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

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

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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

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6/4/2012 1

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
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Minsky Moment

  • Financial Instability Hypothesis
  • Investment Theory of the Cycle and Financial Theory
  • f 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

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A Minsky Half-Century?

  • Stages Approach: 57 Varieties
  • Commercial capitalism
  • Finance capitalism
  • Paternalistic (Managerial-Welfare State) capitalism
  • Money Manager capitalism (predator state, financialization,
  • wnership society, neoliberalism, neoconservativism, shadow

banking)

  • Stability bred instability
  • Accumulation of financial assets/liabilities
  • Globalization
  • Securitization
  • Self-supervision

Decreasing Weight of the Banking Sector

Shares of Financial Institutions (%

  • f Total Assets)

0.00 20.00 40.00 60.00 80.00 100.00 120.00

1 9 4 5 1 9 5 1 9 5 5 1 9 6 1 9 6 5 1 9 7 1 9 7 5 1 9 8 1 9 8 5 1 9 9 1 9 9 5 2 2 5

life insurance companies Managed Money Funding Corporations Security Brokers and Dealers Real Estate Investment Trusts Finance Companies Issuers of Asset-Backed Securities Agency and GSE-backed Mortgage Pools Government-Sponsored Enterprises State and Local Government Retirement Funds Credit Unions Saving Institutions Bank Holding Companies Commercial Banking

Source: Federal Reserve Flow of Funds Accounts

Managed Money Commercial Banking

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Pension Fund Total Assets (% of GDP)

10 20 30 40 50 60 1945 1948 1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 % Private Pension Funds State and Local Government Employee Retirement Funds Source: Federal Reserve Flow of Funds Accounts

Government GSE Private

0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0

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

Total Financial Liabilities Relative to GDP

Sources: Historical Statistics of the United States: Millennium Edition (Tables Cj870-889 and Ca9-19), NIPA, Flow of Funds (from 1945).

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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

0,00 5,00 10,00 15,00 20,00 25,00 30,00 35,00 40,00 45,00 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 2009

Financial Industry Share of Corporate Profits and Value Added (1955-2010)

Share of Profits Value Added (% of GDP)

Source: Bureau of Economic Analysis

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Households and nonprofit

Noncorporate and farm

Nonfinancial nonfarm corporate Private finance

GSE

Government 0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0

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

Total Financial Liabilities Relative to GDP

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

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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)
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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.
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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.
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Shredding of New Deal Reform

  • Deregulation, desupervision, self-supervision
  • Rising inequality
  • Falling wage share
  • Rising consumer debt

Wages and Salaries, % of GDP

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6/4/2012 11

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

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Bail-out and Cover-up

  • No criminal prosecutions of top management.
  • Stimulus $800B.
  • Hank Paulson $800B.
  • Fed: $29 TRILLION.
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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

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JP Morgan Chase & Co. 3% UBS AG (Switzerland) 3% AIG 7% Bank of America Corporation 6% Barclays (UK) 7% Citigroup Inc. 17% RBS (UK) 4% Deutsche Bank AG (Germany) 5% Goldman Sachs & Co. 6% Credit Suisse (Switzerland) 5% Merrill Lynch 16% Morgan Stanley &

  • Co. Incorporated

15% Bear, Stearns & Co., Inc. 6%

Institution Totals Accross All Facilities

Over $400 Billion

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 Bridge Loan 12.9 0.04 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%

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Crimes multiply in the cover-up

  • Burger King Kids: robo-signing, forgeries.
  • Lost note affidavits, backdating docs.
  • Lawyers: perjury in court.
  • 13 million foreclosures by 2012.
  • Homeownership rates already back to pre-boom

level.

  • Blood-sucking vampire squid hedge funds buying up

blocks of homes, cents on the $.

End Game for Money Manager Capitalism

  • Euroland is toast; failure of major bank will set off GFC 2.0
  • Radical euthansia: major banks will fail.
  • Managed funds will fail: pensions, sovereign wealth funds,

mutual funds, insurers, hedge funds.

  • That is a good thing!
  • Minsky’s “simplification” of the financial system.
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6/4/2012 16

End Game for Money Manager Capitalism

  • Will emerge with little private debt, massive

government debt  robust financial system; Constrained with new laws, supervision.

  • Return to underwriting, hold to maturity.
  • Financialization replaced with New Deal 2.0: Higher

Wages, Full employment, Domestic Consumption.

THANK YOU

  • L. Randall Wray, Levy Economics Institute and University of

Missouri—Kansas City www.levy.org; www.cfeps.org; wrayr@umkc.edu BLOGS: NEP: http://neweconomicperspectives.blogspot.com/ Great Leap Forward: http://www.economonitor.com/lrwray/