Renegade Economists 206

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Broadcast Oct, 26th, 2011

K.F: Let’s have a chat with Yanis Tziligakis. He’s a New York based academic – he’s got a bachelors, a masters, and a phd in the field of physics – he’s now realized he’s got to get his head around economics and he’s headstrong into it, in the last 3 years doing some really good stuff on creative commons. We started off talking about Jeffrey Sachs’ new book. He was off to see his speech earlier today. Sachs’ new book is called the Price of Civilization. Anyway let’s get into this right now.

Can you give us a broad brush overview of the Greek economy? How much money do they owe? What’s the next tranche of debt they’re struggling to gain finance for at present? Set the scene for us.

Y.T: the level of the Greek debt is about €350 billion but of course that’s sensitive to the interest rates. Now Greece got about €110 billion bailout from the European Union and this is channeled- it’s been given to Greece in installments so this is exactly what the current problem was because Greece is supposed to be fulfilling certain obligations for each installment to be handed to it. Now as you can understand the problem lies in that those expectations that the Greek economy has to be fulfilling every time the new installment comes due to be paid out is that they are unrealistic. Or let me put it they are overly optimistic.

The Greek government thinks that they can target their deficit by austerity but at the same time losing track of their income – the tax revenues keep shrinking because of the austerity. It seems to me that the battle of tax evasion which is the main affliction of the Greek economy, if not of most of the economies around the world, that’s the battle that is impossible to win without international cooperation and that’s what Greece is lacking right now.

K.F: How do people evade their taxes in Greece? We hear a lot of stories of corruption going on there but tell us some of the stories you’ve heard of how the social contract in Greece is somewhat different to most countries, where only fools pay their taxes.

Y.T: I think the problem of tax evasion is not a moral problem. I’m against this corruption nuance that’s been passed around and I don’t think tax evasion is a corrupt act. I think it’s an act that makes economic sense. It basically shows that the citizens do not trust to give their money to the state. So, actually the Greek citizens have withdrawn their trust from the Greek government way before the markets sniffed something iffy in the Greek economy. Now it’s sort of a vicious circle of merry-go-round.

Greeks are very entrepreneurial people. 80% of the work force are entrepreneurs and only 20% are public servants so that’s another defamation that Greece has been afflicted with that it’s a country of an overgrown public sector – overgrown, overpaid and basically an inefficient public sector . That’s not actually true.

Greece is actually on the bottom tier of the European Union as far as size of public sector workforce and the size of its salaries that are devoted to the public sector. So the tax evasion has a very interesting nuance that actually nobody has picked up yet. The nuance is this – if the Greeks were simply tax evading, Greece wouldn’t have a problem because Greece would have been shrinking its economy and the cost of living in Greece would be going down if the Greeks were simply exporting their money overseas but that’s not really what is happening in Greece.

The money gets evaded to offshore tax havens and mattressed to places like Switzerland, the Caymans – Greeks are champions in offshoring – and the money comes back to the country untaxed – inflating real estate prices – which affects the overall cost of living and the cost of doing business. So that’s how Greece gets doubly hurt by tax evasion.

K.F: Tell us about the size of the Greek property bubble through the 2000s – how high did it grow?

Y.T: Greece’s real estate index inflated from the years 1993 to about 2008 – it inflated about 225%. So Greece has wealth – but it is under the mattress we call “slow turnover yielding capital”. That is called, in common parlance, real estate. Now the tragic-comic aspect to this is that offshore companies hold the bulk of this real estate and they artificially make Greece expensive for its own citizens.

K.F: Phenomenal – and then the property tax system in Greece has the curse of taxing the improvements like it does in so many other countries, so I hear there are lots of unfinished houses with steel turrets poking out of the roof as if the house isn’t really finished (only finished houses pay property taxes on the improvements). Is that one of the common sights around Athens and so forth?

Y.T: The common sight in Athens – but I haven’t visited for a few years – but a number I’m going to give you, Karl, is that a few months ago they had about 200,000 vacant properties – lets say available for sale or rent – I mean that’s an amazing supply of housing, however, the ratio of wages and pensions to rent has been constantly decreasing. In other words it becomes more and more unbearable to come up with the everyday living expenses especially for people who are getting unemployed and especially for pensioners.

Everybody’s talking about unemployment relief and extra relief to the pensioners but nobody can see that an immediate relief, which would be of no cost to the budget of the government, is by taxing rents and thus forcing them (house prices) down.

Another impact of the high rents is also on Greek businesses. About 1000 Greek businesses outsourced themselves – like they leave the country to go across the border – it’s a similar situation between the United States and Mexico. Its almost like it reaches the realm of the tragic-comic in Greece because it looks like Greeks keep shooting their own feet but they don’t seem to realize they are doing that. And it’s tragic for all these Greek companies that Greece is too expensive for them but Bulgaria isn’t. That’s the effect of high rents of an inflated real estate market which affects both workers and businessmen – it affects both labor and capital.

K.F: What taxation – what capturing of economic rents is there in Greece?

Y.T: Right now even though I had predicted and I had been fighting with my fellow Greeks because Greece is a country where 80% of the people have land. It’s not a country where the people are renters. I mean it’s not like the United States where the land belongs to a few people – a few moguls. In Greece almost everybody has some kind of property. So people know the value of their land and it’s hard for them to realize that this economic factor of production needs to be targeted. They don’t understand that land is a passive factor so if you invest in it you hurt the productive aspects of the economy. Greeks don’t seem to realize that.

However, the government realized it recently so they have actually tried to impose a real estate tax which they’re going to collect through the utility bill because that way they hope that they will be able to pinch everybody and nobody can avoid paying their utility bill so that’s the way they think that this tax is going to be imposed. Now as you said before this real estate tax is faulty, economically, in the sense that it punishes improvements on the land but it doesn’t punish speculation on the land values.

K.F: we’ve certainly got some topsy-turvy economic policies filtering around the world and no doubt the Jeffrey Sachs of the world will be continuing on this misinformation that we should be taxing our food and we should be cutting the public service and cutting the wages rather than ensuring that the precious resources we own are used efficiently and the naturally rising value of this earth is recycled back to the people, through the government, rather than all these taxes that just go mad.

So lots of rioting – there’s obviously some passion on the streets as we love Greek people for but what are the N.G.O’s, the resistance – are they actually looking at serious economic policy or is there still too much pain and hurt on the streets for people to be looking at alternative policies?
Y.T: I’m not sure – besides the Communist Party who has a very clear and ironclad ideology – which still doesn’t sound to me very clear on how it can be implemented. It’s one thing to say “support the workers” and another thing how are you going to provide the funds to support the workers in a climate where the businesses that employ the workers leave the country. So besides that I don’t see a very clear and well thought out plan on how to tackle the economic inconsistencies in Greece.

As soon as the government announced this extra real estate tax everybody attacked it. They think that boosting the real estate market is the way that the Greek economy should be going. However, they fail to see that that is actually what doomed the Greek economy. We had a 225% rise in the real estate and yet we are down in the dumps. So I don’t think there’s a clear understanding, even among Greek politicians. Even though I’m not a fan of the PASOK party, or George Papandreou, it sounds to me that he is the more likely to come up with the right economic solution.

As far as the conservative party, it sounds to me like its going to be a Greek version of the American Republican- the American G.O.P. party. So I’m not really hopeful if the conservative party takes the lead of the country – I’m not very hopeful about that.

But the people need to be on the street. The people need to protest not only about the economic demise of the country which is the result of an elite proportion of the population and that is something that the media don’t pay their due justice – their fair justice. They engage in a carpet criticism of the entire Greek people which almost borderlines racial slurring instead of targeting the true culprits which is an economic elite of 5 or 10% of the population.

An indicator that this is the case is that nobody, even from the Europeans, bother about the € 80 billion outflux of Greek savings to Swiss and other European banks last year. They almost put the country to the brink of revolution just for almost a billion dollars discrepancy in the reduction of the deficit this past October. However they don’t seem to bother about the €80 billion of savings that fled from the Greek banks to other European banks. It looks like some people do benefit from the panic by instilling panic into the minds and the psyche of the Greek people. So the Greek people need to think better of who their allies are and who aren’t.

Karl, the last point I want to make is that Andrea Merkel spoke yesterday in a very different and clear tone. She said very clearly that she wants to get her hands on the Greek real estate – on the Greek land, on the Greek natural resources; and solar power- that’s the key for the future. Greece has 50% more sunshine than Germany and yet is 80% behind Germany in taking advantage of that. The Germans want to take a piece of the Greek sun and that’s what this debt crisis is all about.

K.F: Whoa, that is a mad point to finish off with Yanis – thank you very much for joining us here on the Renegade Economists.

Thanks to Paolo Rosa for the pic

Presented by Dr Gavin Putland

Thursday November 6th, 6.45pm

As the panic sets in and discussions about a new financial framework at the Bretton Woods 2 meeting grow, Dr Putland will measure up the trends that continue to lead us into asset bubbles.

What can be done to avoid them? What should the G20 countries be focusing on?

What can we do to build a knowledgebase so that it doesn’t happen again?

Gold coin donation to cover drinks, nibbles.
Venue: Level 1, 27 Hardware Lane, Melbourne

RSVP essential

photo credit: TheeErin

Some A$2 trillion has been pumped into banks globally. Last night saw a record amount of commercial paper sold in the US, with the Fed buying some US$60 billion in debt. A record day in the US sharemarket followed. How many more days like that will last until the Fed’s kitty needs to be replenished?

The Republican administration has ensured that banks worldwide are cashed up. But what do small businessmen think? Will they borrow all this cash to keep investing? Or are their expectations different to the short term political aspirations of politicians?

Business will be hesitant to invest when property prices are expected to drop, but yet policymakers do all they can to avoid this occurring. The resultant hesitation will delay the true market corrections needed.

David Hirst comments on how women are doing the straight talking needed, with the Federal Deposit Insurance Corporation’s Sheila Bair saying:

“We’re attacking it (the crisis) at the institution level as opposed to the borrower level, and it’s the borrowers that are defaulting. That is what’s causing the distress at the institution level … So why not tackle the borrower problem?”

Whilst banks are propped up, copying Enron style accounting by keeping assets marked up beyond their market value, the latest commentary on retail sales figures vindicates our probing. The people’s sentiment is reflected in sales. No matter how well cashed up banks are, they won’t be able to help retail sales.

FURNITURE and electrical retailer Harvey Norman says trading conditions were still tight three weeks after the Reserve bank delivered a surprise 1 per cent cut to official interest rates.

The company said yesterday that written sales at its Australian franchise stores fell 3.6 per cent over the four weeks ended October 26 compared to the same period a year earlier.

Retail sales will only improve when we are spending less on rent. Land and property prices must fall. It will be ugly. The easy profits land speculation delivers led to over-investment.

The government’s of the world are engaged in a blame game, diverting attention away form the prime issue.  Bankers know the real cause. Perhaps deregulation is partly to blame. However, the much bigger issue at stake is the Government’s failure to capture the economic rent delivered to prime locations. This led to the frothing-at-the mouth over investment in land.

We challenge the first banker to stand up and call it as it is!

photo credit: Sepperer Markus | www.weltraumsepp.blogspot.com

We don’t think so. And neither does Dr Michael Hudson in this riveting interview (thanks to Guns and Butter, KPFA radio). Please listen. Forward this on. Hudson sums up the issues behind the credit crunch and the mystery behind the details of the bankers bailout in a damagingly direct manner. The world is at a crisis point. A new economic order is being thrust upon us.

In Australia we have a growing confidence returning to the market. But with Chinese demand slowing, our resource boom is under threat. Reading a Bushite economic advisor one understands why we are in today’s mess. David Hale tells us today that China will grow at 8% because domestic demand is strong. All the world needs is lower taxes.

However in the next paragraph he concedes that housing is in slowdown mode. Can we reflect on that for a second. If apartment prices are dropping by 25% in Guangdong, this flows through to the bank’s balance sheet, where they have to write down the value of their mortgages This infers they have less credit to offer. China’s domestic economy is victim to the same speculative excesses in housing as Australia, China and the rest of the western world. They will follow the US.

Whilst the political system prioritises the bankers over the wider community, land and housing prices will be propped up, meaning we the people have less to spend on food or to save. This prolongs the pain.

We are presently in the eye of the speculative storm. The bankers have been shaken around. They have sped to the front of the neo-handout queue. Soon the effects of high rents will crimp more and more business, sending them to the wall. Unemployment will rise and the people will try to join the neo-handout queue. This trend is increasing daily in America. Soon it will be occurring in China and then Australia.

A dangerous trend is developing. Again policy makers are doing exactly opposite to what the wider community requires.

The Irish Times reports: China acts to boost property sector as figures show sharp drop in growth

The government said yesterday that taxes on house purchases would be reduced and value added tax rebates would be increased for exporters of textiles and machinery.

Thankfully Forbes reveals:

However, the report cited a survey by Sina.com as saying that more than 84 pct of Internet users oppose governments’ efforts to revive the market as they believe such measures will benefit real estate developers by driving prices higher.

Keep thinking beyond the press like the everyday Chinese are.

Unfortunately the new West Australian Liberal government is pandering to the richest people in the nation by cutting Land Taxes. This dangerous reduction in taxes will automatically be pocketed by the land monopolising speculator. Economic law dictates this and will ensure that the looming recession is deeper and longer because we are spending too much on housing and business on commercial property. But hey, the banks love it.

Fred Harrison Press Conference

at the Foreign Press Association, London

photo credit: azrainman

Will it ever be learnt? The Greenspan playbook of cutting interest rates pushed the asset bubble ever higher and higher in the early to mid 90′s. Now Australia’s Reserve Bank governor Glenn Stephens is endeavouring to do the same. And gee whizz the markets rally. Surely this is an act of panic. Yet again a central bank backflips for the financial sector. But to whose advantage?

Once again, the real estate interests and their financial symbiants will get rescued from the folly of ignoring the inevitable real estate cycle. The real estate cycle is caused by government and gets rescued by government. This indicates the real purpose of government: to protect and subsidize the landed interests, including lenders who use land as collateral. Since land values periodically crash, the real interests need to be bailed out if they are to keep being protected. Meanwhile, worker-tenants pay not only taxes but higher rents to the landed royalty.

taken from If you’re going to bailout anybody

Read more on a grounded solution

photo credit: _temaki_

Buyers look for existing houses as land prices soar rolls out all the old chestnuts:

Economic forecaster BIS Shrapnel says the demand for newly built houses is dropping off as the cost of land soars.

It says the limited supply of new land has led to the growth in land prices outstripping the growth in house prices in recent years.

Anyone on a bike commuting to work each day will soon tell you there are multitudes of vacant blocks of land lying idle. Regardless of the 119.623 vacant homes on census night, there are easily as many vacant blocks of land held by speculators in Melbourne.

Yes that’s right, the privately controlled supply of land is what is forcing up the price of land. Urban sprawl forever is not the answer.

Rudd’s Commonwealth land supply is nothing more than a handout for land bankers – unless Rudd backs it up with a holding charge on land. See evidence of land bankers in action on a former commonwealth RAAF site in Melbourne’s poorest community, Braybrook.

No wonder people are paying more as a percentage of wages than ever before. But yet powerful interests are able to manipulate the media into doublespeak. This land banking trend is what has driven the US economy to such meltdown mayhem. We will be next.

Read more about the importance of releasing this privately monopolised supply of land in the I Want to Live Here report.

http://www.flickr.com/photos/pingnews/

With oil surging $15 overnight to record levels for a single day’s trading, one wonders if economic theory is understood by Paulson’s panickers. With US$247 billion pumped into the global banking system over the last week by the world’s central banks to assist liquidity in the short term money market, one wonders why the US Fed now jumps to the beat of Wall St rather than considering the wider ramifications for the rest of the economy?

All this new money has to find somewhere to live. Speculators see such pumping within the economic framework as inflationary. Commodities are typically a safe haven when inflationary expectations rise as consumers will always need that certain commodity – be it oil, barley or wheat. Listen to Phil Anderson on the Renegade Economists to hear this explained.

Thus commodity investors were very excited by Paulson’s panick. But what will happen in the long run?

The high money supply will push interest rates down, reducing stresses on new borrowings and perhaps encouraging new business investment. But there is a proviso.

That proviso is that investment will only occur if stability is maintained. However, with nearly 1 million US sub-prime borrowers about to switch over to higher rates under their Adjustable Rate Mortgages, we’ve only just entered the sub-prime meltdown.

But the lower interest rates will also hinder the necessary correction in the land market. This will drag the US economy through a long recession rather than a shorter sharper one if market forces were left to correct behaviour. Did Ben Bernanke learn anything from his time in Japan? (*Please note, land prices are not measured as part of inflation’s ‘basket of goods’ in either Australia or the US.)

Instead Paulson has bailed out his banking mates and the devil is in the detail:

“The proposal would prevent courts from reviewing the Treasury’s actions while raising the nation’s debt ceiling.”

And surprise surprise the US sharemarket tanked over night. All it will take is a Chinese whisper on bonds and we will back to square one – the market trying to correct itself because too much money is being spent on land/ rent/ mortgage repayments, leaving too little for investment or consumption.

Just one more paragraph as this bailout is simply white collar crime! What else can this US regime do for it’s mates? Why on earth do the people who created this bubble get bailed out? Why aren’t the people who came up with CDO’s and ARM’s being hauled through the ringer? A hint can be seen by the fact that Paulson worked at Goldman Sachs until 2006.

Michael Hudson on AIG

Michael Hudson on the highly respected Democracy Now, telling the inside story on the bankers bailouts. Hudson was recently interviewed on the Renegade Economists, giving insights on the banking system like few others can. Skip to the 10 minute mark if time is your issue, that’s when host Amy Goodman introduces the Hudson segment.

However, it may be worth watching the first 10 minutes as the latest Republican move to reduce the voting roll is revealed. Democracy does not count if your home has been foreclosed, according to those influencing laws in Michigan.

Outrageous!

Then hear what Professor Hudson says on the prevalence of speculative banks. Finally some sense on this madness!

photo credit: laurenatclemson

Michael Hudson

July 14, 2008

I am writing this article about Fannie Mae and Freddie Mac while sitting in the Queens Botanical Garden. This was not my plan today. The central air conditioning in my apartment broke down six weeks ago, and still has not been fixed. (It’s a nice condominium building, but accidents happen.) It is over 90 degrees outside, and nearly 100 as a result of the greenhouse effect in my apartment. Yesterday I took refuge in the Forest Hills Public Library, but it is closed on Sunday. One of the few libraries near public transport that normally is open on Sunday is in Flushing. So I went there to write the final draft describing the past week’s financial turmoil.

Unfortunately, when I got to the Flushing Public Library, a lady explained that because of the city’s budget cuts, the library no longer would be open on Sundays. Already before noon, when it was supposed to open, a large number of Chinese were waiting to get in, expecting to use the books and computer terminals. There was no sign explaining the situation in Chinese, and they continued to wait as I went down Main Street to the Botanical Garden.

At first glance this might not seem to have much to do with the turmoil of the last few days over the fate of Fannie Mae and Freddie Mac or the real estate markets they have helped inflate over the past decade. But actually, my experience today has everything to do with this topic. These two semi-public mortgage-packaging companies dominate the nation’s mortgage market and have supported real estate prices by steering over $5 trillion to enable homebuyers to bid higher and higher prices for homes, earning billions of dollars of bonuses, profits and interest for the bankers, mortgage brokers and Wall Street debt packagers who are the financial beneficiaries of the real estate bubble.

And that is what really is at stake. If cities such as New York did not cut back public services, they would have to do what they and nearly all American cities and municipalities traditionally have done: finance most of their public budgets by taxing property. But to do that in today’s market would leave homeowners – and commercial building owners as well – with less revenue to pay their mortgages. Already this year over a million debtors have defaulted on their home mortgages, and enough have now fallen behind to suggest that Treasury Secretary Paulson’s warning that two million mortgage defaults for 2008 may be a million too low.

So that is the tradeoff: If cities are to maintain their customary level of public services, they will have to tax property at the traditional rate. But this would mean that housing prices would be less. The revenue paid in taxes would not be available to pay bankers to capitalize into interest payments on higher mortgage loans to buy homes at higher and higher prices. given a choice between more affordable housing and better public service on the one hand, or “wealth creation” in the form of higher-priced housing (along with its higher carrying charges), Americans have voted overwhelmingly for the latter – that is, for debt peonage rather than economic choice of what to do with their earnings except pay their bankers.

To me, this seems crazy, but then I’m an economist and we’re notoriously unable to explain why people vote against what seems to be their self-interest. In any case, this seeming craziness is what the plunging prices for stock in Fannie Mae and Freddie Mac last week was all about. One politician after another was televised pontificating about the need to keep real estate at unaffordably high prices rather than falling back to more affordable levels. Nobody mentioned the option of cities and states avoiding public service cuts by taxing the real estate – mainly the land’s site value – that has soared since 2000. Nobody discussed how an economy would look with lower housing prices and less mortgage debt. All they could say was the need to preserve the value of bonds and packaged bank mortgages held by financial institutions, that is, ultimately, by the economy’s wealthiest layer of the population, the 10 percent that are responsible for the net saving – saving that takes the form mainly of loans to indebt the bottom 90 percent.

Debt write-downs and lower property prices would be good for most of the economy, but are anathema to Wall Street. Bear Stearns already has gone under as a result of its business model based on packaging junk mortgages, and last week it looked like Lehman Bros. was going down the same road. It amazes me that the election is not being fought over this economic issue, but I guess that’s why I’m sill in Dennis Kucinich’s camp rather than elsewhere.

The policy question

For millions of homeowners watching the price of their homes fall below the mortgages they owe, the question is whether to pay or default. Many have no choice. They have Adjustable Rate Mortgages (ARMs) that are resetting at sharply higher interest rates and require amortization payments far beyond what the debtor is able to pay.

The looming defaults threaten financial institutions holding mortgages on such properties, moving up the economic pyramid to reach investors and creditors at the top. Somebody must take a loss. But who? Big fish or little fish?

For lawmakers there are two possible policy responses. The first and seemingly most logical response would be to re-set bad debts at levels that can be paid. This write-down would be in keeping with the direction of legislation since the 13th century to favor debtors more than creditors. It would restore balance between what people earn and what they can afford to pay for housing and other debts.

This is not the path that Congress is taking. Instead of bringing debts within the ability to pay, its banking and real estate committees are trying to find a way to re-inflate housing prices. The hope is to enable existing mortgage debtors who have defaulted, or are on the brink of doing so, to get into a position to sell out or to borrow the money due on even easier terms from the Federal Housing Administration (FHA). This would leave government agencies rather than Wall Street holding junk mortgages. It would give security not to home owners and mortgage debtors but to the lenders and speculators holding the $5 trillion in mortgages guaranteed by the Federal National Mortgage Association (FNMA, “Fannie Mae”) and the Federal Home Loan Mortgage Corp. (“Freddie Mac”), as well as the default-insurance companies on the hook and whose IOUs have now sunk to junk status themselves.

What is the point of buying insurance against mortgage defaults, after all, if the insurance reserves are miniscule in comparison to the likely default volume? The monoline insurance companies (firms whose only business is to write default insurance) have made their money writing policies, not paying out. Their executives have already taken the money and run. Yet it is for their wealthy financial clients that Congressional hearts are bleeding, not for the victims of subprime mortgage fraud and the associated Wall Street fraud in packaging junk mortgages and selling them to institutional investors at home and abroad.

The question is, how can an economy survive with millions of homeowners defaulting and wealth ownership polarizing between creditors and debtors. This is what plunged the world into depression in the 1930s, and long before that, reduced the Roman Empire to debt bondage and serfdom.

Is it all happening again today? Or can things simply return to normal with today’s debts be paid off by borrowing yet more money and running yet further into debt, in what is known as the “magic of compound interest”?

The Democratic congress pushes for American families to pay higher home prices

Congressional banking committee heads are simply behaving as politicians traditionally do by giving priority to their major campaign contributors in the financial and real estate sectors. Led by Democratic senators Charles Schumer from Wall Street and Christopher Dodd from Connecticut’s insurance industry, and supported by Congressman Barney Frank from the real estate sector, Congress is seeking to bail out the bubble’s sponsors, not its victims. The plan is to re-inflate the housing bubble at least long enough for the largest banks and other financial speculators to dump their riskiest holdings. Book values on these mortgages – and the real estate that backs them – are purely fictitious, despite the AAA whitewash from bond-rating agencies which themselves are now under investigation for the fatal Arthur Anderson-style conflict of interest between their research and sales arms.

Dealing as they do with real estate, and hence with local urban politics where most of the property values and maneuvering occur, Fannie Mae and Freddie Mac are largely Democratic creations. James A. Johnson ran Fannie for most of the 1990s and was its main lobbyist. Until June he headed Barack Obama’s vice-presidential search team, but resigned when it was revealed that he got mortgages on unrealistically favorable terms from Angelo Mozilo’s notorious Countrywide Financial. FNMA’s former head, Franklin D. Raines, was President Clinton’s budget chief. He was forced to step down when serious accounting problems were discovered. Other Fannie apparatchicks include Jamie Gorelick, former Clinton deputy attorney general, and Thomas E. Donilon, Clinton chief of staff to the secretary of state.

To be sure, political opportunism leads Fannie and Freddie to cover all the bases, becoming known for hiring relatives of powerful politicians wherever they may be in a position to help. But at least this time the problem is not George Bush’s fault. The Wall Street Journal seems closer to reason than the Democratic Congress. Over the weekend its editorial clarified what socialists since Marx have been saying: “What taxpayers need to understand is that Fannie and Freddie already practice socialism, albeit of the dishonest kind. Their profit is privatized but their risk is socialized.” Calling FNMA and Freddie “high-risk monsters,” the newspaper noted that “Wall Street and the homebuilders also cashed in on the subsidized business, and also paid back Congress in cash and carry.” It concluded by questioning whether these government-sponsored enterprises (GSEs) were justified at all. “Apart from outright failure, the worst scenario would be a capital injection that left the companies free to commit the same mayhem all over again two or 10 years from now.”

In a separate article the Journal noted that, “On a fair-value basis, the company [Freddie Mac] had negative net worth of nearly $17 billion.” The problem is that there is no “market” – that is, no supply of equally gullible buyers – to take on these bad loans, except at distress prices. Through short-term greed and incompetence, the home-debt industry has pawned off highly debt-leveraged mortgage loans drawn up from fraudsters. I cannot actually call them crooks because instead of being indicted, they have been rewarded with tens of millions of dollars in bonuses for making so much money as debt innovators for the finance, insurance and real estate sectors.

Their place is to be taken by the government as bad-debt buyer of last resort. I suppose this might be called Finance Socialism – the stage at which it becomes necessary to rescue Finance Capitalism, at least its largest institutions (“too large to fail”) at the top of the economic pyramid. I suppose it might be called “real estate finance capitalism.” But in Washington-talk it is euphemized in the Democratic Party’s usual populist garb as “democratizing property” and “increasing homeownership,” by which is meant indebting a rising share of the population to the point where carrying their mortgage absorbs most of their disposable personal income.

Can a new real estate bubble be inflated?

The fact remains that like every financial bubble in history starting with England’s South Sea Bubble and France’s Mississippi Bubble in the 1710s nearly three centuries ago, today’s bubble has been sponsored by the government. Forget the “madness of crowds” free-market propaganda. Insiders and enabling politicians always try to blame the victim. The reality is that Fannie, Freddie and the FHA gave a patina of confidence to irresponsible lending and outright fraud. This confidence game led them to guarantee some $5.3 trillion of mortgages, and to keep $1.6 trillion more on their own books to back the bonds they issued to institutional investors. Their strategy has been to issue bonds paying fairly low interest rates, and use the proceeds to buy mortgages yielding somewhat higher rates. This kind of interest-rate arbitrage is what the S&Ls did in the 1980s – a relevant parallel, as I will discuss below.

The myth is that Fannie’s and Freddie’s role is simply to spread homeownership by making it affordable for more of the population. Fannie Mae was established in the Depression, in 1938 as part of Roosevelt’s New Deal, and privatized in 1968. Freddie Mac was established two years later, in 1970, to buy up S&L mortgages and give “liquidity” to their mortgages, by developing markets outside of the banks and S&Ls that originated these loans. But this turned out to be the “original sin,” so to speak. Outside investors were obliged to place their trust in the mortgage originators – banks, S&Ls and mortgage brokers, whose ranks are filled with fraudsters and crooks.

Whatever we may call it, their dream is to bring back the seeming golden age sponsored by Alan Greenspan at the Federal Reserve. It was a decade of quick mortgage billionaires writing fictitiously high mortgages and selling them off to pension funds and to German and English bankers eager to seek a few extra fractions of a percentage point in current income so as to justify a big bonus by claiming to outperform more reality-based money managers.

All this is as American as apple pie. Altruistic political talk aside, the reason why the finance, insurance and real estate (FIRE) sectors have lobbied so hard for Fannie and Freddie is that their financial function has been to make housing increasingly unaffordable. They have inflated asset prices with credit that has indebted homeowners to a degree unprecedented in history. This is why the real estate bubble has burst, after all. Yet Congress now acts as if the only way to resolve the debt problem is to create yet more debt, to inflate real estate prices all the more by arranging yet more credit to bid up the prices that homebuyers must pay. The plan is thus to pretend that the Bubble Economy’s financial unreality may be made real by Finance Socialism.

Can the plan work? The reason why Fannie and Freddie have been able to borrow at lower rates than their rivals is because their public sponsorship led investors to believe that there was an implicit public guarantee not to let them fail. And in view of the fact that these two agencies account for some $5 trillion in mortgages – nearly half the nearly $12 trillion U.S. home mortgage market – they do indeed seem to be “too big to fail.” The face value of mortgages they have guaranteed is nearly as large as the entire U.S. federal debt held by the public. This means that the nominal federal debt would double if they went under. But at least the government can always print money, while the real estate backing the mortgages guaranteed by Fannie and Freddie (or held in their own accounts) is plunging in price into the dreaded Negative Equity territory.

But on their shoulders ride the hope of re-inflating housing prices to bail out the financial managers who sought to make money by debt creation rather than tangible capital formation. So the question is whether housing prices can be raised to a level that oblige families to run into even more debt than they now are carrying – with even lower down payments, subsidized at public expense.

In this case the subsidy would not really be for homeowners at all, but for the financial system’s mortgage holders. The aim would not be to make housing more affordable, but less so, because the debts would be larger!

Most investors view the situation as being more political than strictly economic. One hears again and again these days about the “implicit” government guarantee to make good on the bonds Fannie and Fred issued to fund these junk mortgages. Its constant repetition reflects the anxiety that bondholders feel about how sound their bond holdings really are. (The stocks of Fannie and Freddie have now plunged to less than 10 percent of their former highs. Investors obviously expect their equity to be wiped out, a la Bear Stearns.)

The word “implicit” means “not explicit.” There is a tantalizing hint of what might be, but does not yet exist in a legal sense. Financial free lunchers on Real Estate Finance Capitalism claim to be innocent victims of an “unexpected” bad turn in the market. (Bad news always is “unexpected” as far as financial spokesmen and media reporters are concerned, just as Claude Rains was “shocked, shocked” to find that there was gambling going on at Rick’s Café.)

The distinction between implicit and explicit may be too philosophical for most money managers who work in the financial institutions that have bought Fannie Mae and Freddie Mac bonds and packages of junk mortgages. Most of these apparatchiks don’t need much of an education. All they need is greed, and that can’t be taught. It is a mentality – and on Wall Street it lives in the short run, from one annual bonus to the next.

Wall Street bonuses are based on how well one “performs” relative to the norm – a Treasury bond’s rate of return, or the average mutual fund or money market fund. Anyone can out-perform these averages simply by buying the most risky and hence highest-yielding bonds around.

Predator vs. victim – who will Congress support?

On the subway to my hoped-for cool spot in Queens, I opened today’s Sunday New York Times to find an article by the always informative Gretchen Morgenson about a Countrywide Financial customer saddled with an adjustable-rate mortgage re-setting at a rate beyond his means to pay. The mortgagee got so frustrated with non-responses to his earlier attempts at communication that he sent an e-mail message to a block of Countrywide addresses asking to renegotiate his mortgage on more affordable terms so as to avoid default. This is what Henry Paulson has been urging “responsible” lenders to do – and Countrywide is responsible for some $1.5 trillion in mortgage loans, most of them subprime.

The e-mail actually got to Countrywide co-founder and CEO Angelo Mozilo, cited above for having given GNMA head and erstwhile Obama advisor a mortgage on remarkably affordable terms. Mr. Mozilo is the Darth Vader of the global mortgage market, and the person probably more responsible than any other for wrecking more lives financially than any other man on the planet, including Ken Lay and Michael Milken. Until the movie biography arrives, we will have to do with Ms. Morgenson’s article.* (*“The Silence of the Lenders,” The New York Times, July 13, 2008.)

Mr. Mozilo actually responded. He found the request to lower his company’s mortgage demands “Disgusting.” The very thought of debtors not living up to written contracts they had signed – contracts which turned out to be bait-and-switch deals signed under duress – seemed to threaten the institution of private property itself. After all, had not the mortgage agreed to “adjust” his teaser interest rate upward to a more real-world rate of extracting his income?

A Countrywide “workout advisor” on the company’s “home retention team” tried to be more helpful. She suggested that “Maybe you can eat less,” when the mortgagee told her that all he could afford was $10 a day after paying his mortgage.

Perhaps my mind was wandering too far, but I was reminded of Sumerian and Babylonian language for creditors. Contracts said that they would get to “eat” the interest on debts owed by cultivators and debtors. Bronze Age contracts from Hammurapi’s time (c. 1750 BC) typically called for rural debtors to pay their debts in grain (which exchanged on a par with silver, one liter of grain per shekel of silver), weighed out at harvest time on the threshing floor. Post-classical economic theory is based on the principle of diminishing marginal utility. According to this theory, the pleasure of consuming more of any given commodity diminishes with each additional unit that is consumed. This seemed to suggest that as people got wealthier, they would become less greedy, leaving the path open for the poorest consumers to “catch up.” It was a happy picture of economies leading naturally and almost automatically to a more equal distribution of wealth.

Of course, it was utter fiction. But it was a “successful error” that won for the marginal utility school such enormous financial subsidies for economics departments teaching this distraction that it drove classical economics off the board with its discussion of unearned increments, free lunches and the polarization of wealth by rentiers (a word that today is almost as anachronistic as “usurer”).

Obviously, these marginal utility theorists never heard of the wealth addiction that Aristotle and other ancient observers described. How much can a creditor “eat” in practice? The answer is, “everything”! That is what wealth addiction is all about.

It is implicit in the mathematics of the “magic of compound interest.” This is the magic that has causing the real estate crisis plunging Fannie Mae, Freddie Mac and Lehman Bros. to the brink of insolvency.

A replay of the federal S&L insurance crisis: Bailing out the risk-takers, not their victims

Junk bonds issued by corporate raiders were the highest-yielding bonds in the 1980s – before they brought down the S&Ls. Since the Federal Reserve flooded the economy with credit after the dot.com bubble burst in 2000, junk mortgages have been the highest-yielding securities. Meanwhile at the Federal Reserve, Chairman Alan Greenspan deregulated the banking system to let the usual array of financial crooks express the “animal spirits” that he believed were the driving force in his Ayn Rand fantasy world.

The result is a replay of the S&L collapse two decades ago – a financial “golden oldie,” so to speak. The S&L bailout is relevant today because proposals to bail out FNMA and Freddie Mac bondholders are distressingly like the bailout of S&L depositors in crooked S&Ls back in the 1980s. Only a handful of S&Ls went under – and they were the notorious risk-takers. Their depositors were not neighborhood moms and pops. They were large institutional savers, who didn’t care about risk or crooked behavior, because there was a government guarantee by FSLIC: the Federal Savings and Loan Insurance Corporation. And that bailed out the large depositors.

Fast forward to today. FNMA was shown many months ago to have been cooking the books. But large speculators didn’t care. Although there was no official government guarantee, there was an “implicit” protection for risk-takers. Financial insurance firms sharply raised the protection for these two government-sponsored mortgage agencies. But investors still were able to make a few basis points more than normal by buying their bonds.

Should they be bailed out? And if the government does not do so, would this mean that FNMA goes under and the US mortgage market plunges?

Do we really want a new bubble? Or re-industrialization?

Let’s take a step back and look at the function that Fannie and Freddie have played in today’s Bubble Economy.

Who would one expect the Fed as “board of directors” for the commercial banking system, the Federal Housing Agency (FHA), FNMA and Freddie Mac as creatures of the real estate sector, to support? Ostensibly created to serve “the people,” 90 percent of whom are debtors, these institutions actually back the 10 percent of the population who are creditors.

This year already has seen a million foreclosures and the junk mortgage collapse is worsening. Home prices are plunging as interest rates on the euphemistically named adjustable rate mortgages (ARMs) “adjust” in the only direction they ever were intended: jumping up from teaser rates to distress levels. It is more difficult to borrow in today’s market. The economy has reached its debt limit and is entering its insolvency phase.

We are not in a cycle but the end of an era. The old world of debt pyramiding to a fraudulent degree cannot be restored, even if the Glass-Steagall Act is not restored to stop the conflict of interest that it unleashed when the Clinton Administration backed Treasury Secretary Robert Rubin and financial lobbyist Greenspan in repealing it. The real estate bubble was made possible by the unique degree to which America’s population emerged from World War II relatively debt free. Each recovery has taken off from a higher debt level. This something like trying to drive a car with the brakes pressed tighter and tighter to the floor each time there is a stoplight (recession). We have now reached the debt limit, and the economy is stuck. The class war is back in business, with a vengeance. Instead of it being the familiar old class war between industrial employers and their work force, this one reverts to the old pre-industrial class war of creditors versus debtors. Its guiding principle is “Big Fish Eat Little Fish,” mainly by the debt dynamic that crowds out the promised economy of free choice.

This is being portrayed as a post-industrial economy, but it is a much older story. No economy in history ever has been able to pay off its debts. That is the essence of the “magic of compound interest.” Debts grow inexorably, making creditors rich but impoverishing the economy in the process, thereby destroying its ability to pay. Recognizing this financial dynamic most societies have chosen the logical response. From Sumer in the third millennium BC and Babylonia the second millennium through Greece and Rome in the first millennium BC, and then from feudal Europe to the Inter-Ally war debts and reparations tangle that wrecked international finance after World War I, the response has been to bring debts back within the ability to pay.

This can be done only by wiping out debts that cannot be paid. The alternative is debt peonage. Throughout most of history, countries have found again and again that bankruptcy – wiping out the debts – is the way to free economies. The idea is to free them from a situation where the economic surplus is diverted away from new tangible investment to pay bankers for the monopoly they alone have been given to create bank-credit and charge interest on it. That is the classical idea of free markets.

Current proposals would replace bad debts that are not publicly insured (except by an “implicit” guarantee that relevant legislators have been bought into) with new debts, and new suckers are to be left holding the bag. Bahrainis and Saudis in particular are being courted.

But most of all, there is a public campaign being waged by the FIRE sector (Finance, Insurance and Real Estate) to convince the American public that, in the infamous words of Margaret Thatcher, TINA, “there is no alternative.” (See for instance the Wall Street Journal’s excellent coverage of the FNMA/mortgage crisis on July 11, 2002, p. A12.) When one hears this, it means that political censorship is being mobilized to flood the popular media with the intellectual equivalent of sterile fruit flies being released to stop the spread of a threat. All one hears is a barrage of claims that the government must preserve the financial fictions of FNMA and Freddie Mac in order to “save the market.”

But what is “the market” that is to be “saved”? To Wall Street and its Congressional advocates, it is the mass of bad debts growing at compound “magic” rates of interest, beyond the ability of debtors to pay. If the debtors cannot pay, then the Government – “taxpayers” are to pick up the check to Wall Street. Meanwhile, more tax breaks are to be given to leave the finance, insurance and real estate sectors with enough money to “earn back” their losses, by extracting yet more rent and interest from the industrial economy’s consumers and wage-earners.

The usual hypocrisy is being brought to bear claiming that all this is necessary to “save the middle class,” even as what is being saved are its debts, not its assets. Something must give – and the upper 10 percent of the population wants to make sure that it is not its own economic position, but that of the bottom 90 percent. The “way of life” that is being saved is not that of home ownership, but debt peonage to support the concentration of wealth at the top of the economic pyramid.

My modest proposal

Shareholders of FNMA and Freddie Mac probably will be wiped out, as were S&L shareholders in the bailout of S&L depositors in the 1980s. There’s a simple way to save FNMA’s and Freddie’s public functions, if they indeed are deemed necessary to keep supporting the debt market. This can be done without bailing out the speculators who bought the mortgages it packaged.

First of all, not all the mortgages that these two agencies have bought or guaranteed are junk. Most are genuine and are being paid. The poor are honest, after all, and think that they should pay as a matter of honor even if it is not in their economic interest to do so when their homes fall into negative equity. Let these mortgages continue to back the existing FNMA and Freddie Mac bonds to the degree that they actually receive mortgage debt service. If there is a shortfall, let bondholders take the usual haircut that is supposed to go hand in hand with risk. That is why these mortgages had such high rates of interest, after all. The loss would be proportional to the financial and real estate fraud they have enabled. This is the law for all other bondholders when their investments go south. Why make an exception for participants in the real estate bubble?

The rule caveat emptor should apply to bankers and investors here. They have bought a product – a flow of income that they either believed or pretended could be paid. Any student taught the mathematics of compound interest knows that in the end no economy’s debts can be paid. So this should be a special financial caveat.

To keep their activities current, let Fannie and Freddie issue a new series of bonds – the “we won’t fake it anymore” series. They would be based on a new honesty based on more realistic appraisals of the affordability of housing, which they were supposed to be promoting all along. These steps would not cause a collapse.

But before stepping up to save FNMA and Freddie Mac, we might ask whether it would be a tragedy for their debt guarantees to cease. Wall Street has given politicians a cover story that to support FNMA and Freddie on the pretense that its packaging and reselling mortgages in big “tranches” provides liquidity. Its defenders claimed to be “modernizing” the real estate mortgage market by creating uniform standards and homogeneous packages. But these packages were increasingly tainted with junk, putting floor sweepings of ARMs with no-down-payment and NINJA (no income, no job) loans into financial sausages.

What Fannie and Freddie did was to provide a vast new source of demand for mortgages. Their role has been to extend the market for mortgage debt, creating opportunities to make money financially in an environment of asset-price inflation – the Bubble Economy. The effect was to push up housing prices. This has been the great American game for a century. And it has turned increasingly to outside investors (including gullible German banks which were the first to go bust by trusting the U.S. junk mortgage market), swelling the supply of loanable funds that bid up property prices.

Prior to FNMA and Freddie Mac, banks that issued mortgages held onto them, because there were no outside blind buyers. This was the pre-fraud era. It is now looking like a Golden Age. Housing prices were lower, and buyers did not have to go so deeply into debt to purchase homes. But the Senate and Congress – at least the Democrats – are urging the FHA and other government agencies to prop up the mortgage market by issuing zero-down-payment loans and other subsidies. The immediate aim is not to help homeowners – who indeed will have to pay more if the housing market re-inflates. Each new economic crisis adds a few new words to the English language. This time we get “reflate.” Others include NYU Prof. Roubini’s “stagdeflation” for a combination of debt deflation of incomes and price inflation for commodities as the dollar sinks in response to the balance-of-payments deficit resulting largely from the war in Iraq. But that is another story. Today’s story is about how Congress is aiming to bail out the banks that have bought or packaged these junk mortgages, about how needless this bailout is, and about how much simpler and more fair to just write off the bad debts.

Conclusion

America’s $13 trillion in domestic real estate debt is no more payable than is the government’s $3.5 billion dollar debt to foreign central banks, or the public debt itself for that matter. Adam Smith remarked over two centuries ago that no government ever had repaid its debts. At that time the aristocracy – the heirs of the Viking warlords who conquered Britain and other European countries and turned their common lands into private property – held most of the land free and clear. Today, real estate has been “democratized,” but this has been done on credit. Mortgages are the major debts of most American families. In this role, real estate debt has become the basis for the commercial banking system, and hence the basis for the wealthiest 10 percent of the population who hold the bottom 90 percent in debt. That is what Fannie Mae, Freddie Mac and “the market” are all about.

Neither party in Congress supports a new bankruptcy bill. The lobbying money simply isn’t there. So the preferred alternative seems to be a new real estate bubble, which means more debt peonage for new homebuyers rather than housing prices falling back to more affordable proportions.

Of course, there is another alternative (TIAA). It is to change the tax system so as to collect rent as the basis for taxation, not for an expansion of debt to the banks. Real estate could free labor and industry from having to pay taxes. Instead, un-taxing property has forced labor to bear the tax burden, and to pay an equivalent sum in interest to the banks as well.

But that is a topic for a future article.

Michael Hudson is Chief Economic Advisor to Dennis Kucinich and the Kucinich-for-Congress campaign. A former Wall Street financial analyst, he is Distinguished Research Professor of Economics at UMKC, and author of Super Imperialism: The Economic Strategy of American Empire (new ed. Pluto 2002), and Debt and Economic Renewal in the Ancient Near East (CDL Press, 2002). He has more insightful analysis at his website.