adjust the official statistics upwards. First, as the Bureau of Labor Statistics' own data shows, the "official" rate leaves out many workers who are (a) underemployed, working only part time when they'd prefer full time jobs (9.3 million now); (b) fully unemployed,  and desirous of jobs, but not counted in the official statistics because they've given up look (2.3 to 5.6 million). Allowing for these two adjustments already boosts "underemployment" to the 17.5% figure cited in some recent press reports.

But even that figure is too low.  First,  it omits the country's 20 million "self-employed" (incorporated and unincorporated), a growing share of the labor force. All  are counted as "employed" in the official statistics, no matter how underutilized they are. Yet other surveys report that this group is also experiencing serious underemployment.

Furthermore, the official statistics also leave out  about 1.6 million who are now serving in the military, plus the record 2.33 million  US prison inmate population. Both populations are heavily young, male,  and undereducated, and would therefore experience relatively high unemployment. This is especially important for the sake of historical comparability  -- say, for comparisons with the 1930s, when the US military  and the prison populations were both tiny. 

In addition, of course, when the Great Recession started there were at least 8 to 10 million undocumented workers in the US, none of whom appear in the official statistics. Whatever we think of illegal immigration, the fact is that most of these workers have not been able to return to their homelands, and are still here, quietly suffering through this recession. Indeed, to the extent that they are unable to draw on unemployment benefits and other social programs to cushion the blow, they are being forced to compete with the rest of us more fiercely than ever.

All told, therefore, as shown in the adjacent chart (click to pop up), this makes the "real" US unemployment in October 2009 at least 20 percent or more -- twice the official rate.

TO WHOM DO WE TURN?

One might have expected this historic jobs crisis to have provoked a quick, decisive response from Washington  Unfortunately, American workers have also recently been reminded that, disturbingly, the Democratic Party can simply no longer be counted on to put labor's interests ahead of capital's. 

This was evident to some of us when Obama's first stimulus package was being designed -- given that it was loaded up with so many Christmas goodies for special interests and so many regressive tax cuts. 

But by now it should be clear to anyone but the most bullet-headed diehard party ideologues.

Whatever else Obama's February 2009 stimulus package has accomplished, it simply hasn't created nearly enough new jobs, fast enough.

Nor has it provided nearly enough aid to debt-ridden homeowners --  as the continued record-setting pace of home foreclosures and bankruptcies testifies.

These basic policy shortcomings are not due to some Herbert Hoover or Ronald Reagan.  While Obama obviously inherited a mess, by now enough time has passed that his administration has become responsible for  its continuation.

How high does unemployment have to go for the Obama Administration to actually  want to do something more about it?

When FDR took office in March 1933, unemployment stood at nearly 25 percent of the labor force, and he immediately took decisive action to make sure that unemployment was reduced, by establishing targeted federal job creation programs, attacking anti-competitive practices by large banks and corporations, and making sure debt relief got through to small businesses, farmers, and homeowners. 

What is it about the character of the Obama Administration that has made its response so different?

THE FIFTH COLUMN

As we've argued for some time (See "The Pseudo Stimulus," The Nation, February 3, 2009, and "Too Big Not to Fail," The Nation, February 23, 2009),  one basic problem seems to be that Obama's Administration, unlike FDR's, has been overly dependent from the get-go on pro-Wall Street insider/ fifth columnists, captained by the Supreme "Jimmy Do-little"/  Andrew Mellon of the period,  Treasury Secretary Timothy Geithner. 

Not only has Geithner  been far too slow to recognize that the first stimulus was woefully inadequate.

Time and again, he and his x Goldman groupies at Treasury have also piled out of the Trojan horse to defend traditional Wall Street prerogatives. They have:

• ☛Opposed serious restrictions on executive compensation and perks for senior bank staff that are unrelated to performance;

• ☛Opposed  clawbacks or windfall profits taxes on the hundreds of millions in stock options  granted by bailed-out banks last spring;

☛Opposed serious debt relief for homeowners, and failed to strengthen the loan modification program introduced last spring, even after it had clearly failed;

☛Failed to fight hard for "cram-down" legislation that would have required banks to accelerate loan modifications;

☛Opposed   the establishment of a new independent consumer protection agency for financial products; 

☛Opposed forcing banks that have accepted US aid to accelerate lending to small business and homeowners;

☛Opposed proposals for a "Tobin tax" on financial transactions, as suggested by the UK and France, as a way of financing climate change aid;

☛Opposed G20 proposals to clean up a wide variety of tax haven abuses by major bank and companies around the globe;

☛Failed to achieve any serious reforms whatsoever  of financial regulation, more than a year after the crisis;

☛Failed to get anywhere with the vaunted "toxic asset buyback" program;

☛Insisted that any reforms leave the ultimate regulatory authority in the hands of the US Federal Reserve  -- an anti-democratic, pro-Wall Street institution if ever there was one, whose policy errors  have contributed significantly to this costly crisis. 

LOSE THE BOZO

Of course at this stage, with US budget deficits at a postwar high, and controversial measures like health care reform, climate change, Afghanistan, and immigration still in stuck in traffic, plus a mid-term Congressional election fast approaching,  it may well be too late for the Obama Administration to propose a second stimulus. If this were going to happen, it  would have needed Treasury and White House leadership already. 

It is not too late, however, for Obama to send a signal that he actually holds his own senior executives accountable.

Secretary Geithner, I'm told, already has multiple job offers from at least a half a dozen leading banks and hedge funds, so he will only profit from this exit  -- which he probably anticipated all along. 

By clearing the decks and bringing in a fresh team with some new, more progressive ideas,  more daring-do, and independence, this could  help prevent Obama from repeating Jimmy Carter's sad, rapid one-term involution. 

In any case, when the history of the Obama Administration is written, it is worth remembering that at least a few progressives warned about all this very early  --  the risks of adopting a "pseudo-stimulus," failing to aid small debtors and businesses, and failing to exert strong control over the banks.

Ultimately, that may be one of the biggest costs of this crisis --  the lost opportunity to show that Democrats really are still capable of providing the country with outstanding, disinterested economic leadership in times of crisis. 

(c) SubmergingMarkets, 2009

"WHO KNEW?": WILMINGTON NAMED WORLD'S WORST HAVENWild Protests in Geneva, Vaduz, and GuernseyJames S. Henry

---

"Delaware Named As Better Place to Hide Money Than Switzerland"

"Delaware Beats Switzerland As Most Secretive Financial Center"

"Delaware Most Opaque Haven, Switzerland Third."

---

(Geneva) Thousands of angry private bankers from Switzerland,  Liechtenstein, and the Channel Islands have taken to the streets to denounce Delaware's official designation as the world's worst "financial secrecy center" by the heretofore-renowned international critic of tax havens, TJN International.

"Surely this is one contest that we deserved to win," said a leading Geneva private banker. "We feel like Chicago after the Olympics selection."

A Guernsey banker echoed his sentiments. "I smell a rat. Just because the US VP is from Delaware, the fix must have been in. Our assets have been flowing out since 2005. Now we know where they've gone."

"Wilmington.  Who'd' a thunk it?"

For the past few years jurisdictions like Switzerland,  Liechtenstein, and the Channel Islands  have indeed been competing vigorously for the prize of the "world's worst haven."

According to Dubios Pictet von Hentsch, another  long-time Swiss banker, "I don't know what they want from us. We have tried everything -- including  having many senior bankers from our largest banks get indicted and convicted for helping thousands of wealthy foreigners evade taxes!

"This was supposed to be OUR YEAR!"

"We've also been laundering all those smarmy Euros  for decades! This is the thanks we get?  Meh!  " 

"What's happened to "pay-for-performance" in financial services?"

A Vaduz-based private banker from BIL, the legendary Liechtenstein private money-laundering bank owned by the Crown Prince's family, also expressed shock and dismay.

"We're just a tiny developing country (even if we do happen to have the world's highest per capita income.) How's our Crown Prince supposed to feel after this? After all our efforts to help wealthy foreigners all over the planet evade taxes over the last decade, we lose to...Wilmington? Meh!"

"All the really dirty money has been flowing to an even tinier, more obscure place than we are:  this place called  Wilmington.  And we didn't even know about it. We are obviously a little embarrassed." 

"Personally I've never been to Wilmington. But I am dying to go there now. Are there any direct flights?"

 A Singapore banker commented, "Wilmington?  Uh, where is that, exactly?  Surely If its number one, it must be packed with non-doms, wealthy sheiks, fancy hotels and shops, and of course lots and lots of ultra-ancient, ultra-discrete private banks, law firms, and accounting firms." 

"How is the skiing and the diving, by the way? Not good? Meh!"

Other sources confirm that  until it was disclosed by TJN,  Wilmington's  role in global financial chicanery was  one of the world's best kept secrets. 

"Apparently all the truly sophisticated dirty money goes there," said a Panama lawyer.

 "It's a facade-- purposefully understated, if you will."

"Of course we had all heard rumors. But now  that it has been officially confirmed by TJN,  it must be true."

 "I tell you,  you  Americans are something else.  For years you have been pointing the fingers at the rest of us, while secretly preparing this bid. 

Now it turns out to be you who are the real winners. Meh!"

A Luxembourg private banker commented: "We got the third highest per capita incomes in the world and these peons  in Wilmington wanna piece of our pie!! " 

THE WAY THE WORLD WORKS

The Luxembourg private banker agreed to expand a bit on why he thinks the first prize for Wilmington is just so unfair.

"Ok, sure, yeah, everybody has known for some time that First World countries like the US, the UK, Switzerland, Austria, the Netherlands, and Luxembourg  are the world's largest ultimate havens -- at least since that book Banqueros Y Lavadolares (1996) laid out the whole story.  Foreign money has been  flowing out of higher-tax places and developing countries for decades. 

"Part of it is just natural risk-diversification. For example, what moron wants to keep all his hard-earned shekels in a place like Mexico? The place is a cesspool of corruption, on the front lines of the drug wars, with lots of kidnappings, and the courts for sale to the highest bidder.  You wanna keep all your money there or pay taxes to a government like that?  Knock yourself out."

"But  it isn't just a question of diversifying away from country risk, because that doesn't explain why all the money gets invested in FIRST WORLD banks. 

We First World havens also worked really hard  to become the world's top laundromats, so the money would come here."  

THE BEST TAX CODE THAT MONEY CAN BUY.......

"First of all,  we got the tax laws right, hiring the best lawyers on the planet to design them to attract capital flight and tax evasion, as well as any criminal proceeds that happen to come along for the ride. 

None of these rich countries wealthy foreign investors on, say,  the interest income they get from, say, bank deposits at UBS or HSBC or Citigroup,  or our 200 offshore banks in Luxembourg.  And sure we'll respond if the US Department of Justice comes a callin'."

"But we sure as hell don't report this income to, say, the Mexican IRS.

"So all the wealthy foreigners from developing countries investing in First World banks?"

"There are no big customers secrets!  The banks know who they are! 

"We have to. They are all our private banking clients!"  

"So Angel Gurria can keep his lousy foreign accounts in New York and Geneva, we ain't gonna tell nobody." 

You see -- even if the US IRS knew the "beneficial owners" of every offshore account in Luxembourg, and New York, and London, and Wilmington, the income these owners earn isn't taxable here. And under the rules we've set,  no  First World government is going to turn over this information to some no-count Third World country Hey, there's big bucks at stake! "

"It isn't  about "secrecy," my friend.  It's about tax laws and the people who write them. Or at least that's what we always thought -- until now!"

 ....WRITTEN BY PRIVATE BANKERS

Number two,  we build a vast global pirate banking industry.  We put together  top fifty most powerful First World Banks, law firms, and accounting firms in the world, and unleashed them on the developing world, where most of this  

"Who do you think made all these tax and banking laws, Elwin?  Did they just sorta pop up?"

"Naw, this haven stuff is a big business.

"So our  lobbyists went to work and designed all these  tax laws, plus the banking laws that accomodated them.  If  we don't get it done with lobbyists, we  get a Treasury Secretary or two -- like Robert Rubin, who came from Goldman Sachs and went back to work at Citigroup, or former US Senator Phil Gramm, who was Chairman of the Senate Banking Committee for five years before he left the Senate to become Vice Chairman of UBS.

"Understand one thing:   the City of London, Geneva, Zurich, and New York City would barely exist without this offshore banking/ investments businesses. Naturally Singapore and Hong Kong and Dubai now want a piece of action."

THE IRRELEVANCE OF "SECRECY" TO TAX JUSTICE

"You see, my friend -- that's why we're so troubled by Wilmington's victory here.

We don't understand how all the pure "corporate secrecy" in the world has anything necessarily at all to do with being an outstanding tax haven -- or the flip side, with taking money out of poor countries and keeping it outside, tax free. Or with "tax justice."

"We always thought: we take care of the tax laws and have an aggressive private banking industry, then  we will win."

"Since  the banks and hedge funds know who their clients are anyway, the government could always order them to cough the info up, whether or not there's a single "secret" beneficiary anywhere.

On the other hand, you could have all the most perfect information on beneficial owners in the world, and if you can't get First World governments to either (a)  tax foreigners on their investments or (b) share the information with developing countries, it won't matter. "

REDOMICILIATION - WAH? 

"But now, according to this index,  it isn't enough for us havens not to tax foreigners. It isn't enough for us to have the world's most aggressive private bankers."

"Now we gotta get down and  compete with Wilmington Delaware on all the 14 technical/legal factors in this stupid index!  You look closely at this fancy index,  which took two years to complete. 

"You find, for example, that  Luxembourg lost first place to Delaware just because Delaware corporate law allows redomiciliation and ours doesn't?  

"What private banking client ever heard of redomiciliation in Delaware? Of redomiciliation anywhere? Tax rates? Sure. Information exchange? Sure. Great private banking services? Absolutely.  Redomiciliation??

Are you shitting me?"

"Any corporate lawyer worth his salt knows you can accomplish the same thing in lots of other ways."But now that CNN is talking about it, you're gonna have every two bit crook in the world running around saying "Redom....redom....Nah nah nah-nah nah...You ain't got it, we're heading to Wilmington!"

Who are they working for, the Delaware Secretary of State?" 

A NEW DAY DAWNS IN WILMINGTON

Meanwhile, in Wilmington, the town's 72,000 residents woke up this morning to discover that the world had literally shifted under their feet.

"Our cover has finally been blown," said one local banker. "I'm not sure this is a prize we wanted to win. Certainly it comes as a huge surprise to most of our community -- except for the tiny, carefully selected group that have been in on the secret. "

"The VP was not one of them, so we think he's in the clear. Hopefully."

"TJN really knows their stuff. I think they even sent a small squad of undercover investigators here last summer -- a group of Brits, mainly.

 "We immediately suspected them of being up to something, but we didn't know until now just how much sleuthing they were doing. We thought they were here for the nightlife, the boys and girls. It never pays to try and fool those folks."

"After all, after having had a hand in the design of offshore havens in Anguilla, Antigua, Aruba, Bahamas, Barbados, Barbuda, Belize, Bermuda, BVI, the Cayman Islands, the Cook Islands, Cyprus, Gilbraltar,  Guernsey, Hong Kong, the Isle of Man, Malaysia, Mauritius, Nauru, Niue, St. Kitts,  St. Lucia, St. Vincent, Singapore, the Turks and Caicos, and the UAE, they really know a good haven when they see one."

"Naturally our heart goes out to all the other secretive financial centers in the world. It's never fun to go to bed one night thinking you were number one,  and discover that some tiny town that no one has heard of has beaten you to a pulp."

"The downside?  Well, it'll probably be much harder to be a secretive financial  center, obviously.  And now we'll have all those smarmy Euros, plus a lot of Florida cosmetic surgeons  coming here with their bags of cash. Meh!"

"Personally I'm already thinking about moving to Wyoming." 

(c) JSH 2009

"WHAT MIDDLE CLASS"?Global Wealth Inequality (2007-08 Average)James S. Henry and Brent Blackwelder(Click chart)

Res Ipsa Loquitur.

TWO MEMORABLE SEPTEMBER 11ths James S. Henry

Many of us have our own strong private recollections of September 11, 2001.  I happened to have been at  Boston's Logan Airport that morning, boarding a prop plane for an American Eagle flight to Long Island's Islip Airport. It was leaving around 8 am from Gate 22,  at roughly the same time that Mohammed Atta and four other reputed Saudi hijackers of Flight 11 were taking off from Gate 26 at the very same terminal, along with 86 other passengers and crew.  We must have passed each other, but I didn't notice them. I do have a distinct recollection that security at the check-in  that morning was very lax, but other than that, my own flight was uneventful -- until we landed in Islip and heard the shocking news that two planes had just hit the twin towers. So "death  reached by and took another....."

My heart goes out to all who lost loved ones on that awful morning. May we redouble our efforts to establish a Truth Commission, and determine the full story, yet untold.

***

But it is important to put our 9/11 in context. This was not the only September 11th that is etched indelibly in my memory -- let alone the most important case of international terrorism.  

I also distinctly recall the Chilean coup of September 11,  1973  very clearly.  I was at­tend­ing a graduate economics course at Harvard  taught by a protégé  of  Chicago Professor Milton Friedman. One of my fellow  students was Sebastian Pinera, a member of one of Chile's oldest fami­lies, the future owner of the airline LanChile,  and right now the leading conservative candidate  in Chile's upcoming December 2009  Presidential elections. 

Sebastian had somehow  gotten word  halfway through  the class that Allende  had been ousted.  He was  absolutely jubilant -- “We won!,”  he cheered.                                                        

The profes­sor, a prominent econometrician from the University of Chicago,  shared Sebastian's de­light. Like   many other American  economists, he saw the overthrow as a victory for the neoliberal doctrines preached  by leading Chicago economists like Friedman and Arnold Harberger,  who both later consulted directly for Pinochet’s  junta.

Over  the next twenty years, these “Los Chicago Boys” came to       exert  a strong influence on Chilean  economic policy.   The label was  perhaps a little  un­fair  to Chicago -- there was certainly no shortage of Harvard  disciples of  brutilitarian free-market doctrines.

  For example,   Jose Pinera,   my classmate’s brother,  was also  Harvard- trained.  He eventually became one of the main architects  of Pinochet's labor policies,  which included a  ban on strikes and  closed shops,  the privati­zation of all pension funds, and sharp cuts in  real wages, jobs, and  unemploy­ment benefits.  

In hindsight,  Pinochet’s little laboratory conducted the first in a series of   experiments by the New Right  that culminated in the neoliberal programs of Margaret Thatcher  and  Ronald Reagan  in the First World, and a lengthy list of Third World imitators.  Among  First World democracies, their programs were  mod­er­ated  somewhat by the need for popular support. But in countries like  Chile, Brazil, Mexico,  and Argentina,  where the lines between rich and poor were starker  and the political systems were basically rigged, much  less time was wasted on democratic  niceties.  

To their credit, a few principled  conservatives were bothered by  the resulting dirty little al­liance between dic­tatorship and  liberal economic reform. But  many others -- including Sebastian, who opposed  holding plebiscites on Pinochet  in 1980 and 1988 --   got lost in the thorny thicket of distinctions between “authoritarian” and “totalitarian”  regimes. 

In Chile’s case,  the resulting repression produced at least 3197 murders, disappearances and extra-judicial killings (about the same number as 9/11 in this country). [i] There were also thou­sands of secret arrests and tortures (including 35,000 identified victims of torture and abuse ). All told, Chile spent six­teen long  years without  free elec­tions, in what  had previously been  one of Latin America’s  most  democratic coun­tries.

Of course we now know that all this state terrorism was tolerated, supported and indeed encouraged by the Nixon Administration and its dictator friends elswhere in Latin America -- presumably on the cocka-mamie theory that othewise we'd have Fidel running Santiago.  In fact the narrowly-elected Allende would have held elections when his term was up, and he probably would have lost.

 However, these points are pretty general -- repression is very concrete. As Herr Friedman reportedly told General Pinochet at a Santiago audience in l975,  “When you cut the tail off a dog you don't cut it off inch by inch. You cut it off at the root.”  I   remember a 1974 lecture by another Chilean economist, Orlando Letelier, who was killed  in l976 by a car bomb  planted by the DINA, Pinochet’s secret police, in Washington D.C.  And I remember  Victor Jara, a  talented Chilean guitarist whose music I greatly admired.   When the junta seized power he was arrested and transported  to a soccer stadium in Santiago where “political”  prisoners were held. The police took him out in front of the crowd  and they cut off his hands.........

***

 The overthrow of Salvador Allende's elected Popular Unity government in September  1973  was greeted with jubilation by Chile's propertied  classes.  He’d been elected with a 36 percent plurality  in l970, and  the Popular Unity coalition’s  support in­creased to 44 per­cent in the March 1973 Congressional elections. But   the  elite  was  eager for a change by any means.  From l968 to l973, at first under the Christian Democrat  Eduardo Frei Montalva and then Salvador Allende,   government spending as a share of GNP had in­creased from fifteen  to forty percent.  A third of  large farms and many  pri­vate companies had been nationalized at  low prices;   there was   700 percent infla­tion and frequent shortages of consumer goods; Chile’s foreign debt  had reached the un­precedented  level of $2.5 billion. Foreign investment dried up and  flight capital was pouring into  accounts at Bankers Trust, Chase and JPMorgan, Chile’s leading creditors.

The good old CIA, multinationals like ITT, and the USG certainly played a prominent role in 1970-73 coup activity that followed -- with a hefty dose of financial chicanery, in order to, in Nixon’s words’ “make the economy scream.” But intervention had not started there.

For example, according to former CIA agent Philip Agee, who had been stationed in Uruguay in the early 1960s, future Bush Pioneer and Presidential Library trustee John M. Hennessy, Chairman of Credit Suisse First Boston (CSFB) from 1989 to 1996, had been the Assistant Manager at Citibank’s Montevideo branch in 1964, and reportedly helped to transfer substantial funding to the campaign of Eduardo Frei Montalva,  who was running for President against Allende that year. Frei won the election, and served as President from 1964 to 1970.  In the early 1970s, Hennessy later became Assistant Secretary of the Treasury for International Affairs in the Nixon Administration, reportedly coordinating economic pressures against Allende’s government.[ii] In 1974, having succeeded at that Hennessy returned to Wall Street, where he became Managing Director of First Boston Corp., which was later acquired by Credit Suisse.    

In any case, despite the CIA’s involvement, the sufficient conditions for the 1973 coup against Allende were provided by a “Francoist” alliance of military officers, the Catholic Church’s hierar­chy, the top ten percent of landowners and industrialists, and the next twenty per­cent of the income distribution, the so-called “middle class.”  Immediately after the coup  these folks began to get what they thought  they wanted.

LOS CHICAGO BOYS

The junta turned to a small band of inexperienced but supremely self-righteous  economists, “los Chicago boys,” so named because their mentors University of Chicago economist and future Nobel laureate Professors Milton Friedman and Arnold Harberger.

After Pinochet took power, there was actually a prolonged period when several different economic camps competed for the junta’s favor. But Friedman and Harberger,  who was Dean of the Chicago Economics Faculty,  seem to have tipped the balance when they visited Chile in March 1975. Since the 1950s, with the support of the Rockefeller and Ford Foundations, Harberger had developed a close relationship between the University of Chicago  and Chile’s Catholic University, where he had taught as a Visiting Professor.  With support from the Rockefeller and Ford Foundations, scholarships were provided for bright young Chileans who wanted to study economics.  Many of these Chicago-trained economists returned to Catholic University to teach, and later served in Pinochet’s government.

 Their trip was sponsored by the Chilean businessman Javier Vial, head of the business group BHC, one of the country’s largest conglomerates, the eventual owner of Banco de Chile, the country’s largest private bank at that time, and 60 other companies. He was also a very strong supporter of Pinochet’s dictatorship, on personal terms with the General.[iii]  Friedman reportedly got $30,000 for the three-day trip. His wife Rose  reportedly objected to the visit because Pinochet’s hard right regime and the goose-stepping Chilean military  reminded her of Nazi Germany.  But Professor Friedman tried to assuage her guilt by requesting the release of two Jewish political prisoners who were supposed in the custody of Pinochet’s police.

 Just one month after the visit, in April 1975,  the junta introduced an orthodox monetarist “shock plan,” along the lines that Friedman and Harberger had recommended.  And Professor Friedman’s  Chicago-trained protégé Sergio de Castro replaced Fernando Leniz as Minister of the Economy. Other key neoliberals  on Pinochet’s economic team included Pablo Baraona, President of the Central Bank, Alvaro Bardon and Jorge Cauas Lama at Treasury, Rolf Lüders as Treasury Minister and Minister of the Economy, and Juan Carlos Mendez as Director of the Budget.  Unfortunately the two Jewish prisoners were never located.

 This tiny band’s shared vision of Chile’s future was one that later became common among neoliberal Third World governments -- sort of a low-wage, export-oriented  Asian tiger, complete with weak unions, low inflation, privatized pension funds, and a minimal state --  apart from the police, the military, and the national copper company, of course, whose income went to the military. 

To pursue this anti-Marxist utopia they started out with a sharp recessionary  shock. They banned strikes, abolished price con­trols for  food and housing, and slashed tariffs from 100 percent to 10 percent in just two years. The  junta also intro­duced Latin America’s most radi­cal  privatization program ever. In l973-74, more than  250 nationalized companies were re­turned to  their former owners and 200 more were sold off at bargain prices.  These were not the  mid­dle-class privatiza­tions  of France, Japan, or  the UK, where the buyers  included  millions of small investors.  Like other developing countries,  Chile had a very  thin capital market, and hard times had  made it even thinner. So the big buyers at this fire sale were a handful of closely-held   grupos  like  Javier Vial and Cruzat-Larrain, which owned most of the local banks,  and also had very strong ties to foreign  banks.[iv]

All these changes set the stage for the dictatorship’s 1977-81 phase,  which was de­scribed at the time by the Wall Street Journal’s neoconservative editorial page in even more glowing terms than it reserved for the Argentine junta --   as “the Chilean economic mira­cle.” Indeed, during this brief period, when the economy was recovering from the sharp recession that los Chicago Boys had engineered, growth averaged  5-8 percent a year. 

 But what was perhaps most miraculous was the regime’s inability to foresee  that its  economic policies -- in addition to increasing poverty and inequality --  were about to cave in on each other, completely bankrupting the country and forcing  the national­iza­tion of the entire private sector. 

THE CHICAGO ROAD TO SOCIALISM -- AND BACK

By l977,  the junta had wiped out  any organized political opposition  and achieved most of its early economic goals. But the neoliberal  ideologues  pushed  it on to new extremes.  Under José Pinera’s 1979 radical right “Plan Laboral,” the government abolished closed shops for unions and tried to privatize everything from  health care and pensions to education. The 1980-81 pension fund privatization, which substituted a “fully funded” system administered by privately-managed pension funds – managed by institutions like Citigroup and Aetna, which came to dominate the highly-concentrated private system -  for the old “pay-as-you-go” government system,   was probably the most successful of these reforms. [v]  Many others succeeded only  in cutting social spending, while sacred cows like mili­tary spending and the nationalized copper company were  spared. 

The copper company was fa­mous because of the uproar provoked when Allende seized it from Anaconda in 1971. But Pinochet kept it nationalized --  a secret law  gave the military  ten percent of its profits.  So even under the junta, Chile’s largest  enterprise and exporter remained “socialist.”

In any case, the junta’s most important  neoliberal experiments -- and worst mistakes -- concerned macroe­conomic policy.  Here the point man was  Sergio  de Castro,  the los Chicago Boy who became Pinochet’s second Finance Minister in l979. Like Argentina’s “Wizard”  de Hoz,  De Castro was a strict believer in the monetarist view that the best way  to fight inflation in “small” economies like Chile  was  by  eliminat­ing tar­iffs, deregulating capital and trade, and maintaining a fixed exchange rate.[vi]   So he fixed Chile’s peso at 39 pesos to the dollar and held it there  from July l979 until June l982.   With copper prices in a slump and the size of the state sec­tor shrinking,  this was only possible be­cause foreign banks were willing to lend money hand-over-fist to Chile’s private sector.  Foreign  banks were sympathetic to  Pinochet’s conservative economists, much as they had been to the Argentine junta’s de Hoz;  they were also flush with cash and  very compet­itive, given Chile’s high real domestic interest rates.  

So, just as in Argentina,  many domestic borrowers took advantage of  fixed exchange rates and the temporary generosity of their foreign bankers to make lucrative  back-to-back deals.  For example,  Javier Vial, the sponsor of Friedman’s 1975 visit, and Chile’s richest man by 1978, acquired control over Banco de Chile in the late l970s and used it as a front to borrow heavily from foreign banks like Bankers Trust and  Chase. When he was its President,  Banco de Chile, in turn, reloaned the dollars to Vial’s many other private companies, including sev­eral that were based in Panama, like Banco Andino.  All these shenanigans be­came public af­ter Vial’s empire cracked in 1983.  In 1997, after a 14 year investigation, he was sentenced to 4.5 years in jail for bank fraud, and former Economy and Treasury Minister  Rolf Lüders, who’d owed 10 percent of BHC, was sentenced to four years.[vii]  Chile had gotten  stuck with his debts when the bank failed and was nationalized.   All this was no surprise to his foreign bankers -- as one former Bankers Trust officer who had personally  handled Vial’s Panama accounts told me, “We knew he was lending to himself, but  no one wanted to pull the plug.” [viii]  

As a result of de Castro’s policies,   Chile’s private foreign debt boomed  during  the “miracle” years.  In  l981 alone,  $6 billion of new credits were issued by foreign banks, a huge amount for this small economy, mainly  to  the leading domestic private banks like Banco de Chile, Banco de Santiago,  Banco Internacional, and Banco Colocadora, whose grupos,  in turn, owned a huge equity stake in Chile’s private sector.  From l980 to l982, private  foreign debt doubled; by l982  the total foreign debt had ap­proached $20  billion,     two-thirds of  it private.  The Central Bank re­peatedly warned  that it was not responsible  for the  private debt, but  it  al­lowed the spree to continue.  Given   all the “cheap” dollars and low tariffs, im­ports  also soared --   luxury imports became  Chile’s equivalent of flight capi­tal.  

A NEOLIBERAL CRISIS

The whole situation  finally began to  unravel in  May  1981  when Crav, a leading sugar company, failed.  The real crunch came in the summer of l982  when the Latin American debt panic dried up new loans, forcing  Chile to devalue and tighten interest rates, a lethal combination.  By January 1983 unemploy­ment   was thirty  percent,  and the six top private banks and the country's two largest pri­vate “grupos,” Vial  and Cruzat-Larrain, had also both folded. 

At this point Finance Minister de Castro began to get  intense pressure from foreign banks  like Chase and Bankers Trust to “nationalize”  the private foreign debt.  For a while he stuck to his free-market principles, reminding them of his  earlier warnings -- that such a move  would be no more justified than Allende’s nationalizations, and that this was, after all, private foreign debt, freely contracted, presumably with compensation for the risks of default built into the interest rates.  

But  the great big banks were not concerned with  such abstract princi­ples -- any more than they are today.   In January 1983,  they  quietly cut off  all Chile’s foreign trade credit lines – to the point where oil tankers en route to Santiago started to turn around and head home.   De Castro was forced to resign, and his replacement quickly declared that, indeed, the junta would as­sume responsibility for the private foreign debt (though not its offshore flight assets!) after all.  In the words of one Chilean banker, “Pinochet achieved what Allende only dreamed of -- the complete so­cialization of  our private sector.”[ix]   

Nor was this  the end of the story. When Pinochet’s fourth Finance Minister, a de Castro protégé named Hernan Buchi, took office in l985, he had to em­bark on  yet another, even larger  round of privatizations, simply  to rid the government of all the debt-ridden companies that the government had just acquired through the forced nationalization.  

(To his credit, General Pinochet did support the compulsory nationalization of Chile's largest banks -- as compared with the far more generous, CEO-friendly bailouts that the US Treasury has recently employed.)

Subsequently,  foreign bankers, the World Bank, Wall Street, and the IMF all gave Buchi  and the Pinochet regime rave re­views for their brilliant privatization strategy,  designed to attract foreign investment, boost savings,  and downsize Chile’s state.  But they never seemed to acknowledge why his privatization program  had been necessary  and possi­ble  in the first place  -- because  in 1983, neoliberal policies had produced a disaster, and   the junta and Chilean taxpayers had been forced by its  foreign credi­tors to take the fall for so many bad debts.

Finally, capping it all,  whom do you suppose were the main beneficiaries of Chile’s latest round of priva­ti­za­tions?  To  avoid the insider-trading outrages that had characterized many of the 1970s privatizations – helping groups like Vial and Cruzat to grow quickly --   Buchi did offer low-cost loans to workers and pension funds to help them buy stock.  By l988 worker-owned funds owned 14 percent of the privatized shares,  not a bad achievement in worker control for an ostensibly right-wing regime.

But two other kinds of investors became even more important.  The first were  foreign  investors, especially Sergio de Castro’s old friends, the foreign banks. In l986, under the  Central Bank’s “Chapter 19” program,  they  were al­lowed to swap their  (dubious) nationalized loans for equity in state-owned companies that were  priva­tized on very  fa­vorable terms.  

As a result,  Bankers Trust obtained forty percent  of Provida, the country’s largest pension fund, plus  Pilmaiquen, a power plant, for   half its book value;   Aetna Insurance bought the country’s second largest pension fund;   Chase, MHT, and Citibank  also acquired major  local interests. Already by 1990,  a handful of foreign-managed pension funds   controlled seventy percent of  Chile’s pension system,  its largest pool of  capital.  Alan Bond, the er­ratic  Australian investor whose  financial em­pire  later collapsed,  was even permitted to buy the fa­mous telephone company that ITT  had fought Allende so hard for.  COPEC, Chile’s oil company, which had been privatized for a song to Grupo Cruzat-Larrain in 1976, had since turned into a debt-ridden conglomeration of fishing, mining, forestry, and finance companies, including half of Banco de Santiago.   When Cruzat cratered in 1983, Chile’s government re-acquired ownership of the now-heavily indebted COPEC, which was also by then Chile’s largest private enterprise. Four years later, it reprivatized COPEC to Grupo Angelini, another leading Chilean private conglomerate, again at fire-sale prices. And so the cycle continued.....[x] 

All told, this  “Chapter 19”  debt-equity swap program was credited  by its supporters -- especially the banks -- with reducing Chile’s debt by more than $2 billion. Of course it was a little ironic for the banks to be praising this achievement. Many others saw  the program  as a dead give-away.  By assuming  all the pri­vate foreign debt in the first place, Chile had rewarded bad lending.   And after a decade of tight-fisted government  many of the  privatized assets had actually been in pretty good shape.  Except for the copper company and a few military sup­pliers, the only ones the government retained were “dogs” no one else wanted.  It made little sense to let foreigners trade du­bious loans for valuable equity  at rock-bottom prices  -- maybe even less sense than Allende’s    nationalizations.  It seems that Chile hadn’t really eliminated state intervention; it had merely inverted its class bias.

The other key investor in Buchi’s  privatizations was the good old Chilean elite -- like Sebastian and his brother.   As we’ve seen, while the government nationalized  private debts,   it didn’t touch  private foreign assets.  And Buchi now offered flight capitalists  a gener­ous tax amnesty  if they brought their money  home.  His “Chapter 18” program  allowed them to buy   debt from the banks and swap it for  government bonds or equity in state companies at very  favorable prices.  By l990,  this program had brought in another $2 billion. Again, the banks and their clients  naturally sang Chapter 18’s praises. However,  it re­warded tax evasion and effectively swapped for­eign  for domestic debt that may  well prove more costly to service in the long run. Such criticisms meant little to the  officials in charge of the program, however -- some of them even benefited  from it personally. Soon after he left government, for example, Jose Pinera be­came president of an electric utility that had been privatized. And his brother ended up owning the privatized national airline – which he proceeded to turn into quite a profitable enterprise, even while serving in Chile’s Senate.

So the  circle was complete:  having been bailed out of their foreign debts by the government,  Chile’s  elite and the foreign banks now bought back their assets at less than fifty- sixty cents on the dollar, often with the very same flight dollars  that the original loans had financed! 

Here we have one of the purest cases of abusive banking,  one that poses the ques­tion of the foreign banks’ responsibility very clearly. For  Chile’s  1983 debt crisis obviously had little  to do with  inefficient public enterprises, excessive public debts,  godless Marxists, welfare-state liberals,   or  all the other usual suspects blamed by neoliberals.   At that point, fully two-thirds of  its  foreign debt was  private, and Pinochet and Co. had long since elimi­nated much of the state’s inefficiency, not to mention the political opposition.  Yet by the end of l983,  Chile  had ended up with one of the highest per capita foreign debts in the world, as well as  one of the developing world’s largest state sectors.

And this “Chicago road to socialism,” it seems, was taken in part because there was no  political opposition, no ac­countability – no one to say “enough” to the foreign banks, the domestic elites, their unregulated domestic banks, and the generals. So perhaps democracy had its uses, after all; perhaps  “free markets” alone were not sufficient. 

One could almost imagine the righteous tail-cutters in Chicago, taking a break for a micro-second from their round-the-clock crusade for more-perfect markets, experiencing perhaps just a momentary tremor of self-doubt.

*** 

---

[i] As of 2001, Chile officially recognized the existence of 3197 disappearances and extrajudicial killings  between September 11, 1973 and March 11, 1990, when the elected government  of Patricio Aylwyn assumed power. See “Korean Panel To Cooperate with Chile To Reveal Truth over Mysterious Deaths,” Korean Herald, February 7, 2001.  

[ii] See Morton Halperin, Jerry Berman, Robert Borosage, and Christine Marwick, The Lawless State.  The crimes of the U.S. Intelligence Agencies. (New York: Penguin Books, 1976), 16.

 

[iii]  For more about Vial, see “La Nueva Derrota,” Que Pasa, November 10, 1997; S. Rosenfed and J.L. Marre, “Chile’s Rich,” NACLA Report on the Americas, May/June 1997.

 

[iv]  See “Milton Friedman: Gurú a regañadientes, “ Revista Qué Pasa, February 28, 1998.

 

This account of the l973-78 period benefited greatly from  an excellent paper by Paul E. Sigmund, “Chile: Privatization, Reprivatization, Hyperprivatization.” (Princeton University, unpublished, July 1989).

 

[v] See, for example, Rodrigo Acuña R. and Augusto Iglesias P., “Chile's Pension Reform After 20 Years,” The World Bank -  Social Protection Discussion Paper No. 0129, December 2001.  Chile’s pension reform, which substituted a privately-funded system for the traditional “pay as you go” government system, was enabled by the fact that its military government could simply mandate the substitution. Subsequent attempts at privatization in more democratic countries like Argentina and Uruguay proved much less successful. 

 

[vi] This theory, espoused by arch-monetarists like Colombia University’s  Robert Mundell, argued that this policy would constrain inflation to the world rate by making a large share of the money supply endogenous.  It basically ignored exchange rate specu­lation and capital flight.

 

[vii]  For Vial’s and Lüder’s October 28, 1997 sentences, see “La Nueva Derrota,” Que Pasa, November 10, 1997, available at www. quepasa.cl/revista/1386/18.html..

 

[viii] "Chile Military Analyst,"  Sao Paulo, 2.21.89; “Miami Banker,” 5.91.

 

[ix] Raul Fernandez, former Director of Public Credit for Costa Rica, International Bank of Miami,  4.22.88. 

 

[x] See the account of COPEC in S. Rosenfed and J.L. Marre, “Chile’s Rich,” NACLA Report on the Americas, May/June 1997.

TOO BIG NOT TO FAIL? James S. Henry

(A version of the following story appeared in the Nation on February 23, 2009, here )

Even if a global economic recovery still eludes us, has President Obama's new team at least already achieved a stunning turnaround in US economic policy?

Or has the administration just been fighting the last war,paying far too much attention to ancient history, special interests, political correctness, and its own pre-recession agenda, in its programs to stimulate the economy, fix the banks and providing debt relief to homeowners?.

For lifelong students of the Great Depression like Federal Reserve Chairman Ben Bernanke and Larry Summers, it probably seems that Obama's economics team is on track.

In less than a month, Obama has pushed his record $787 billion stimulus bill through a highly partisan Congress. The resulting projected federal deficits will be even larger as a share of of national income than those incurred under FDR, until World War II. At a time when unemployment is rising sharply, this should be good news for the economy--- if the plan is sufficiently stimulating.

On February 10, Treasury Secretary Timothy Geithner announced a bold, if somewhat imprecise, $2.5 trillion program to relieve US banks of dodgy assets once and for all. Combined with trillions in other loans and guarantees from the US Treasury and the Federal Reserve, this is designed to avoid another costly Great Depression-type error, in which scores of banks were allowed to fail and credit markets seized up. If the plan really is expected to work, that should also be good news for the economy.

Bernanke also concluded from his lengthy studies of the Great Depression that the Federal Reserve had blown it way back then by keeping monetary policy too tight. So ever since last summer he's made the US money supply as loose as loose can be, ballooning the Fed's balance sheet to nearly $1 trillion and driving real interest rates down to zero, while pressuring his counterparts in Europe and Japan to folllow suit.

Obama's team also has emphasized the importance of avoiding the beggar-thy-neighbor "protectionism" of the 1930s--aside from a little "Buy American" language in the stimulus bill and a few remarks from Geithner about China. If loose monetary policy and tighter lips are sufficient for recovery, it should be just around the corner.

Finally, in the course of Obama's drive to pass the stimulus, he traveled to troubled communities in Indiana, Florida and Arizona and heard first-hand that millions of American homeowners and small businesses could use a little financial aid of their own right now. So Obama has committed $275 billion of the remaining TARP/"Financial Stability" funds to this purpose. In principle, this should also be good news for the economy--if we really believe that the plan has what it takes to stem the galloping pace of foreclosures and bankruptcies.

Obama and his team may really believe that their first month in office compares favorably with FDR's in 1933. Historical pitfalls have been avoided, and there has been no shortage of good intentions, optimism and action. The new president has also assembled a team that includes, by its own admission, the nation's brightest economists and its most experienced veterans of the Fed and the Treasury.

But something seems to be missing. During FDR's first few months in office, and well into his second term, he received an overwhelmingly positive response not only from the public at large but also from the stock market, despite the fact that FDR and Wall Street generally detested each other.

In contrast, the reaction of global stock markets and market analysts to Obama's flurry of policy initiatives has been overwhelmingly negative. In the past week alone, since the passage of the stimulus, the announcement of the Geithner plan and the president's new plan for mortgage relief, the stock market has declined more than 10 percent. Indeed, the country's largest banks and auto companies, which were supposed to be the beneficiaries of much of these new programs, are on the brink of bankruptcy.

So what's the problem? Actually there are several problems. The first, as I noted in part one of this series, "The Pseudo Stimulus," there really is much less to Obama's stimulus than meets the eye and far less than will be needed to head off the dramatic increase in unemployment that is fast approaching.

For reasons of political convenience and a desire to move quickly, Obama and his advisors decided to appease a handful of key Republican senators, rather than seize the bully pulpit and rally support around a larger, more direct spending package with more debt relief for homeowners.

Ultimately Obama succeeded in getting just three "moderate" Republican senators and zero House Republicans to support the package. (Eleven House Democrats also voted against it.) These votes were costly. The final bill ended up slashing almost $40 billion from the package, while boosting the share of tax cuts to nearly 40 percent--including almost half of all relief provided in the critical first year when it is essential to get the downturn under control.

Most macroeconomists still believe that under conditions of excess capacity, tax cuts generate much less employment per dollar of lost revenue than almost any kind of spending, because upper-income types will save the proceeds or use them to pay down debts. Furthermore, many of the tax cuts in Obama's bill are regressive, even allowing for his favorites, "Make Work Pay," the earned income credit and child care credit. This means their impact on jobs will be even more limited.

For example, of $214 billion of individual tax cuts in the first two years, $100 billion will go to the top 20 percent, while the bottom 60 percent gets $81 billion. Indeed, for one of the largest single tax cuts in the bill, the $70 billion reduction in the "alternative minimum tax," 70 percent will go to the top 10 percent, while the bottom 60 percent--including most unemployed workers--get .5 percent. So Obama's vaunted plan relies on this premier-class AMT cut, plus another $100 billion of business tax breaks, for 27 percent of its first two years of "stimulus."

On top of this, Republicans like Arlen Specter also have shown that they give no ground to Democrats when it comes to sausage-making. I won't repeat part one's list of trinkets, except to note that almost all the worst projects survived, and indeed were only enhanced by the solons' scrutiny.

As a former Minnesotan I'm all in favor of free WiFi for each and every one of the nation's two million farmers; I've also recently written here in glowing terms about the merits of government- sponsored research and development and "green housing." But this kind of spending has little to do with putting millions of unemployed people--most of whom are in urban areas--back to work.

All told, at least $200 billion of this stimulus spending, on top of the $200 billion of wasteful tax cuts, is not remotely related to the urgent goal of creating as many jobs as possible in the next twelve to eighteen months. The cause of recovery was hijacked by a weird coalition of environmentalists, energy companies, venture capitalists, public-sector unions, state governors, tax-cut nuts and other special interests.

The stimulus program was supposed to realize Obama's declared goal of saving or creating at least 4 million new jobs by 2012--even then, at the average cost of $200,000 per job. According to the Congressional Budget Office, even that level of job creation would only reduce the US unemployment rate by an average of less than one percentage point a year by 2012, for a cumulative reduction of 2.5 to 3 percent relative to the CBO's projections of what unemployment will look like without the program.

By the time the Senate got through with it, Obama's stimulus became much weaker. So most economists now agree that it will be lucky to create or save even an extra 2.5 million jobs by 2012--about a 1.5 to 2 percentage-point cumulative reduction in the official unemployment rate by 2012, at an average cost to taxpayers of $315,000 per job.

The contrast with FDR's focus on spending programs that really did put people back to work, is striking.

THE REAL UNEMPLOYMENT RATE

Recent trends in unemployment help us to understand just how much work we will have to do to define victory and to see how close we really may come to another Great Depression.

All the standard measures of unemployment are woefully inadequate, but the shortcomings change with the times. In good times, with tight labor markets, conservative economists find it satisfying to remind us that the degree of "involuntary" unemployment is probably overstated, because workers can afford to game the welfare system--for example, by collecting unemployment insurance while refusing reasonable job offers.

In hard times like these, however, official unemployment rates seriously understate the degree of slack and hardship in labor markets. For example, in addition to the 13 million people now unemployed (that's 8.5 percent of the labor force) another 7.8 million workers report that they are underemployed; at least 2.1 million to 5.9 million more (none of whom are collecting unemployment) say they're not in the labor force because they've given up looking. By another measure, the peak labor force participation rate, established when labor markets were very tight in 1999 and 2000, shows the potential supply of labor not counted as unemployed is even larger--10.6 million right now.

All told, this means by now there are already at least 23 million to 33 million American adults who are already experiencing increased unemployment, up from 13 million to 17 million from a year ago. By the end of 2009, as the official unemployment rate passes 10 percent and the other indicators of slack labor markets grow as well, this figure will swell to 40 million American adults--at least 9 million to 18 million more under-utilized workers than we have now.

A majority of these people have families. Furthermore, the unemployed population constantly turns over, with a median duration of joblessness that now exceeds ten weeks. This means that during the next year, up to one-third of the entire US population will personally encounter someone facing the harsh realities of involuntary unemployment, and perhaps homelessness and poverty as well.

These figures omit several other kinds of "hidden" unemployment that are not recorded in conventional labor force and unemployment statistics: the 1.44 million people on active duty in the military and the unemployment they would face if and when they return to civilian life; the 2.3 million inmates in federal, state and local prisons, all of whom are omitted from labor force and unemployment statistics; and the estimated 8.1 million undocumented workers in the United States who are in the labor force.

In many ways undocumented workers are the most vulnerable victims of the crisis. Most support families either abroad or home. Many also have been working hard here for years and have now lost their jobs, without any unemployment insurance, healthcare, rights to Social Security or other benefits. And since Congress has not been able to agree on a decent immigration reform bill, they may not even be able to count on achieving US citizenship, after years of working and waiting. Now they face a hard choice between remaining here, unemployed, or returning to violent, corruption-ridden "Bantustans" in Mexico, Central America, the Philippines and elsewhere.

It's important to take these factors into account when we consider how this downturn compares with earlier financial crises. Unemployment statistics for the 1930s are difficult to compare with our current situation, given the different statistical procedures employed and the very different demographics in the two eras. But my analysis shows that it is possible that this crisis may turn out to be comparable to the situation in 1933, when unemployment peaked at roughly 25 percent of the US labor force.

This analysis provides a context for assessing Obama's original goal of creating/saving 3 million to 4 million jobs by 2012. The fact is, even that original goal simply wasn't anywhere close to being ambitious enough--and it certainly won't be met under the sadly compromised final "stimulus" plan. The negative reaction of global stock markets markets to Obama's plans so far appears to confirm this. We're going to have to stop the political games and get serious.

GEITHNER'S TARP II

What about the second leg of Obama's new post-Depression economics policy initiatives, Geithner's plan to inject yet another $2.5 trillion of ("public-private") capital into US banks to get rid of their toxic assets?

Markets reacted negatively to the plan not because investors necessarily opposed his new toxic asset buyback scheme. Most analysts felt that his long-anticipated statement was long on rhetoric about "stress tests and transparency" but short on digestible content--like being invited to dinner and then served pictures of food.

Indeed, like his website, FinancialStability.gov, Geithner's plan remains under construction. But critics may have missed the point--this lack of detail actually may be a political necessity. If the American people understood just how high a price the Obama adminstration may be willing to pay simply to keep our country's largest failing private banks private, we might need a few more guards at the Winter Palace.

Tim Geithner is not a former Wall Street insider in the Paulson/Rubin mold, nor was he ever for a single day a community organizer. He's an ambitious and cautious policy technocrat, whose lucrative private-sector career and board seats are still in front of him. We'd be hard-pressed to find anyone who, at age 47.5, had already punched more establishment tickets. His grandfather was a Ford Motor executive and Eisenhower adviser; his father is a Ford Foundation officer who raised Tim on three continents. He graduated from Dartmouth and Johns Hopkins, became a consultant for Kissinger Associates, a protégé of Robert Rubin and Larry Summers at Treasury in the 1990s, an IMF policy director in 2001-2003, a Council on Foreign Relations fellow and finally head of the Federal Reserve of New York. As of the end of 2008, he was still a member of the CFR, the Group of Thirty and the Economic Club of New York, organizations not routinely associated with sponsoring deep reforms in post-capitalist economies.

Geithner has seen his share of banking crises firsthand: Mexico in 1995, when the entire banking system had to be re-nationalized; Thailand, Indonesia and Russia in 1997-98; Argentina in 2001; and now the biggest one of all right here. All of the Third World crises just noted ended badly--costly, poorly-managed fiascos that did nothing to enhance the reputations of the US Treasury and the IMF. But perhaps Geithner was just an apparatchik. He worked closely last year with Hank Paulson and Bernanke on Bear Stearns bailout, the Lehman/Merrill decisions, the AIG takeover and TARP I. So he probably understands full well not only the gory details of program design but also two fundamental political realities.

The first is that while nationalizing top-tier global banks may be politically acceptable in places like Norway, Sweden, Chile, Iceland, Ireland and even Japan and the UK, it is still viscerally opposed by most members of the power elite in New York and Washington--including most of his former club members.

The second is that by now, most American taxpayers have simply had it with huge Wall Street bailouts, supine members of Congress, overpaid banker chutzpadiks and high-handed Treasury secretaries. If they were ever asked, there is no way in Naraka that taxpayers would ever approve yet another open-ended injection of public capital into banks--especially one costing three times the entire "stimulus" and three-and-a-half times TARP I.

So the trick is to not ask them. With bank stocks sinking every day, the credit crunch hampering recovery and high expectations about policy changes, Geithner had to say something. But not too much. The whole subtext of his vague announcement was to finesse the question of precisely where all the money would come from. The hope was that this would buy time to line up private capital, perhaps by negotiating some kind of insurance subsidy that would induce it to participate. The hope was that this would do enough to stem the decline in bank stock prices and redirect attention away from the new "N"-word--nationalization. 

WELFARE FOR BIG BANKERS

The public outrage is justified. Since October, more than 360 US banks (out of 8,367) have already received at least $353 billion of TARP I funds from the Treasury. This is by far the largest corporate bailout in US history, more than twenty times the original $17.4 billion auto industry bailout.

Of this, more than half went to the top fifteen banks in the country. This includes $145 billion of capital injections awarded to Citigroup, Bank of America, JP Morgan and Wells Fargo, the top four US commercial banks; another $10 billion each for Goldman Sachs and Morgan Stanley, two worthy investment banks that decided to become commercial banks to avail themselves of federal aid; and a grand total of $84 billion to the rest of the US banks. There was also $40 billion in capital injections and $113 billion in credit in AIG, the profligate insurance company that sold so many flaky credit derivative swaps to investment banks like Goldman that it pioneered a whole new new "too fraudulent to fail" rule. In addition, by now US banks have also received at least $1.82 trillion of federal loan guarantees and $872 billion in federal loans.

These sums need to be viewed in the context of the staggering amount of government assistance that has recently been provided to private financial institutions all over the world. By February 2008, by my reckoning, banks and insurance companies have already absorbed at least $817 billion of government capital injections, $251 billion of toxic asset purchases, $2.6 trillion of government loans and $5.9 trillion of government debt guarantees. If we added the guarantees for once quasi-private entities like Fannie Mae and Freddie Mac, the loan guarantees double to $10.9 trillion.

To put all this in perspective, the 1980s savings and loan crisis cost taxpayers from $150 billion to $300 billlion in comparable 2007 dollars. The 1998-99 Asian banking crisis cost $400 billion. Japan's prolonged banking crisis in the 1990s cost $750 billion. And the total amount of debt relief received by all Third World countries on the $4 trillion of dodgy foreign debt that they incurred from 1970 to 2006 was just $310 billion.

Those crises are completely over, while this one is still unfolding, so its ultimate cost is still uncertain. Already it is clear that ordinary taxpayers around the world are on the hook for total losses that will easily dwarf all the costs of all these other recent banking crises combined--including $2 trillion to $4 trillion of further bank write-offs beyond the $1 trillion of losses already recognized. Since no government on earth has the surpluses on hand needed to fund such largesse, this means that we will be paying for this bailout one way or another for the rest of our lives, and probably for our children's lives as well, through increased inflation, taxation and reduced government services.

Never has so much been given to so few by many. Yet despite all this public generosity, much of the US banks' recent behavior been execrable. For example, in December we learned that the US Treasury got preferred securities in exchange for the first $254 billion of TARP funds that, right off the bat, were worth $78 billion less than the funds they received.

We've also watched with amazement as they've continued to fund corporate jets and other perks, and as several of the largest recipients of TARP funds have paid extravagant bonuses to senior executives for "performance" in 2008--a year when the banking industry contributed mightily to the tanking of the entire global economy. Nor have most banks been forthcoming about what they've actually done with all the TARP money--except to to concede that they haven't done much new net lending. After all, they say, in this economic environment, with regulators suddenly breathing down their necks about leverage and toxic assets, they are not eager to take risks.

That's all well and good at the micro level, but at the level of the overall economy, we badly need banks to swallow hard and start churning out new loans--and not just to gold-plated borrowers who don't really need the money. Since TARP I funds were not dedicated to new lending, and, indeed, since policy makers like Paulson, Bernanke and (presumably) Geithner decided to leave TARP I's use entirely up to the banks' discretion, this period of extreme largesse and low interest rates has also coincided with tight credit markets--except for well-off corporations and elite borrowers and refinancers, who have actually been the main beneficiaries of Bernanke's low-interest rate policy.

So while both the Federal Reserve and the Treasury have been busy demonstrating that they have finally taken the lessons of the Great Depression to heart, and have been setting records for generosity and loose lending, at the end of the day they still allowed the private banking system to keep its elephant in the hallway, blocking the road to recovery.

In the four months since receiving the first TARP Installment, the US banking industry has become a supersized version of the US auto industry--on the verge of bankruptcy, kept afloat by government capital, loans and loan guarantees, with no long-run strategy other than to continue its well-funded lobbying efforts and heavy campaign contributions and to occasionally show up in DC before toothless Congressional committees for well-choreographed rituals of contrition.

Since October 2008, the net worth of the entire US banking system-- all 8,367 domestic-owned US banks--has declined by $420 billion, to just $540 billion. In other words, TARP was one of the worst investment decisions in corporate history--the banks' net worth has declined by more one dollar of equity value for each additional dollar of TARP funds injected.

Indeed, the net worth of two of the largest banks in the system, Citigroup and Bank of America, is now around $30 billion, less than half of the $70 billion in government capital that they have received from TARP I, on top of $424 billion of federal loan guarantees. Not only has their own "value added" during this period evidently been negative. For a fraction of the funds we've given these two banks, we could have stopped begging them to clean up their balance sheets, restructure their mortgages, stop wasting money, change their compensation plans and initiate sensible new lending programs. We could have bought a controlling share, hired new management from the droves of idle bankers now out on the street and re-privatized them at a profit for taxpayers in two to three years--just as successful "turnaround nationalization" programs have done again and again in these situations, from Norway to Chile.

No wonder that growing numbers of critics--not just hard-core lefties and Nobel laureates like Paul Krugman and Joseph Stiglitz but even pragmatic politicians like South Carolina Republican Senator Lindsey Graham--have started to break the taboo and talk explicitly about "nationalization."

But in an important sense the taboo had really already been shattered by TARP I, last year's expansion of FDIC deposit insurance and all the other new federal loan guarantees for the bank. In effect, these already "nationalized" the banks' debts. Now we're just talking about the other side of the balance sheet, where there might at least be some value, if only under new management.

TOXIC ALTERNATIVES

Geithner is hardly unaware of this short-term nationalization approach to the credit crunch, or of the success it has in many other markets. But he has apparently rejected it in favor of a much more costly and uncertain route--establishing a public-private bailout fund that will somehow entice the banks to sell off their lousy assets and still have enough equity left to survive as private entities.

The limitations of this approach are best understood by taking another close look at Citigroup and Bank of America, two of the most troubled institutions in this story. On their most recent balance sheets reported to the FDIC, these two big banks alone accounted for $4.1 trillion of official on-balance-sheet "assets"--mostly loans and federal securities, but also a hefty amount of potentially dodgy mortgage-backed securities and other asset-based securities.

Right off the bat, therefore, at least by the accounting numbers, these two top banks alone now account for more than 30 percent of all the assets outstanding in the entire US banking industry. Indeed, the top fifteen banks account for over 60 percent. This represents an incredible increase in banking industry concentration since the early 1990s, when Citibank and Bank of America held just 7 percent of all US bank assets, and the top fifteen banks held 21 percent.

This increase in industry concentration was hardly an accident. It originated in the desires of bank executives to grow, boosting market share, short-term earnings, stock prices and the executive bonuses driven by those metrics. But it also reflected the gloves-off stance that Congress, regulators and antitrust enforcement took toward bank expansion during this period. And that, in turn, was probably related to the more than $1 billion contributed by the financial services industry, their lobbyists and law firms, to politicians of both major parties since 1990, which turned the Senate Banking Committee the House Financial Services Committee and other key Congressional committees, in effect, into wholly owned subsidiaries of the banking industry.

Now how much might all these assets on the banks' balance sheets actually be worth? There is no active exchange for most bank assets, especially those that are hardest to value in this environment, like mortgage-backed securities. And by law, the banks are permitted to value the assets on their books at "fair market value"--in essence, whatever their accountants tell them they are likely to be worth, given historical experience with loan losses. But the difference between these accounting numbers and today's market value for these assets may be huge--up to half or more of book value. And the banks have a strong incentive to hold on to the loans and hope that things get better, rather than sell them off right now at whatever the market will bear. After all, as soon as they start selling down one loan bundle, they may be required to "mark to market" all similar ones. And the resulting writedowns might well be enough to wipe out all stockholder equity, leading to insolvency.

This whole situation is reminescent of the 1980s Third World debt crisis, when banks like Citibank, Morgan and Chase resisted for years the demands of policy makers and developing countries to write down or sell off the billions of overvalued loans on their books--for no other reason than, as one former Chase banker put it, "a rolling loan gathers no loss." Similar behavior occurred during the prolonged Japanese debt crisis of the 1990s, when banks stubbornly resisted the efforts to get them to "mark to market" because several of them realized they would be bankrupt and no longer with us if they did so.

There's not really much moral culpability here. At ground level, from the standpoint of any individual bank, this behavior is understandable. After all, they have just gone through a period of careless underwriting, and are trying to reduce their loan losses and improve their capital ratios--just like most bank regulators want them to do. The larger banks have balance sheets that are best described as follows: "On the left side (assets), nothing is right; on the right side (deposits and other capital), nothing is left." And since the economy is still slipping at an unpredictable pace all around them, no loan officer is eager to take on more risks. So it is hardly surprising that in the last quarter of 2008, even as the TARP money started to flow, US bank lending suffered its sharpest decline since 1980. It also makes perfect sense for them to resist selling off its loans and securities at what may eventually turn out to have been fire-sale prices.

While all this may be well and good for bankers, however, for rest of us it means that even after all those trillions in federal bailouts and loan guarantees, the economy is still starved for credit. The fact that major banks as a group continue to sit on all these lousy loans at book value, rather than selling them off and writing them down, means that they don't have much room on their balance sheets and in their capital/asset ratios for new loans. So the credit crunch continues. And banks that we eventually may find out were really insolvent may walk around in a trance for months or even years, like a scene from Night of the Living Dead. We're not talking about restoring the loose lending of the 2005-2007 bubble; we're talking about the essential liquidity needed to keep the wheels from coming off, stimulate demand and stem the decline in housing prices.

The importance of all this becomes clearer when we take a close look at the composition of Citigroup's and Bank of America's $4.1 trillion of assets outstanding. It turns out that these include $1.3 trillion of real estate loans and mortgage-backed securities (22 percent of the US industry's total), $153 billion of credit card loans (38 percent of the total) and $150 billion of auto loans, student loans and other loans to individuals (25 percent). Clearly all these book values may be severely at risk in the current economic crisis.

But these potentially troubled categories of assets only add up to about $1.6 trillion; why is Geithner talking about a $2.5 trillion program? The FDIC's latest statistic a provides a clue. It reveals the dominant role that the country's top banks have also played in issuing derivatives, including not only interest rate and currency swaps, but also in more notorious debt-based over-the-counter derivatives. As of September 2008, JPMorganChase, Citigroup and Bank of America accounted for an incredible 90 percent of $7.9 trillion of these "off-balance sheet" credit derivatives that have been guaranteed by these banks themselves--including $2.6 trillion guaranteed by B of A and Citi. So when Secretary Geithner was talking about running "stress tests"--scenarios for future housing prices, default rates and interest rates--against the balance sheets of particular banks, he was not talking about First Federal of Tuscaloosa or Suffolk County National in Riverhead. They've probably never guaranteed a credit derivative in their lives, much less tucked anything away in some Cayman Island "special purpose vehicle." Clearly, Geithner had his friends on Wall Street in mind.

REALLY A POLITICAL PROBLEM

In short, we have a choice to make: we can spend perhaps $150 billion to $200 billion buying out the equity of a handful of leading banks that have gotten themselves in this mess and reform them. This would involve taking them over immediately, installing new managers, giving their creditors a haircut, writing down the toxic assets (which the government-owned bank could do without fear of market reactions) and then preparing them for privatization when the market recovers.

Or we can follow Secretary Geithner's lead, fiddle around for months, throwing trillions more of government capital, loan guarantees and portfolio insurance at the problem, without any guarantee that the resulting cockamamie approach to creating a "public-private" toxic bank will ever work--while the same old troubled institutions are left standing, no longer encumbered by their dodgy assets perhaps, but still encumbered by dodgy managements.

There are lots of technical issues to be weighed in making this choice. But after reviewing all the objections to the kind of short-term, temporary, partial nationalization, I'm convinced that the most important issues are simply political, a choice between our commitment to a failed, hands-off model of bailouts and banking regulation and decisive, FDR-like action.

It is precisely because it is so hard to value these dodgy assets at all that we are even having this discussion. Given the absence of competitive markets for the assets, the uncertain environment and their dependence on taxpayer subsidies and insurance, the prices established are intrinsically political. Either they will be set so low that banks will have to take such massive writedowns that their shareholder equity will disappear entirely anyway, or--more likely--the prices or insurance arrangements will be set so that even more taxpayer wealth is transferred to these very same top-tier banks.

Meanwhile, the whole economy is hostage to this decision. We have no time to waste. We should get on with it, making use of one of the clearest market signals available in this situation--the current value of Citibank and Bank of America shares.

This argument is not at all anti-market, or necessarily even anti-bank. At their best, private markets, entrepreneurship and innovation are absolutely essential. My real objection is to a very specific kind of bank-dominated political economy. To call this "capitalism" is to have Ayn Rand and Friedrich von Hayek turning somersaults in the crypt. Time and again, this pathological form of pro-bank development has jeopardized the prosperity, stability and innovation of the small businesses, inventors and would-be savers who are the backbone of market economies. Bank-dominated political economies don't really deserve to be called "capitalism," since big bankers have never really been entrepreneurs who are content to stick to the capitalist rules of the game. Instead, they periodically demand the divine right to take unlimited risks, privatize the resulting gains and stick the rest of us with any resulting losses.

It is time for accountability, we are told by our new president. If so, we should start by holding the world's largest banks, hedge funds, insurance companies, mortgage brokers and private equity firms, together with their many friends in accounting, law, public relations, credit rating, central banking and higher office accountable for this crisis--if in no other way than by refusing to award them this even more massive TARP II bailout, permitting them to rob us, once again, with both hands.

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