The Credit Shock

The New York Times reports that Treasury Secretary Henry Paulson will speak tomorrow about the intervention of the US government in crumbling credit markets. According to the Times, Mr. Paulson will say, “This is not about finger-pointing, it is about putting an aggressive plan together and moving forward.”

What was the first plan? An ill-founded scheme to demonstrate how mercenaries supporting aspirants to the Junior Chamber of Commerce could secure a US beachhead in the Middle East? Or, how historic low interest rates set by the Federal Reserve coupled with the crippling of regulatory authority for land use and natural resource decisions could trigger vast societal benefits through a boom in housing markets?

In any case, we are nearing the end of the Bush presidency whose legacy is as described in a 2002 conversation between a senior administration official, probably Karl Rove, with Times’ writer Ron Suskind: “We’re history’s actors and you, all of you, will be left to just study what we do.”

Please, God, that we should be left only with that.

Three weeks ago major US banking institutions, represented by Citigroup Inc. and JPMorgan Chase & Co., began meeting with the former Goldman Sachs chief, now Treasury Secretary. The topic of conversation: a plan to revive the asset-backed commercial paper market.

In so far as the “reality-based community” is concerned, people who “believe that solutions emerge from your judicious study of discernable reality”, investors aren’t wasting time cogitating: they’re well along the process of turning the US dollar into garden mulch.

In an exceedingly carefully phrased roll-out in major newspapers, details are beginning to emerge of the new discernable reality: its essential features are bribery papering over fraud.

The fraud, as defined by cratering secondary markets for mortgage backed securities, is exactly as Warren Buffett predicted of financial derivatives: they are proving to be “weapons of mass financial destruction.”

The bribery appears to be in the creation of a new, multi hundred billion dollar fund–the result of the meeting between the big banks and the US Treasury– for which fees will be paid to Wall Street executives and lawyers in order to dispose in “an orderly way” off-book assets that are worth far less than banks have told their investors.

Cynics, gather ’round: it’s nearly fascinating as watching the Greenland ice sheet melt. Both are happening slowly but with a fair degree of certainty that the end of the day is a big stinking mess we lack tools to clean up. The reality-based community of investors are not going to take this well.

This is not how disaster capitalism is supposed to work (read Naomi Klein’s, ‘Shock Doctrine, the rise of disaster capitalism‘), but it does appear to be the new Manifest Destiny.

In so far as immediate finger pointing is concerned, this past July Wall Street executives told the public that problem in debt markets were contained to the subprime sector for mortgage backed securities. In other words, poor homeowners in Dearborn and Detroit. That little fiction didn’t sell through.

Throughout the late summer and fall, banking committees in Congress have been spinning themselves into a fine fettle, mixing Democrats and Republican indistinguishably, seeking solutions to the millions of homeowners at risk of foreclosure. The main event appears to be simply loosening the bridle that had been put on Fannie Mae and Freddie Mac for financial misdeeds.

Let them loan more. Let them loan more freely. Having finished, apparently, the finger pointing at the greed that had marred Fannie Mae and its quasi-public mission only a few years ago.

As much as network news likes to feature stories of foreclosed homeowners, the real meat is Wall Street whose executives became addicted to the profits from financial derivatives.

Now, the banks themselves have to be rescued to restore “free markets” to normal operation. In 1998, it only took four billion and the cooperation of the Treasury Department with the big banks to bail out the private hedge fund, Long Term Capital Management.

Today the mainstream media shies from reporting the extent of what is unfolding: a few hundred billion is a drop in the bucket compared to the total market for of asset backed securities at risk that underwrote the late, great building boom.

There are two reasons the mainstream media has lagged behind the story.

First, the blizzard of profits from the housing boom obliterated depth perception as it might be applied by a critical analysis of how corporate America and government is organized: to keep consumers passive, dumb, and happy.

Second, the proliferation of financial derivatives-intended to diversify risk-has the collateral benefit of distributing the fantasy of asset values in slow motion.

Trillions of asset-backed securities are floating around the globe on digital pulses through fiber optic cables, but no major financial institution wants to be the first to re-price assets to market.

They will hold these on the books or off the books as long as possible, at inflated values that don’t connect in any appreciable way to reality.

How odd that Wall Street lives and dies by quarterly profit reports from publicly traded corporations yet have been sitting on a toxic financial dump in credit markets for years with not even a whisper of complaint.

In the New York Times, Paulson’s efforts are described as “a delicate balancing act between two very different goals.” Those goals are: maintaining the confidence in financial markets and also, keep the game going for the housing industry and mortgage bankers who chafe at the notion of additional regulation.

Today, there is no will on the part of Congress to put the regulatory harnesses to a source of campaign cash that derives from a market that is essentially unregulated: financial derivatives.

Wall Street doesn’t want it. The home builders don’t want it. Why tamper with what your biggest campaign donors want? On the other hand, the version of disaster capitalism that is emerging is what only the short-sellers want.

The creators of asset backed mortgages take ordinary mortgages and package them into pools. The derivatives created from these packages of mortgages are sold to investors: they are sliced, diced, and reformulated in many different ways-but each time they are slightly changed, they create a rain of bonuses, fees, and commissions.

In recent years, mortgage backed sercurities were generated in the hundreds of billions by persuading consumers to take on more debt than they could reasonably afford. It was almost like spontaneous generation.

Take your ordinary suburban tract housing in Florida, for instance. In the past decade, production home building on cheap outlying land metastasized throughout the state of Florida.

During this time, environmentalists chewed mostly on each other over compromises to slow the pace of housing and commercial development in former wetlands and wildlife habitat. While most environmental organizations were distracted by divide and conquer and diversionary tactics, the building lobby converted the purposes of local government to zoning and permitting-doing battle with local regulations against the nation’s premier environmental laws meant to protect the air and water and natural resources we share.

In some cases, these were outright assaults that ended up in federal court challenges. But the worst damage, during this time of ascendancy in real estate speculation, was the domination of and appointment by local elected officials of lobbyists to local boards charged with “protecting the environment”.

In Florida, for instance, these environmental review boards worked with state agencies, like the Florida Department of Environmental Protection, to control water quality issues that had been abandoned by the federal EPA under duress of scientists. The legal term is “delegation”.

Once upon a time, suburban sprawl and all its accoutrements-from hollowed out urban cores to scary strip mall culture-were sold to the public as what the market wants. Every single day, that myth is played out in the halls of local government as though the crisis in the greater world of debt has no bearing whatsoever on reality.

The very nature of derivatives is meant to disperse risk: what they really disperse is accountability. The delegation of accountability so that it disappears is an essential feature of disaster capitalism.

Its manifest destiny has defined the problem as government itself-leading in the direction of divesting authority from federal to state, and from state to locally elected officials who live, virtually, in the pocket of the growth machine. Its result is exactly the sprawl-ridden, unsustainable landscape of Florida.

Today owners of asset backed securities are in the dark about the value of their investments. It is so distressing that hundreds of billions of asset backed securities cannot find buyers in the secondary markets, or, only at distressed prices.

That is what happens to junk when it is fairly valued.

Bloomberg reports, “Nothing in free-market theology says markets always work properly,” said J.D. Foster, a senior fellow at the Heritage Foundation in Washington and former Bush administration official. “If there’s something that can be done of a temporary nature to help markets, then that seems perfectly appropriate.”

What nonsense: a fairy tale from the party of “fiscal conservatives.”

Mispricing the true costs and accounting for growth is another way that asset back mortgages were able to deliver higher rates of return than baseline government debt.

To be purposeful and clear, means having a vision to protect and conserve-using regulations as a way to guide investment. It means wringing the speculators from the housing markets and from land development.

The solution is reformulating the system of packaging mortgages and their ratings. The new formula needs to be based on a clear and rational way to allocate development rights at the local level; in other words, integrating community design with long-term financing from private investors.

Intrusive? No more intrusive than disaster capitalism as it now exists for Americans, who appear to live on a giant set of a colossal Budweiser TV commercial, from sea to shining sea filled with intelligent Clydesdale horses, talking frogs and happy dumb us.

ALAN FARAGO of Coral Gables, who writes about the environment and the politics of South Florida, can be reached at



Alan Farago is president of Friends of the Everglades and can be reached at