I was trying to think of a title for this post when the idea of an updated version of a quote from the 1939 book of interconnected short stories, Goodbye to Berlin by Christopher Isherwood, "I am a camera with its shutter open, quite passive, recording, not thinking" occurred to me. Writing a blog, I feel like a passive observer of a period in time which has the ambience of 1934 Berlin where the glitter and decadence of the city is about to be transformed by the up thrust of right wing undemocratic forces in society. Isherwood’s list of characters, their relationships and surrounding events as described in his semiautobiographical book are counterpoints to the current situation. In the book, The Weimar Republic by Torsen Palmer and Hendrick Neubauer, there is a passage in the chapter entitled “The System is collapsing” which says:
Long before Hitler’s political breakthrough, there was a readiness among the industrial elite to sacrifice parliamentary democracy in favour of an authoritarian solution which would rigorously curtail the welfare state and make it possible to develop the ailing economy on the backs of the working classes.
If we transform the industrial elite of 1934 Germany during the Great Depression into the bankers of 2011 America during our Great Recession, we see the same processes at work.
The video above is a very articulate rant on the metaphor of bankers as the scum of the earth. I wouldn’t go that far and think that banking as a utility for the assignment of credit in society for the more efficient distribution of capital in the economy is alright but the rapacious looting of Main Street by banks in the form of economic rent is wrong. From this, I would like to segue to something that has been puzzling me for a while. Facts from a story in the Alternet website by Danny Mayer:
Since 2002, the bank (J P Morgan) has turned its attention to another easy revenue source: city, state and national government debt. Along with other large banks like Goldman Sachs, it began selling a new type of complicated loan to countries like Greece, states like Connecticut and Mississippi, and cities as far-flung as Birmingham, Alabama, and Milan, Italy. Even the Delaware Port Authority and the Pennsylvania school system have gotten caught in the JP trap.
These derivative packages, named “swaps” to ensure they do not get officially counted as debt on government balance sheets, essentially act as second and third and fourth-mortgages on public infrastructure projects like airports and highways. Loaded with adjustable rates and a slew of fees and “trigger points” that ensure rapid debt growth, the swaps essentially ensure the privatization of public government assets. In the case of Birmingham, Alabama, for example, Rolling Stone journalist Matt Taibbi has reported how a city sewer project initially estimated to cost $250 million generated “a total of $1.28 billion just in interest and fees on the debt,” most of which went into the private coffers of J.P. Morgan. The result for Birmingham? “Between 2008 and 2009,” Taibbi notes, “the annual payment on Jefferson County’s debt jumped from $53 million to a whopping $636 million.” The debt now stands at $4800 per resident.
On July 7th, 2011 J P Morgan took over all of Kentucky State’s financials including payroll, deposits and the disbursement of federal money from the Farmer’s bank which has held the position continuously since 1928 in a competitive bid process that the bank won. The federal money portion is really important because it makes up for the estimated short fall in sub national government revenue since 2008 of between 30 and 40 percent. Property tax revenue for municipalities is only 28% of their total income with senior level government disbursements to local government being 40 percent.
The total official sub national municipal bond market in America as described by the mass media and other sources is about 2.8 trillion dollars. Most mass media commentators state that 28 percent of American households are “underwater” or to put it more explicitly the owners currently owe more on their mortgages than the house is worth. The unspoken caveat is the 28 percent only represents the first mortgage and not second mortgages or household lines of credit. If all of the financial instruments claimed against homes were included, the actual rate of folks who are “underwater” would be 40 percent. Let’s assume for the moment that an equivalent percentage of the total claims on “muni” bond are off ledger including these debt swaps and other financial transactions mediated by the banks. This would imply an additional 1.2 trillion dollars of sub national debt off ledger which is an enormous amount of money. If the rate of increase in debt interest and transaction fees was the same as the Birmingham sewer deal about which Matt Taibbi discussed in my quote, then we’re looking at a potential “muni” hidden exposure of 6 trillion dollars that isn’t even being discussed in any media forum, online or any other place. Of course, we don’t know since it’s not on record so let’s be very conservative in our calculations and say that the true value of the hidden debt is really 16% of my conclusion. That’s still a trillion dollars and enough to bankrupt many sub national governments in the States especially when you consider that the federal government aid to local government ends next year and won’t be renewed. If you think that it isn’t possible to miss such a large amount of debt in the American economy then read the media reports (esp. its credit rating) about the Greek financial position before its economy imploded. Most “muni” bonds in America are triple A in spite of the acknowledged state and local financial woes and the argument is that municipalities are traditionally low risk. This revealed truth is from the same people who said in 2007 that home prices would always rise since the empirical evidence is that home prices have always increased for the last fifty years. The fallout from this false supposition was the Great Recession. What will be the fallout from the circular argument that “muni” bonds are low risk because of empirical evidence? I can assure you that at the time the shit hits the fan the senior levels of government will not bail them out regardless of the outcome of the super committee deliberations. In theory, the American federal government with a sovereign fiat currency can print as much money as it wants to save sub national governments but will it do under President for Life Perry who wants a “government that is inconsequential in your life” or Capitulator in Chief Obama?
You may think that I have no basis for my speculation about a vast unreported off ledger debt liability by American sub national governments but there is another avenue of analysis. The banks may deny knowledge of this debt but since they are the enablers and recipients of the financial shenanigans, they will also want to protect themselves against the inevitable catastrophic failure of the “muni” debt. The means by which they do this is the infamous CDS or credit default swaps that are, in essence, insurance against financial loss. From Wikipedia:
A credit default swap (CDS) is a form of insurance that protects the buyer of the CDS in the case of a loan default . If the borrower defaults (fails to repay the loan), the lender who has bought traditional insurance can exchange or "swap" the defaulted loan instrument (and with it the right to recover the default at some later time) for money - usually the face value of the loan.
The significant difference between a traditional insurance policy and a CDS is that anyone can purchase one, even those who do not hold the loan instrument and may have no direct "insurable interest" in the loan. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan or any credit instrument named in the contract (typically a bond or loan) defaults, creating a credit event.
Credit default swaps are not traded on an exchange and there is no required reporting of transactions to a government agency. During the 2007-2010 financial crisis the lack of transparency became a concern to regulators, as was the trillion dollar size of the market, which could pose a systemic risk to the economy.
In the case of just one state, California, a few major banks have over $14 billion in CDS betting that California will default on its debt obligations in spite of a history of zero default. From Reuters:
Data reported in the news media and other sources show that the prices, or spreads, on California CDS wrongly brand our bonds as a greater risk than those issued by such nations as Kazakhstan, Croatia, Bulgaria and Thailand.
The banks disclosed the trades to California Treasurer Bill Lockyer last month (July, 2011) in response to his request that all 86 of the state’s bond underwriters detail the volume of credit default swaps they traded on the state’s roughly $80 billion of general obligation bonds in the three months ending Jan. 31(2011).
Here are the amounts per bank of credit fault swaps reported to California Treasurer Lockyer:
Goldman Sachs – $4.3 billion Morgan Stanley – $2.5 billion
Barclays – $2.5 billion Citigroup – $1.9 billion
JP Morgan – $1.5 billion Bank of America Merrill Lynch – $1.9 billion
Remember that the total general revenues of California is $88 billion and the total CDS which is much greater than the $14 billion of the banks (only six of the 86 California bond underwriters which had their bets revealed) indicates that the underwriters are worried about the possible loss of an enormous amount of money in just this one state and this is only at the state level and not the local level of government debt which was not included in this analysis. California’s credit rate may currently be AA but in 2008, Greece’s credit rating was ‘A’, upper medium investment grade according to S & P even though some of the major US banks in conjunction with the Greek government had been using interest rate swaps to hide the true extent of Greek sovereign debt for years.
The final objection to my conclusion is that the counterparties (i.e. the state and local governments) would know and the information about the hidden debt would be revealed to the public. This didn’t happen in the Jefferson county situation until they faced bankruptcy which now seems inevitable and won’t happen until the same debt crisis happens on a national scale. Why would sub national governments seek Chapter 9 remediation of their debt problems? There are some advantages – political cover by blaming the bankruptcy receiver, tearing up contracts with their staffs under chapter 9 as well as removing pension benefits already incurred which is happening in the current situation in Central Falls, Rhode Island. The really big reason is the ability of the bankruptcy receiver to sell off and privatize public assets at will in non competitive bids for any price. Both the banks and local entrepreneurs would make huge amounts of profit from this divestiture of public assets at fire sale prices. This is what occurred in South America during the last century in their liquidity crisis as described by Naomi Klein in her book, Shock Doctrine. What would be left is a toll gate society where every activity by the citizenry would be individually charged by private enterprises.
The final point is that I believe this would lead to a repetition of the 1933 business plot. This historical event has been suppressed by most observers but it did happen. The story was denounced by the New York Times (of course) as a hoax but later in 1934 confirmed by Congressional committee who redacted the names of the business leaders involved. From Wikipedia is the Business plot and from another blog:
In 1933 Major General Smedley Darlington Butler reported to Congress a coup d'etat plot against President Franklin Roosevelt, sponsored by corporate interests. Alarmed by Roosevelt's Democratic "New Deal" which would redistribute wealth from the rich to the poor, Irenee Du Pont, Grayson Murphy, William Doyle, John Davis and other representatives of J.P. Morgan banks, Du Pont, Goodyear and Bethlehem Steel sought to overthrow the U.S. government with a military coup and replace it with a fascist state, based on the recent success of Mussolini and Hitler in Italy and Germany.
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