Wade Frazier: The Global Financial Meltdown

This is written on January 1, 2008. I derive no great pleasure in describing dynamics that give rise to repeated financial scandals. This latest unfolding scandal was easy to predict, although the mainstream pundits and other capitalistic cheerleaders did not see it coming, as usual. The so-called soft-landing that was being predicted as late as the summer of 2007 has become a full-blown international banking crisis that is a long way from hitting bottom, which was a result of all the insanity in American real estate, precipitated by imprudent monetary policy (the Federal Reserve lowering interest rates to about zero in the wake of the dot.com implosion of 2001, in order to keep the economy propped up). It increasingly looks like we never learn. This latest crisis has many parents, and the public accounting profession’s complicity has yet to be assessed. However, phony appraisals to support larger real estate loans (which helped fuel the speculative frenzy in U.S. real estate) are already being uncovered, which the public accounting profession will partly answer for.

Part of the dynamic behind this unfolding subprime scandal is based on the endemic greed of capitalism. This is the fourth major financial scandal in my lifetime, all rooted in seeking the “marginal” borrower in order to enhance revenues and profits. The situation of petrodollars funding third-world debt in the 1970s was the first one. That it was not really intended to help the people of those nations is also part of the logic of predatory capitalism, increasingly admitted by insiders. When the S&L scandal was brewing, its companion incipient scandal was related to “junk bonds,” where corporations with poor credit were able to borrow vast sums of money. Michael Milken was its poster boy. The chickens have yet to really come home to roost on that one. Milken’s stratagem helped begin the age of the corporate raider, where capitalistic sharks devour companies by stripping their assets and then moving the money offshore (to gain “legal and tax” advantages, which is a euphemism for unaccountability). Corporate raider organizations are now euphemistically called “hedge funds,” and those hedge funds have become central players in the unfolding scandal. That was part of what Enron did in its raping of California (stealing money and taking it offshore), which was a minimized aspect of the Enron scandal. That kind of behavior eventually dooms the economies they occur within. When the law of the jungle prevails, everybody ultimately loses.

With the Bush regime’s catastrophic invasions of the Middle East and Central Asia, and its relentless saber-rattling at Iran, Venezuela and other oil-rich nations that refuse to kneel to Western oil companies, the perfect economic storm may well be on its way, with the collapsing U.S. dollar being one of its harbingers. Of course, in the 2008 presidential horserace, none of these issues are being productively engaged. These times are particularly ominous, and 2008 will likely be very eventful, in a painful way, particularly for Americans. It does not have to be this way.

A week ago, the USA’s government announced that it was taking over Fannie Mae and Freddie Mac, the two quasi-private institutions that support America’s residential real estate market. Today, the USA's fourth largest investment banker, Lehman Brothers, filed for bankruptcy, while Merrill Lynch agreed to be acquired by Bank of America, not many months after Bear Stearns, the next largest investment bank, collapsed. For the past year, my day job has been intimately involved with America’s collapsing financial system, with residential real estate at its epicenter. I experience deja vu on a daily basis, although today’s events are more ominous than those relatively innocent days of the 1980s. On some days, half of the financial news headlines impact my day job and/or life. A year ago, I said to my co-workers that the coming meltdown would reach $1 trillion in losses, while the mainstream pundits were estimating losses of less than $50 billion. Now, it looks like I was being optimistic, with up to $2 trillion in losses being forecast by the analysts worth listening to.

The dynamics that led to the past year’s economic turmoil were easy to see, although the pundits, as usual, did not see it coming, and once reality began dawning on them, they announced that we were in the ordeal’s last innings.[21] Now, it is being increasingly admitted that nobody knows where the bottom will be. The public accounting profession’s complicity has yet to be assessed, but it will not emerge unscathed. Already, I am seeing evidence of accounting shenanigans to hide the losses, and the public accounting profession will be bludgeoned, perhaps out of existence, if they collectively look the other way again.

In economics parlance, there is a concept known as risk-and-reward. The riskier a certain activity is, the higher the reward may be. A primary preoccupation of Wall Street’s bright minds is concocting complex financial instruments/transactions that separate risk and reward, so that the clever people doing the inventing reap the reward while the “suckers” shoulder the risk. The standard model in USA finance is a public subsidy of risk and a privatization of the profit. That is how the rich keep getting richer. All government interventions in the past year (all the emergency lending by the Federal Reserve, brokering the acquisition of Bear Stearns by J.P. Morgan, and now the nationalization of Fannie Mae and Freddie Mac) have made the taxpayer responsible for the “free market’s” excesses.

Since the 1973 oil crisis, the USA’s economy has increasingly moved from an industrial one to a FIRE (finance, insurance, real estate) economy. A FIRE economy does not produce much of anything, but mainly moves around money in the exchange aspect of economics. Instead of a business cycle, we are now seeing a serial bubble cycle, with this real estate collapse being the latest instance. An Onion satire article about the bubbles was even cited by the Wall Street Journal as being funny because it was true.

The Roman Empire did not collapse in a day, nor did the British Empire. The decline of the American Empire will take some time, but its decline is gaining steam, with the USA’s financial institutions begging for foreign capital injections to stay in business, with foreign investors buying up huge amounts of USA government debt. Invading the Middle East and Central Asia (while killing millions of people) is the mark of a weak empire, and the USA is having difficulty digesting what it seized, in a classic instance of imperial overreach. In the end, the American Empire’s creditors will probably end up bringing it to heel.

I believe that we are in the early innings of the turmoil that will likely see the American Empire go the way of other empires. Of course, it does not have to be this way, but unless there is a mass awakening in the USA, this nightmare will only get worse.

As 2008 ends, 2009 looms portentously for most Americans. The last few months of 2008 were the most economically radical in American history, as economies began collapsing, first nationally, then globally. The American government nationalized much of the nation’s financial system and bailed out the insurance and automobile industries, while extraordinary interventions occurred in virtually all industrialized nations, with Iceland being the first Western nation to accept IMF money since the 1970s (about a third of Iceland’s citizens are considering whether to flee the disaster by emigrating from their mother country). The Kondratiev wave is becoming a relevant topic again, and Marx’s “crisis in capitalism” is being revisited in light of current events. Systems based on greed and fear will never be sustainable. Those who turned the global economy into a casino are doing their best to make off with their plunder.[22] I recently saw an interview with one of the few economists who saw it coming, James Galbraith, and his moment of realization was at about the same time as mine and for the same reasons: when lending became crazy, with all those exotic loans and an abandonment of lending standards (and what further convinced me was a greed-based hysteria — a.k.a. "irrational exuberance" — that began manifesting in the American public). I clearly saw it coming in 2004, when it really began getting out of hand. I also called the top in California in 1989, when I saw similar dynamics.

In capitalism, there is a concept known as “risk and reward.” Activities seeking the greatest returns are also the riskiest, at least in theory. Many smart minds on Wall Street have always sought to rig the game by developing ways to separate risk and reward: seize the reward and give somebody else the risk. The S&L Scandal began with deregulation to supposedly save an industry in crisis, which turned into a gold rush for the cronies of those doing the deregulating. When it all came crashing down, the USA’s taxpayers were handed a bill for more than $100 billion. The current crisis dwarfs the S&L Scandal, with more than $1 trillion already committed in a bailout of the USA’s economy that will reach several trillion dollars when finished. The story of Bernie Madoff, the former chairman of the NASDAQ Stock Market who stole at least $30 billion in a Ponzi scheme, capped a year full of economic catastrophe. The Big Four accounting firms are already being implicated in the Madoff Scandal. The USA’s financial system has been trying to undermine fair value accounting standards, to avoid writing down those real estate related assets to reflect their balance sheets’ reality: they owe more than their assets are worth. Most of the USA’s large financial institutions are essentially bankrupt, but are doing their best to prevent the accounting system from declaring it. These are the same dynamics that led to the S&L Scandal, where a compliant system allowed the orgy of greed to reach a crescendo, and when the inevitable collapse came, the taxpayer paid for capitalism’s excesses. The USA has borrowed at unprecedented levels, and will either hyperinflate or bankrupt the debt away, just as every other nation has that entered into unsustainable debt.

My day job has given me a front-row seat to the unfolding collapse. I was given the task of accounting for tens of millions of dollars of “good as cash” investments we were sold by our now defunct investment manager, which we can’t sell and are worth a small fraction of what we paid for them. The building frenzy in Bellevue is turning into a crash, with several large projects delayed/canceled, and skyscraper projects heading for foreclosure before they are finished. If Microsoft and Boeing have layoffs in 2009, the Seattle economy will take a steep dive that will further impact the real estate crisis.

In my upcoming energy essay (which I plan to publish sometime in 2009), I will discuss economics and its three aspects in classical study: production, exchange and consumption. Virtually everything passing for economics today is focused on its exchange aspect, which is not productive at all: its main function is ensuring that the idle rich can amass huge incomes and maintain control over the world economy. Wall Street was and is completely worthless, from a productive standpoint. The USA has largely become a global parasite, with most of its oil imported (while we invade and threaten nations that do not let us plunder their hydrocarbon deposits), with poor Mexicans producing our food (and the world’s poor, in general), with poor Asians making our clothing, electronics and other products. With the immensely corrupt automobile industry collapsing, the American Empire is in swift decline, with its real economy in shambles.

A few choice statistics can describe the big picture. Hydrocarbons power the industrialized world. To an overwhelming extent, energy is the economy, something easily ignored by people focused on the exchange (“what’s in it for me?”) aspect of economics. Today, humanity is burning those hydrocarbons about a million times faster than they were created. Since today’s technologically advanced societies are almost completely dependent on hydrocarbon fuels, burning up their primary resource a million times faster than it was created is about the most important issue they can face. The neo-Malthusians are accurate in describing the American invasions of Asia as “plan war,” where the world’s nations fight over dwindling hydrocarbon deposits.

The USA rode history’s largest economic bubble in the decades after World War II. Energy use per capita skyrocketed, to peak in 1973, when the U.S. had its first energy crisis. It is no coincidence that U.S. wages peaked in the same year. Since peaking, energy per capita has declined by about 6% and wages by about 10%.[23] The difference between the 6% and 10% is partly explained by the increasing economic disparity in America. As the pie has been shrinking, the rich and their servants have been devising ways to enlarge their disproportionate share. It began with moving the USA’s industrial capacity to low wage nations, which accelerated during the 1980s. The astronomical executive pay of recent years is only one symptom of this phenomenon, as is Bill Gates’s enjoying a net worth equivalent to the collective net worth of the poorest hundred million Americans (and the poorest half of humanity - which might be the most mind-boggling statistic of global capitalism).

My fellow baby boomers do not need statistics to understand the trends. When I was growing up in 1960s suburbia, almost all mothers stayed at home while raising the children, and the father’s income was plenty to keep the family comfortable. The stay-at-home mother is nearing extinction in America, primarily confined to wealthy or welfare mothers. I received a virtually free college education in California in the 1970s. Those days are long gone. My wife’s father not only provided for five children on his schoolteacher’s income, but he also had a large recreational boat. A hiking buddy was raised on Mercer Island on his schoolteacher father’s income, and they also had a boat that they spent the summers on, sailing to British Columbia and Alaska. Paul Allen is Mercer Island’s richest resident today, and there are no schoolteachers living there with their boats moored at their docks. It is almost surreal to consider those days of economic plenty that vanished in my lifetime.

Those days of plenty can return, but only when the energy issue is permanently resolved. Resolving the energy issue can also lead to heaven on earth and the exchange aspect of economics can fade away, as it does on the Earth depicted in Star Trek. The only thing keeping us from experiencing that reality is us. It can be different, but it is up to us.

[21] Numerous pundits did not see this crash coming and have been calling a bottom regularly, ever since, with no success. Alan Greenspan, who was a primary architect of the real estate bubble, did not see it coming [or so he says — ed.], admitting to a bubble only after the collapse had begun. Cheerleaders, such as Lawrence Yun of the National Association of Realtors, saw a silver lining in each dark cloud that formed. More sober analysts such as Nouriel Roubini clearly saw it coming; he was initially called a madman pessimist, and now is called a prophet.

[22] The globalization movement was a construct of capitalism, and perhaps the most telling statistic is what happened to foreign exchange transactions since the early 1970s, before the Bretton Woods system began being dismantled. In 1970, about 90% of all international exchange transactions were to settle real economic exchanges, such as manufactured goods being sold across international borders. By the early years of the 21^st century, about 90% of the international exchange transactions, at an astronomical level of $2 trillion per day, were pure speculation or, in other words, gambling.

[23] In 1949, per the U.S. Energy Information Administration, energy use per capita hit 357 million BTUs per capita in the U.S. in 1973, up from 214 million per capita in 1949. It declined in subsequent years to rise again and peak at 359 in 1978-1979, when the second energy crisis hit. Since then, energy use per capita has remained stagnant, declining to 337 million BTUs per capita in 2007. It will obviously decline in 2008 even further, with oil wildly fluctuating, and the USA’s economy going into a tailspin. Real wages per hour peaked in 1973, and have declined by about 10% since then.