THE GLOBAL FINANCIAL CRISIS: CAUSES. BAIL-OUT. FUTURE. L. Randall - PDF document

6/4/2012 THE GLOBAL FINANCIAL CRISIS: CAUSES. BAIL-OUT. FUTURE. L. Randall Wray Levy Economics Institute and University of Missouri - Kansas City www.levy.org; www.cfeps.org; wrayr@umkc.edu Causes of the Collapse • The Minsky Moment • Minsky ’ s Stages • Money Manager Capitalism • Financialization, Layering, Liquidity • Fraud and the Real Estate Bubble • Shredding of New Deal Reforms • Bubbles, Goldilocks and Budgets 1

6/4/2012 Minsky Moment • Financial Instability Hypothesis • Investment Theory of the Cycle and Financial Theory of Investment • Hedge  Speculative  Ponzi • Big Bank and Big Government Rescue • Stability is Destabilizing Boom and Bust • 1980s Thrift & Bank Crises • Thrifts and Commercial real estate • Banks and LDC debt • 1980s Leverage Buy-outs • Michael Milken and Junk Bonds • 1990s New Economy and Nasdaq • “ Irrational Exuberance ” • 2000s Residential Real Estate • Subprimes; foreclosures • 2000s Commodity Markets • Quadrupled oil prices; food riots; starvation Each follows the pattern and each crisis is worse than the previous 2

6/4/2012 A Minsky Half-Century? • Stages Approach: 57 Varieties • Commercial capitalism • Finance capitalism • Paternalistic (Managerial-Welfare State) capitalism • Money Manager capitalism (predator state, financialization, ownership society, neoliberalism, neoconservativism, shadow banking) • Stability bred instability • Accumulation of financial assets/liabilities • Globalization • Securitization • Self-supervision Decreasing Weight of the Banking Sector life insurance companies Shares of Financial Institutions (% of Total Assets) Managed Money 120.00 Funding Corporations Security Brokers and Dealers 100.00 Real Estate Investment Trusts Managed Money 80.00 Finance Companies Issuers of Asset-Backed Securities 60.00 Agency and GSE-backed Mortgage 40.00 Pools Government-Sponsored Enterprises 20.00 State and Local Government Retirement Commercial Banking Funds Credit Unions 0.00 Saving Institutions 5 0 5 0 5 0 5 0 5 0 5 0 5 4 5 5 6 6 7 7 8 8 9 9 0 0 9 9 9 9 9 9 9 9 9 9 9 0 0 1 1 1 1 1 1 1 1 1 1 1 2 2 Bank Holding Companies Source: Federal Reserve Flow of Funds Accounts Commercial Banking 3

6/4/2012 Pension Fund Total Assets (% of GDP) 60 Private Pension Funds 50 State and Local Government Employee Retirement Funds 40 % 30 20 10 0 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 Source: Federal Reserve Flow of Funds Accounts Total Financial Liabilities Relative to GDP 5,0 4,5 4,0 3,5 3,0 2,5 2,0 1,5 Private 1,0 GSE 0,5 Government 0,0 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Sources: Historical Statistics of the United States: Millennium Edition (Tables Cj870-889 and Ca9-19), NIPA, Flow of Funds (from 1945). 4

6/4/2012 Financialization, Layering, Liquidity • Rising share of profits and value added going to financial sector. • Layering debt on debt on debt. • Positions in assets financed through very short term (overnight) borrowing. • Casino-like speculation dominates. Financialization of the U.S. Economy Financial Industry Share of Corporate Profits and Value Added (1955-2010) 45,00 40,00 Share of Profits 35,00 Value Added (% of GDP) 30,00 25,00 20,00 15,00 10,00 5,00 0,00 2009 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Source: Bureau of Economic Analysis 5

6/4/2012 Total Financial Liabilities Relative to GDP 5,0 4,5 4,0 3,5 GSE 3,0 2,5 2,0 Private finance 1,5 Government Nonfinancial nonfarm corporate 1,0 Noncorporate and farm 0,5 Households and nonprofit 0,0 1916 1918 1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946 1948 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Sources: Historical Statistics of the United States: Millennium Edition (Tables Cj870-889, Ca9-19, Ce42-68, Cj787-796, Cj748-750, Cj389-397, Cj437- 447, and Cj362-374), Historical Statistics of the United States: Colonial Times to 1970 (Series X 689-697), NIPA, Flow of Funds (from 1945). Keynes: When speculation dominates enterprise the job is likely to be ill ‐ done 6

6/4/2012 Real Estate Bubble and Fraud • Like Shrek ’ s onion: Every link in the Home Finance Food Chain was fraudulent: • Appraisers, brokers, lenders, MERS recording, securitizers, trusts, accounting firms, ratings agencies, and servicers. • Most fraud was on part of lenders. • Fed recognized as early as 2000; FBI warned in 2004 “ epidemic of fraud ” . • Most foreclosures are fraudulent. Securitization: The basis for leveraged bets • Basic idea: pool a bunch of debt (i.e. mortgages) to act as collateral for securities. • Why? Insufficient sovereign debt. • Payments on the debt used to pay the promised interest on securities. • Can create series of tranches, with different “ seniorities ” of varying risk. • Underwriting standards deteriorate: • Low doc  no doc  NINJA (don ’ t ask, don ’ t tell) 7

6/4/2012 New Home Finance Model • Jimmy Stewart ’ s Thrift: loan officer, bank teller, home appraiser; public recorder. • Loans held to maturity • New more “ efficient ” Wall Street model: • Involves broker, appraiser, lender, servicer, MERS, securitizer, credit rater, rocket scientists and proprietary models, MBS trustee, CDOs squared and cubed, CDSs and monolines, investors, traders, accountants, lawyers, lender processing services; robo-signers, document “ recovery ” services (forgery). • Model: originate to distribute, pump and dump, foreclose and resell. • Capitalizing unrealizable home values. 8

6/4/2012 WHY???????????? • Why the complexity and fraud at every layer? • Model was flawed from beginning: could not have been profitable; interest payments could not cover costs, • Needed mortgages @100% or 120% of value to book fees, • Complexity essential to hide accounting fraud. • Everyone rewarded by through-put. • The beauty of a Casino: the house always wins. • $10T of homes  tens of trillions of dollars of bets. • Foreclosure was inevitable, desired, outcome: bet on failure then reboot thru foreclosure and to hide the fraud. • Like 1929 investment trusts. 9

6/4/2012 Shredding of New Deal Reform • Deregulation, desupervision, self-supervision • Rising inequality • Falling wage share • Rising consumer debt Wages and Salaries, % of GDP 10

6/4/2012 Financial Bubbles, Goldilocks and Budgets • Bernanke and Great Moderation. • No bubbles in sight. Fundamentals are strong. • Reality: biggest debt, equity, commodity, and real estate bubbles in history. • Financialization, Globalization, Neo-liberalism, Predator State, Money Manager Capitalism, Ownership Society. • Propped up by Big Government and Big Bank—No cleansing through debt deflation dynamics. GFC 2007: It all started with Goldilocks • 1996: US Federal Government begins surpluses; continued for 2.5 years. • Clinton projects surpluses for next 15 years. • All Government debt will be retired. • Private debt explodes. Why? The Three Balances. • The Meaning of Zero: 0=Private Balance + Government Balance + Foreign Balance 11

6/4/2012 Bail-out and Cover-up • No criminal prosecutions of top management. • Stimulus $800B. • Hank Paulson $800B. • Fed: $29 TRILLION. 12

6/4/2012 Paulson/Geithner Plans: Trying to restore Money Manager Capitalism. Lloyd (the Squid) Timmy Hank Select Fed Assets, 1/3/2007-9/2011 Mortgage Backed Securities 13

6/4/2012 JP Morgan Institution Totals Accross All Facilities Chase & Co. Over $400 Billion 3% Bear, Stearns & UBS AG Co., Inc. (Switzerland) 6% 3% AIG 7% Bank of America Corporation Morgan Stanley & 6% Co. Incorporated 15% Barclays (UK) 7% Merrill Lynch 16% Citigroup Inc. 17% Credit Suisse RBS (UK) (Switzerland) 4% 5% Goldman Sachs & Deutsche Bank AG Co. (Germany) 6% 5% Summary: $29,523,510,000,000 Conventional Unconventional Facility Total Percentage Facility Total Percentage TAF $3,818.41 12.93% CBLS $10,057.4 34.1% TSLF/ TOP 2,005.7 6.8 ST OMO 855 2.9 PDCF 8,950.99 30.3 Bear Stearns 12.9 0.04 Bridge Loan Maiden Lane I 28.99 0.10 Maiden Lane II 19.5 0.07 Maiden Lane III 24.30 0.08 AIG RCF 72.35 0.25 AIG SBF 802.32 2.72 AMLF 217.35 0.7.4 CPFF 737.07 2.5 TALF 71.09 0.24 MBS 1,850.14 6.6 $5,824.12 19.7% $23,699.01 80.3% 14