The Great Financial Crisis


All the major financial analysts claim the ongoing and deepening financial crisis is in large part the result of investor uncertainty. This is because the investment banks, derivatives and hedge funds placed high risk, sub-prime mortgages and junk bonds, along with other more reliable debt paper into packages and sold them to institutional and private bankers who in turn ‘retailed’ them around the world.

The rating agencies, who are paid by the sellers, all gave top billing (AA, AAA) to these hybrid securities, mortgages and junk bonds, encouraging investment advisers to push them on to risk-averse client looking for higher returns than Treasury notes. Most of the investors do not know whose and what paper they are holding, nor how much their hedge funds are losing or have lost. Those who can, have pulled out. The banks are reticent to loan to any applicant. Leverage funds are a dirty word among lenders. Hedge funds are either selling assets to pay loans or not telling what they own or owe. Derivatives have been deflowered. Central Banks in the US, Japan and the European Union have poured (and keep pouring) over $250 billion to the private banks hoping to create liquidity but the banks won’t lend–because, as one prominent banker in Palm Springs told me "Nobody knows who’s got a turd (worthless investments) in his brief case."

Meanwhile, Goldman Sach, Bear Stearns and Lehman Brothers are all closing down bankrupt investment funds or trying to prop them up. The Fed props up all the worst speculators in the name of ‘saving the financial system’ – in a way that it would never prop up the failing American health system. The financial system has the ‘runs’ and infusions of Fed funds have failed to block the ‘run for cover’.

"Everybody for himselfand don’t look back’, is the watchword of leading equity bankers. The Democrats are calling for the usual inconsequential Congressional hearings about what went wrong. Congressmen Levin and Barney Frank will ask the wrong questions to the wrong people–going after the weakest fall guys–the rating agencies–for overrating the fraudulent deals, not the dealmakers themselves. The ‘turds’ in the briefcases are big and smelly but no one knows how big: $250 billion or $500 billion. There are a lot of bankers and hedge fund billionaires walking around with invisible clothespins on their noses.

Where is Greenspan, since he started the whole scam with his low interest, deregulated financial markets? The homely hero of all hedge-derivatives-innovative financial scamsters sanctioned, approved and promoted the pyramid swindles. He’s off advising Deutsch Bank and suckering the international bankers for $100,000 fees for his failed financial recipes. But for those speculators who made a bundle and left, Greenspan is not part of the emerging turd culture. For them he is still the financial genius who made their fortunes.

So unless the fund directors come clean, empty their brief cases and open their balance sheets we won’t know who are carrying the turds: The great unknowns include the unredeemable bonds, the worthless mortgages and the illiquid hedge funds. Without knowledge of the size and scope of the turds, the great uncertainty has frozen most investments and loans–it is paralyzing the financial system. Even Fannie Mae and Freddie Mac (the federally-funded mortgage companies) can’t come in and buy up the ‘turds’ (otherwise known as ‘bad debts’), no matter how many hundreds of billions of US taxpayers’ money they are willing to spend.

All the financial wizards, the super-smart scientific, mathematical, guaranteed 30% per year investment advisers have less credibility than a street corner con man. The most arrogant, pretentious, scientific speculators have been humbled; especially those oracles who practiced what is call among the insiders as ‘Quantitative investment’.

Quantitative investing (QI), the use of complex computer models in making investment decisions, was used and promoted by some of the reputedly smartest and highest regarded ‘gurus’ of Wall Street. For a decade the complex mathematical modeling produced extraordinary profits for Renaissance funds, Goldman Sachs and numerous other asset managers and hedge funds. With the massive sell-offs of assets to pay debts and the desperate drive for liquidity, all the assumptions of the QI went out the window. "The Model" cannot account for any crisis which calls into question ‘historical trends’. The best and the brightest are baffled. At first, the QI geniuses said the crisis was a localized problem for the sub-prime bottom-dwelling speculators. But as their own funds dropped they blamed hysterical investors who over-reacted. "A problem of perceptions", they psychologized. But their funds continued to decline: the Market wasn’t acting as their ‘model’ dictated. Hearsay flourished, skeptics surged.

"What’s the problem: The Market or the Model?", one QI practitioner asked his colleagues.

The answer from the Market: "It’s the model stupid: All the QI use historical models that extrapolated past patterns into the future as if capitalism is a crisis-free system which changed incrementally and in which investors borrowed rationally to leverage purchases in line with their capacity to pay back any losses. That’s Main-Street folklore for retail brokers and the daily fare of American Enterprise ideologues."

Scientific mathematical modeling in the Great Casino predictably turned out to be as fallible as numerology spun by Shamans to explain the life cycle.

No one’s going out of the window of the upper stories of high rise offices–yet. What’s keeping the suicide rate down is precisely what’s keeping investors running: no one knows how many hundreds of billions in worthless paper is being held. With the demise of the mathematical modeling speculative science, we are now in the period of the Mystical Black Hole. The big investment houses and hedge funds are holding back on revelations, hoping that investment confidence will return if investors are kept in the dark about how much they lost. This is a step below Voodoo Economics. How can investor confidence return if they don’t know if the big turds are in the briefcase of the Renaissance Funds, Goldman Sachs, First Quadrant or any one or all of a thousand and one Ali Baba hedge funds?

Let them lose their pants, writes orthodox Market pundits like Marty Wolf in the Financial Times. "In order to value risk, they should lose properly. To bail them out", they argue, "is a moral hazard." Meaning of course, that if the hype and scam speculators are covered by a Federal Bank bail out, they lose nothing, and will repeat swindling in the future. Bailouts are a formula for financial scam recidivism. So much, alas, for the advice of orthodox market experts. European Central Banks and the US Federal Reserve know what class they represent: Real existing speculator plungers, not textbook risk-calculating value-oriented entrepreneurs, are their reference group. The risk of letting the bad boys sink is that there are too many of them, working in most of the most powerful investment houses, managing too many funds, for the most powerful financiers.

"There are no good financiers and bad speculators", one philosophically inclined fund manager (who is likely carrying a turd) put it, "We are all in this together, if we sink so does the whole financial system." Is this a self-interested plea for financial solidarity, a closet Marxist or a prophet of doom? Nobody knows till we delve into the Black Hole of the financial crisis. That won’t happen till the brief cases open.

JAMES PETRAS, a former Professor of Sociology at Binghamton University, New York, owns a 50 year membership in the class struggle, is an adviser to the landless and jobless in brazil and argentina and is co-author of Globalization Unmasked (Zed). His new book with Henry Veltmeyer, Social Movements and the State: Brazil, Ecuador, Bolivia and Argentina, will be published in October 2005. He can be reached at: jpetras@binghamton.edu

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