The Coming Financial Crash: Learning from History

Panic: The Story of Modern Financial Insanity

Edited by Michael Lewis

WW Norton (2009)

Book Review

This book is a collection of essays about the four major Wall Street crashes of the last 30 years. The first was Black Monday, on October 19, 1987; the second the 1997 Asian financial crisis; the third the Dotcom crash of 2000-2002; and the fourth the global economic crash of 2007-2008.

Black Monday

At the time, Black Monday was the worst Wall Street crash in history – with a percentage decline in stock prices twice that of the 1929 crash. The various essays blame Black Monday on two main causes: an overvalued stock market (with too many shares bought with borrowed money) and new computerized trading programs that automatically sold larges volumes of institutional stocks (from pension plans, mutual funds, etc) once their price dropped below a designated price.

Asian Financial Crisis

The collapse of South East Asian currencies (South Korea, Philippines, Indonesia, Thailand, Hong Kong, Malaysia) in 1997 is blamed on a variety of factors. Malaysian Prime Minister Mahathir Mohamad blamed Soros, but Lewis claims the latter had temporarily stopped currency trading in 1997. The Asian crisis was contagious, causing investors to also pull their funds out of Russia and Brazil, as well as the six Asian countries. Both the ruble and the Brazilian real collapsed in 1998.

China, India and Vietnam were virtually unaffected, as they defied the US and IMF by imposing capitol and currency controls (preventing foreign investors from withdrawing funds or exchanging large amounts of currency without government authorization).

All three countries continued to experience 9-11% growth during the next decade.

Dot Com Crash

The Dot Com boom was largely fueled by the advent of computerized day trading, allowing investors to purchase large volumes of stock directly without going through established brokers. It was also the first time in history that investors scurried to buy shares in companies that operated at a loss. The immediate cause of the Dot Com crash was a decision by the Federal Reserve to raise interest rates, bankrupting hundreds of Internet startups that could no longer afford to borrow money. Amazon, which also operated at a lost, was spared by the continued support of Silicon Valley venture capitalist John Doerr.

The 2008 Global Economic Collapse

The most interesting essays in this section are by analysts who predicted the collapse. Hedge fund manager John Paulson made $3-4 billion in 2007-2008 by correctly predicting the timing of the crash and purchasing cheap credit default swaps.* As mortgage bonds started failing, demand for CDS’s skyrocketed as investors rushed to limit their losses.


*A credit default swap is a financial swap agreement that the bank that issues the CDS will compensate the buyer in the event of a debt default or other credit event.

 

 

 

Britain’s Squatters Movement

Give Us Space

Directed by Claudia Tomas (2015)

Film Review

Give us Space is about the grassroots movement which has formed in response to the British housing crisis. It features fascinating interviews with squatters and other housing activists. All are extremely critical of Conservative policies that make it virtually impossible for working people to find affordable housing in London.

In addition to the current recession, which has driven down wages, the mortgage/foreclosure crisis and the government sell-off of subsidized housing, British workers also confront skyrocketing house prices and rents due to speculation by foreign buyers (who purchase homes they don’t intend to live in as assets).

As one activist points out, Asian countries charge foreign buyers a 15% tax to discourage speculation in their property market. In Britain, in contrast, the government actively encourages developers to market their property to foreign buyers.

For me the most interesting part of the film was the history of Britain’s squatters movement, which first began after World War II. At the time, there were insufficient homes to accommodate soldiers returning from the front.

In 1946, squatting in vacant buildings was so widespread that the government permitted local councils to charge squatters rent.

The movement experienced a resurgence in the late sixties with the release of the Ken Loach film Cathy Come Home and again following the 2008 economic downturn.

The Tea Party: Brought to You by Wall Street

pity the billionaire

Pity the Billionaire: the Hard Times Swindle and the Unlikely Comeback of the Right

By Thomas Frank

Havill Secker (2012)

Book Review

Pity the Poor Billionaire describes how the right wing corporate elite used the 2008 economic crash to build a pseudo-populist movement (aka the Tea Party) to build blue collar support for harsh free market austerity policies that benefited Wall Street at the expense of working people.

According to Frank,  the Tea Party was the fourth conservative uprising in the last half century. The first was the backlash against the anti-Vietnam war movement that resulted in Nixon’s election in 1968 and 1972. The second was the Reagan revolution in 1980; the third the Contract with America revolution that won Republican control of Congress (in 1994) during Clinton’s first term.

The Demise of Unions and the Left

With each of these movements, US political and economic life became increasingly conservative, with all public institutions – churches, hospitals, universities, museums, the US Post Office and even the Army and CIA – succumbing to pressure to operate according to free market principles.

The same period saw the virtual demise of both labor unions and any organized US left. Nevertheless, according to Frank, right wing strategists managed to flood the media with rhetoric ramping up popular fear the left was “on the march.” It mainly  focused on a fictitious behind-the-scenes conspiracy to provoke a crisis – through overspending that would collapse the US economy.

Swaying Popular Anger from Wall Street to the Government

This messaging, crafted by right wing think tanks funded by right wing billionaires like the Koch brothers and delivered by Glenn Beck, Russ Limbaugh and similar right wing celebrities, was spectacularly effective in convincing a majority of Americans that the neoliberal corporatist Obama is really a socialist.

Oil billionaire Charles Koch warned back in 2008 that the global economic downturn could lead to the same “loss of liberty and prosperity” (for billionaires) as the Great Depression did. He and his brother David went on to deliberately manufacture an “astroturf”* movement (ie the Tea Party) to thwart Obama from enacting the same type of public spending projects Roosevelt used to reverse the 1929 depression.**

They did this by using Tea Party protests and right wing media to sway public anger away from Wall Street and onto the government. Via sophisticated psychological propaganda, working people were systematically conned into believing their interests coincide with those of Wall Street corporations.


*Astroturfing is the practice of masking the sponsors of a message or organization to make it appear as though it originates from grassroots participants.

**Frank challenges (with data) the common Tea Party assertion that Roosevelt’s New Deal reforms failed to halt the 1929 depression (ie that it took the World War II mobilization to lift the US out of depression). Between 1929 and 1933 (when Roosevelt took office), the US GDP dropped by more than 50 percent. Following the enactment of the New Deal, it increased by 11% in 1934, 9% in 1935, 14% in 1936 and 13% in 1937. Overall GDP growth 1933-37 was the highest the US has seen outside of war time.

Goldman Sachs the Vampire Squid

money and power

The Secret is Not Getting Caught

The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming it’s blood funnel into anything that smells like money.” Matt Taibbi, Rolling Stone 2009

In his classic Rolling Stone article, Matt Taibbi blames Goldman Sachs for causing the Great Depression, the Internet bubble and the skyrocketing price of gasoline. Author William D Cohan dismisses the article as a “screed” and “conspiracy theory journalism.” Yet after reading Cohan’s 604-page Money and Power: How Goldman Sachs Came to Rule the World, I have to agree with Taibbi. For over 133 years, the secret of Goldman’s success has been an uncanny ability to extract a fee from any transaction involving human need.

It’s hard to read a book like this without understanding the complicated derivatives trading responsible for the 2008 Wall Street crash. Cohen does a credible job of explaining these complex financial trades. What comes across loud and clear is that derivatives trading is merely a sophisticated form of gambling. Like the owner of a Las Vegas casino, Goldman knows exactly how to turn the odds in their favor. This almost always entails unethical and illegal conduct. Goldman executives excel at not getting caught, which seems to be the main reason they receive such massive bonuses. They’re also really good at maximizing their high level connections in the federal government.

After reading Money and Power, I’m more convinced than ever that the only way to end Wall Street corruption is to break up the big banks by ending their ability to create money out of thin air. Once the creation and control of our money supply is rightfully restored to public control, no bank will ever be too big to fail.*

US Justice System Too Slow and Cumbersome

Goldman’s history is filled with a litany of criminal indictments and civil lawsuits stemming from unethical and illegal activities. Although both federal and state government’s have a wealth of anti-corruption laws they could use to prosecute Goldman and other Wall Street banks, the American criminal justice system is far too slow to inflict severe enough penalties the criminal activity. The close involvement of Goldman chief executives in federal government (which Cohan refers to as “government Sachs”), most notably Robert Rubin in the Clinton administration and Hank Paulson in the Bush junior administration, is also be a major factor in the bank’s enduring financial success. Remaining limited Goldman partners while holding cabinet appointments, both men were responsible for a range of federal initiatives favorable to their “former” employer.

Goldman’s Role in 1929 Crash

The first federal indictment against Goldman was lodged in 1947, an antitrust lawsuit related to the fraudulent and speculative activity by Goldman and sixteen other Wall Street banks which caused the massive 1920s stock market bubble and 1929 crash. In 1929 alone, Goldman created $1.7 billion of market value through a pyramid scheme in which they resold the same shares of stock seven times. The lawsuit was dismissed in 1950 – the Department of Justice couldn’t produce convincing evidence the seventeen banks actively colluded.

Finding Charges that Would Stick

In 1970 Goldman faced over twenty lawsuits and a SEC complaint for selling commercial paper (from Penn Central Railroad and Mill Factors Corporation) when they knew it was worthless. This time the court found for the SEC and Goldman was forced to settle the civil cases.

In 1986 two Goldman vice presidents pleaded guilty to insider trading.

In the late 1980s and early 1990s, Goldman lost a series of sexual discrimination suits by female traders.

In 1994, two pension funds sued Goldman for disposing of Maxwell Communications Assets and disturbing the proceeds to Maxwell’s estate rather than the pension funds. Goldman settled for $400 million after the Justice Department threatened them with criminal charges.

Enter Eliot Spitzer**

In 2002, Goldman faced a series of federal and state indictments related to their role in the dot com bubble. Specifically the SEC and New York attorney general Eliott Spitzer charged them with bribing independent analysts to issue favorable reports on worthless Internet stocks, as well as with “spinning and laddering”*** to drive up the share price. Goldman eventually settled with the SEC for $40 million and with the state of New York for $110 million.

The following year Spitzer charged them with fraud and “front running” (ie insider trading) in trading in non-traditional insurance products and reinsurance. Goldman settled for $800 million.

Goldman faced a rash of new indictments and lawsuits stemming from the 2007-2008 crash. In December 2007 the Massachusetts attorney general cited Goldman for selling mortgage backed securities without informing them that the mortgagees were at high rate of delinquency. Goldman settled for $10 million, as well as spending another $50 million to alter the terms of the mortgages to reduce the risk of default.

Later in 2007, a Mississippi pension fund (representing 300,000 pensioners) sued them for knowingly selling worthless mortgage backed securities.

The 2008 Wall Street Collapse

In 2010, the Securities and Exchange Commission (SEC) sued Goldman for incorrectly forecasting the performance of mortgage backed securities they sold to clients while betting against the MPS’s by purchasing credit default swaps (CDS)**** on them. Goldman began purchasing credit default swaps in February 2006 as soon as they realized the mortgage market was unraveling. Goldman settled this suit for a record $800 million.

Goldman was the only Wall Street bank not to suffer major losses in 2007 and 2008. Because of their massive holding holdings in credit default swaps, they easily absorbed losses from mortgage backed securities that became worthless when real estate values crashed and mortgages became delinquent.

In 2007 they had a net profit of $11.4 billion, despite a $1.2 billion loss in their mortgage backed securities. In 2008, their net profit was $2.3 billion, despite a $1.7 billion loss in their mortgage division.

Goldman CEO Lloyd Blankfein argued against receiving a TARP bailout because they obviously didn’t need it. Treasurer Secretary Hank Paulson insisted they take a $10 billion bailout anyway to “inspire investor confidence.” Goldman repaid it with a 23.5% annualized dividend in July 2009 – banks with outstanding TARP loans were restricted in the size of CEO bonuses they could pay.

Goldman would also receive $14 billion of the bailout AIG insurance received. This covered the credit default swaps AIG had sold them.


*See An IMF Proposal to Ban Banks from Creating Money
**Eliot Spitzer was one of the few government prosecutors willing to go after Wall Street banks for white collar crime. His popularity resulted in his election as governor of New York in 2007. The banks fought back behind the scene and forced his resignation in 2008 by exposing his involvement with a high end prostitution ring. This is described in the 2010 documentary The Rise and Fall of Eliot Spitzer
***”Spinning,” which is illegal, is defined as the offering of free or discounted IPO (initial public offering) shares to executives of an outside company, in the hope they will influence the company to buy additional shares at an inflated price. “Laddering” is another illegal practice in which underwriters and clients collude to drive up share prices (by trading them at inflated prices) and selling them once they hook in enough suckers. Many analysts suspected laddering occurred in the Amazon initial public offering (IPO), with the share price bottoming out when all the insiders sold their shares.
****A credit default swap (CDS) is a type of insurance, a bet that pays off if a particular security goes belly up. CDS’s are traded like other derivatives and you don’t have to own the security for the CDS to pay off.

Also posted at Veterans Today