The Great Deformation (10 page)

This puts the lie to an urban legend assiduously promoted by the bailsters at the time and repeated endlessly by their apologists ever since. Their preposterous claim was that the $600 billion globe-spanning behemoth known as General Electric could not find replacement financing for the approximate $25 billion of commercial paper scheduled to mature on a fixed schedule (i.e., it was not subject to call on demand) between September 15 and the final months of 2008. The very idea that GE had been incapable of raising even a billion dollars of funding per business day was ludicrous on its face.

That this proposition was seriously embraced by mainstream opinion is undoubtedly a measure of the panic which had been shamelessly induced by the Washington bailsters. The true facts of the case, of course, were more nearly the opposite. GE Capital could have readily generated sufficient cash to meet its CP redemption obligations by selling only 8 percent of its assets, even at fire-sale discounts of up to 50 percent of book value, if that had been necessary.

In the alternative, the GE parent corporation could have raised new debt and equity capital, again at whatever deep discounts might have been demanded by the distressed markets of the moment. For example, a 4 percent increase in its long-term debt would have raised $15 billion, even if it required a coupon double GE's average 5 percent rate. And a mere 10 percent increase in its outstanding common shares would have raised $10 billion, even had they been placed at $10 per share or 50 percent below its $20 stock price at the time.

Thus, the mix of potential asset disposals and stock and bond issuance available to GE was nearly infinite. Any combination chosen would have generated sufficient cash to redeem its expiring commercial paper. Indeed, it is blindingly obvious that the taxpayer-supported bailout of General Electric was simply about earnings per share and the threat to executive bonuses that would have resulted from asset sales or stock and bond offerings.

The fact is, these “self-help” methods of raising cash according to free market rules would have also have whacked GE's earnings by perhaps $2 per share, owing to losses or earnings dilution. Either way, shareholders would have gotten the beating they deserved for having so egregiously overvalued GE's debt-inflated earnings and for putting such reckless managers in charge of the store.

Instead, GE shareholders were spared any permanent damage. Likewise, GE and GMAC had combined long-term debt outstanding of nearly a half trillion dollars, all of which remained worth a hundred cents on the dollar, thanks to Uncle Sam's safety nets.

This means that the bond fund managers who were the “enablers” of these unstable finance company debt pyramids got off without a scratch. So the pattern was repeated over and over. The post-Lehman meltdown in the wholesale money markets, including the various types of commercial paper, was of consequence only in the canyons of Wall Street. The thin slab of permanent debt and equity capital that supported these bubble-era pyramids of inflated assets and toxic derivatives was the only real target of Mr. Market's wrathful attack.

Had this attack been allowed to run its course, hundreds of billions in long-term debt and equity capital that underpinned the Wall Street–based speculation machines would have been wiped out, including huge amounts of stock owned by executives and insiders. Such a result would have been truly constructive from a societal vantage point. It would have implanted an abiding 1930s style generational lesson about the deadly dangers of leveraged speculation.

BERNANKE'S PANICKED DEPRESSION CALL

At the end of the day, the stated purpose of the Wall Street bailouts—to avoid a replay of the 1930s—was drastically misguided. It was based on a phantom threat which arose overwhelmingly from the faulty scholarship of a single official: the former math professor who had come to head the nation's central bank. The analysis was actually not even his own, but was the borrowed theory of Professor Milton Friedman.

Forty years earlier, Friedman had famously claimed that the Fed's failure to run its printing presses full tilt during certain periods of 1930–1932 had caused the Great Depression. Bernanke's sole contribution to this truly wrong-headed proposition was a few essays consisting mainly of dense math equations. They showed the undeniable correlation between the collapse of GDP and the money supply, but proved no causation whatsoever.

In fact, as will be shown in
chapters 8
and
9
, the great contraction of 1929–1933 was rooted in the bubble of debt and financial speculation that
built up in the years before October 1929, not from mistakes made by the Fed after the bubble collapsed. In the fall of 2008, the American economy was facing a different boom-and-bust cycle, but its central bank was now led by an academic zealot who had gotten cause and effect upside-down.

The panic that gripped officialdom in September 2008, therefore, did not arise from a clear-eyed assessment of the facts on the ground. Instead, it was heavily colored and charged by Bernanke's erroneous take on a historical episode that bore almost no relationship to the current reality.

Nevertheless, the bailouts hemorrhaged into a multitrillion-dollar assault on the rules of sound money and free market capitalism. Moreover, once the feeding frenzy was catalyzed by these errors of doctrine, it was thereafter fueled by the overwhelming political muscle of the financial institutions which benefited from it.

These developments gave rise to a great irony. Milton Friedman had been the foremost modern apostle of free market capitalism, but now a misguided disciple of his great monetary error had unleashed statist forces which would devour it. Indeed, by the end of 2008 it could no longer be gainsaid. During a few short weeks in September and October, American political democracy had been fatally corrupted by a resounding display of expediency and raw power in Washington. Every rule of free markets was suspended and any regard for the deliberative requirements of democracy was cast to the winds.

Henceforth, the door would be wide open for the entire legion of Washington's K Street lobbies, reinforced by the campaign libations prodigiously dispensed by their affiliated political action committees (PACs), to relentlessly plunder the public purse. At the same time, the risk of failure had been unambiguously eliminated from the commanding heights of the American economy. Free market capitalism thus shorn of its vital mechanism to purge error and speculation had become dangerously unhinged.

Yet the September 2008 meltdown was a financial cyclone which struck mainly within the vertical canyons of Wall Street, and would have burned out there in short order. This truth exposes the crony capitalist putsch that occurred in Washington during the fall of 2008 and invalidates its self-serving narrative that America was faced with a continent-wide flood which would have wracked devastation across the length and breadth of Main Street America.

There was never any evidence for Bernanke's Great Depression bugaboo, a truth more fully explicated in
chapters 28
and
32
. So it is also not surprising that bailout apologists cannot explain the origins of the Wall Street meltdown. Indeed, they treat it as
sui generis
, meaning that the “contagion,” whatever it was, had suddenly arrived as if on a comet from deep
space. And after hardly a ten-week visit, as measured by the return of speculators to the beaten-down bank stocks in early 2009, it had adverted once again to interstellar blackness.

It is not surprising, therefore, that the corporals' guard of Treasury and Federal Reserve officials who carried out this financial coup d'état never once provided any detailed analysis of why this mysterious “contagion” had struck so suddenly; nor did they ever lay out the financial system linkages and pathways by which the contagion was expected to spread; nor did they present any review of the costs, benefits, and alternatives to bailing out the major institutions which were rescued. Hardly a single page of professionally competent analysis and justification for the Wall Street bailouts was presented to the president or any of the leaders of Congress at the time.

Indeed, the Bernanke–Paulson putsch was so imperious and secretive that Sheila Bair, head of the FDIC and the one regulator who thoroughly understood the balance sheet of the American banking system, and also did not buy into knee-jerk fear mongering about “systemic risk,” was simply not consulted, and commanded to fall in line. As Bair recounted the events, “We were rarely consulted … without giving me any information they would say, ‘You have to do this or the system will go down.' If I heard that once, I heard it a thousand times … No analysis, no meaningful discussion. It was very frustrating.”

Sheila Bair was the single best informed and most tough-minded and courageous financial official in Washington at the time of the crisis. She had a sophisticated grasp of the manner in which deposit insurance had been abused to fund excessive risk taking in the banking system and a resolute conviction that the capital structure enablers—that is, bank bond and equity holders—needed to absorb losses ahead of the insurance fund and taxpayers.

None of this was remotely understood by Paulson's cadre of former Goldman associates led by Neel Kashkari. He was a thirty-four-year-old former space telescope engineer who had done two-bit M&A deals in Goldman's San Francisco office for two years before joining the Treasury Department and being assigned the bailout portfolio.

The fact that the abysmally unqualified Kashkari led the bailout brigade while Bair was systematically excluded from the process speaks volumes as to how completely public policy had fallen into the clutches of Wall Street. Kashkari and his posse had no sense whatsoever about the requisites of sound public finance. So in the fog of Washington's panic, prevention of private losses quickly and completely supplanted any reasoned consideration of the public good.

THE BLACKBERRY PANIC OF 2008

The exclusive diagnostic tool used by the principals during this entire episode was carried in their pockets. This was the BlackBerry Panic of 2008. What was going down hard was not the American economy, just the stock prices of Goldman and the other big banks.

As the “eye witness” accounts contained in the numerous histories written by financial journalists make clear, the driving force behind every action and each decision was the instantaneous oscillation of stock prices and credit spreads, and the openings and closings of financial markets around the globe. Needless to say, the dancing digits on the hundreds of BlackBerries toted about on the field of battle measured nothing of relevance to the public interest, even as they kept instant score on the price of the stocks and bonds of the financial institutions in play.

The journalistic histories also make clear the method of persuasion used by Washington officialdom to deliver the keys to the nation's exchequer to Wall Street and its agents in the Treasury and the Fed. In a word, it was fear—lurid premonitions of cash machines gone dark, payrolls undelivered, air freight grounded, and assembly lines stopped-out.

In the cold light of day, however, it is abundantly clear that none of these catastrophes would have occurred had TARP never been enacted. Trillions of bank deposits were already well protected by the FDIC's existing powers to guarantee deposits and take over insolvent banks, along with the Fed's capacity to make virtually unlimited discount window loans to member institutions on the presentation of standard collateral.

This fear-based stampede to adopt TARP was made all the easier by the White House's virtual abdication from the policy process. Indeed, the contrast between these September 2008 acts of perfidy by the Bush administration and the comparable betrayal of conservative principles by a Republican White House in August 1971 is striking.

Back then, Richard Nixon called his government to Camp David for an entire weekend and personally led the charge for policies—wage and price controls, import protection, and closure of the gold window—which were antithetical to GOP principles. In September 2008, however, George W. Bush simply delegated his raid on the American taxpayers to the Treasury Department and then reverted to his habitual somnolence on matters of economics.

And not surprisingly. During his brief interval of success in scalping a handsome profit from the Texas Rangers franchise, George W. Bush had apparently learned little about business and virtually nothing about the nation's now massively debt-ridden economy. So as president in the white
heat of crisis, he was easy prey for the fear-mongering of the cabal lead by Treasury Secretary Paulson and Chairman Bernanke.

At a meeting of the congressional chieftains, the president thus tersely conveyed the entirety of his comprehension of the momentous matter at hand. “This sucker is going down,” he told them, and in a comparative flash the nation's petrified legislators wrote out a $700 billion blank check.

And so the TARP bailout was enshrined as a last-resort exercise in breaking the rules to save the system. Ever the master of malapropism, President Bush soon took to proclaiming, “I've abandoned free market principles to save the free market system.”

Ironically, however, the truth was more nearly the opposite. The financial meltdown of 2008 was occurring because sound economic principles had already been abandoned—years earlier, in fact. The right solution was to restore these discarded canons, not to eviscerate them further. That meant promptly dismantling the giant gambling halls which had ushered in the crisis.

It also meant returning the Fed to its proper role as guardian of the dollar's value and stern taskmaster of banking system liquidity; that is, to a policy of dispensing discount window loans only at a penalty rate of interest against sound collateral while remanding insolvent institutions to the FDIC for closure. But most importantly, it meant liquidation of the massive pyramids of debt and leveraged speculation that had built up throughout the American economy over more than three decades.