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Wall Street privatises US government: be very afraid

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The US low-tax zealot, Grover Norquist, is famous for wanting to "shrink government down to the size where we can drown it in the bathtub". Still alive, he is not turning in his grave, but his idea has been well and truly buried - and not by the Democrats he hates; they have been tongue-tied on the credit crisis.

It is Wall Street, the paradigm of "red in tooth and claw" capitalism, that has turned to government subsidy on an unprecedented scale.

Low, ideally non-existent, taxes may be very desirable, but when free-market principles came into conflict with the survival of business as we know it, priorities were clear. The US Federal government's full faith and credit - in other words, the resources of American taxpayers - should be urgently deployed to preserve as much as possible of the financial industry.

Luckily for Wall Street, government was still too big to fit in that bathtub - and proved only too willing to take up the challenge.

The scale of the operation has been huge. The Bear Stearns' takeover last March by JP Morgan was helped down by a spoonful of sugar in the form of $29bn of quasi-equity investment by the Federal Reserve Board that can only go down in value, never appreciate. Nice money if you can get it - well done JPM! (I must declare an interest: I am a future pensioner of JP Morgan, so I like to see its fortunes improved.)

By March the Fed might have been forgiven for hardly noticing a mere $29bn: it had provided more than $250bn in liquidity assistance to the money markets, accepting dodgy mortgage paper as collateral. Lucky old Wall Street - though, to be fair, this liquidity was the only justifiable aspect of the Fed's conduct in the 15 months of credit crunch.

The "Bear" was only the hors d'oeuvre, as anyone could see. After a mid-summer Act of Congress promising major help to the mortgage market, the full scope of potential largesse from Washington was more thoroughly exploited last weekend when the two giant "government sponsored enterprises", nicknamed Fannie Mae and Freddie Mac - here collectively "Frannie" for convenience - were formally extended a Federal government guarantee by Treasury Secretary Paulson.

Frannie is emphatically, in fact by definition, not part of the sub-prime crisis. Out of the country's total home mortgages of $10.5 trillion the lowest tier, sub-prime, is (or was) about $1.5 trillion, with another dubious category called "Alt-A" (also not "prime"), of another $0.5 trillion.

Within sub-prime, came the so-called "Ninja" mortgages: qualifications required being No Income, No Job or Assets, and in the bulk of cases no documentation either. Wall Street's enthusiasm for this kind of paper led to the losses even at 15 per cent higher, house prices a year ago, requiring the hors d'oeuvre described above.

With house prices now nearly 20 per cent down from their peak, the story has moved on from sub-prime to prime. Frannie is the main course. The definition of a prime loan is one that can be taken onto the Frannie balance sheet, or placed with investors under a Frannie guarantee. With about $8.5 trillion of prime loans out there in total, Frannie is on the hook, in one form or another, for more than half, some $4.5 trillion.

Back in the sound-money days of more than a half-century ago, Senator Everett Dirksen came up with the classic thought about the US Federal government: "A billion here, a billion there… pretty soon you're talking about real money". How quaint that sounds. In these go-go days for fiscal "conservatives", it is more like "a trillion here, a trillion there…".

The Frannie deal is big even by today's standards. It single-handedly vaults the US from a public debt ratio in the sound-money range into the company of fiscal basket-cases like Italy and Belgium, and that long-standing economic invalid, Japan.

The chart shows how the net US government sector debt pre-Frannie was about the same size relative to the economy as Germany, though worse than other G7 peers such as Canada, Britain and France. Now with one bound, the addition of $4.5 trillion puts it up there with Italy and Japan.


Fed closes the door on hands-off economics. Source: Lombard Street Research

For connoisseurs, the post-Frannie endorsement of the rating agency, Standard & Poor's, may raise an eyebrow: the triple-A rating of the US government is unaffected, we were told after last weekend's events. Many a nasty, even catastrophic, deterioration of credit has started with such a reassurance.

I have myself dealt with bankruptcy of a company that was actually "in the can" less than a year after it was triple-A rated. But triple-A rated mortgage securities trading at 50 cents in the dollar are bad enough. A bank whose credit-worthiness requires public defence has generally lost it. A government has greater resources, but questions are bound to be asked.

Nor is the monetary policy of the Federal Reserve designed to give comfort. Last autumn and winter, only too clearly panicked by Wall Street's fear of meltdown, the Fed made huge cuts in interest rates, as well as advancing (much more reasonably) over a quarter trillion dollars to the money market. The sense of panic told global investors all they needed to know.

China's accumulation of reserves, running at $500bn a year, had to be kept in dollars to support its (unwise) policy of controlling the yuan/dollar exchange rate. But the funds all got shifted to government or Frannie paper - no doubt a major force behind the US government's backing of Frannie: sudden withdrawal of China's dollar support genuinely might lead to financial Armageddon, in contrast with a few badly needed Wall Street failures.

Others flew the dollar - to anything they could think of. The euro, the yen, but notably to oil and other commodity derivatives. Commodity derivatives held off the public exchanges, "over the counter" (OTC), grew six-fold in three years, from $1.5 trillion at the end of 2004 to $9 trillion at the end of 2007 (and no doubt more since, though the data have yet to be published).

This is eight times the size of public-exchange commodity derivatives about which information is more detailed. Nobody knows the form of these OTC positions. But oil prices doubled from $70 a barrel just before the credit crisis to over $140 at the peak in July this year - and have since seen one of the fastest commodity price collapses ever, to little over $100. Those positions contained huge speculative accounts.

Who pays for dearer oil? Chiefly, the US consumer. So the rescue of Wall Street has panicked the Fed into a policy that has hammered American taxpayers, just as they have been called upon to finance the bailout of Wall Street.

The Fed's goals, as specified by Act of Congress, are to sustain good growth and keep inflation low (in that order). By its subjection to Wall Street priorities, it has both stimulated price inflation - the CPI was up 5.6 per cent over the latest 12 months - and thereby cut the real value of US incomes, and with them US growth.

It has thus failed in both its mandated goals. With one bullet - panicky interest rate cuts that have little relationship to saving Wall Street in any case - it has shot itself in both feet.

The irony is - I hesitate to say "joke", though black joke it is - that Wall Street did not need it, and will not (of course) be grateful. Sometime over this weekend, probably - or maybe a little later - Lehman Brothers is expected to endure a similar fate to Bear Stearns six months ago.

Perhaps "Hank the hunk" Paulson, former head of the leading Wall Street firm, Goldman Sachs, will play his usual highly visible part in devoting US taxpayers' resources to the cause. And will the world come to an end? Just as was feared at Y2K, or the CERN experiment last week? Well, actually, no.

And Wall Street realised this on Thursday when, after several days' worry over Lehman's fate, the stock market managed to go down sharply at the opening and then realise that it did/does not matter so much after all, ending up sharply instead. Neither would it have mattered much last March, had Bear Stearns simply been let go. Finally light has dawned.

In the meantime, the world has been changed. Free markets have been abandoned in America at the crucial hour by their chief exemplars, the financial masters of the universe. Let us hope that the convictions of the British financial and political community, though less confidently flaunted, will prove more durable.

Firms that fail after doing stupid things - or sometimes firms that are just plain unlucky - should go to the wall. Opinions may differ as to which category Northern Rock (our own particular policy disgrace) falls into.

The economy will recover sooner if banks that have made stupid mortgage loans suffer, and house prices fall more rapidly to levels at which affordability is obvious and buyers come forward. Society will also be more just. We should be grateful the Bank of England has an inflation target, not a confusing mishmash like the Fed. And that Mervyn King sticks to it.

It seems that President Bush and the Republicans are not just well to the left of Grover Norquist. They leave clear blue water on the left of Gordon Brown, much to the envy of Euro-lefties no doubt, who would love to ditch what they call "neo-liberalism", and what we call free markets, as easily as the American right wing.

Small wonder Barack Obama is having trouble establishing a distinct political identity - not to mention a feasible economic policy. And where subsidy is concerned, whoever may lead, can Detroit be far behind?

We read of a request for $25bn of Federal help to the car industry - both Messrs McCain and Obama think the amount should be twice that. Pigs to the trough - with or without your lipstick!


Man is made by his belief. As he believes, so he is.

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The government also did a lot of military privatization.

If it's not technically military, is it really supposed to follow the field manual and international accords?

Here's the Rumsfeld BS excuse:

Rumsfeld: "Thank you. It is clearly cost-effective to have contractors for a variety of things that military people need not do, and that for whatever reason other civilians, government people, cannot be deployed to do. There are a lot of contractors, a growing number. They come from our country but they come from all countries, and indeed sometimes the contracts are from our country or another country and they employ people from totally different countries including Iraqis and people from neighboring nations. And there are a lot of them. It's a growing number. Of course we've got to begin with the fact that, as you point out, they're not subject to the Uniform Code of Military Justice. We understand that. There are laws that govern the behavior of Americans in that country. The Department of Justice oversees that. There is an issue that is current as to the extent to which they can or cannot carry weapons, and that's an issue. It's also an issue, of course, with the Iraqis. But if you think about it, Iraq’s a sovereign country. They have their laws and they're going to govern, the UN resolution and the Iraqi laws, as well as U.S. procedures and laws govern behavior in that country depending on who the individual is and what he's doing. But I personally am of the view that there are a lot of things that can be done for a short time basis by contractors that advantage the United States and advantage other countries who also hire contractors, and that any idea that we shouldn't have them I think would be unwise."

Here's a private ops company losing it's contract:


The Iraqi government said Monday that it was revoking the license of an American security firm accused of involvement in the deaths of eight civilians in a firefight that followed a car bomb explosion near a State Department motorcade.
The Interior Ministry said it would prosecute any foreign contractors found to have used excessive force in the Sunday shooting. It was the latest accusation against the U.S.-contracted firms that operate with little or no supervision and are widely disliked by Iraqis who resent their speeding motorcades and forceful behavior.

Underscoring the seriousness of the matter, the State Department said Secretary of State Condoleezza Rice planned to call Iraqi Prime Minister Nouri al-Maliki to express regret and assure him that the U.S. has launched an investigation into the matter to ensure nothing like it happens again.

Interior Ministry spokesman Abdul-Karim Khalaf said eight civilians were killed and 13 were wounded when contractors believed to be working for Blackwater USA opened fire in a predominantly Sunni neighborhood of western Baghdad.

We have canceled the license of Blackwater and prevented them from working all over Iraqi territory. We will also refer those involved to Iraqi judicial authorities," Khalaf said.

The spokesman said witness reports pointed to Blackwater involvement but said the shooting was still under investigation. It was not immediately clear if the measure against Blackwater was intended to be temporary or permanent.

Blackwater, based in Moyock, N.C., provides security for many U.S. civilian operations in the country.

The secretive company, run by a former Navy SEAL, has an estimated 1,000 employees in Iraq and at least $800 million in government contracts. It is one of the most high-profile security firms in Iraq, with its fleet of "Little Bird" helicopters and armed door gunners swarming Baghdad and beyond.

Phone messages left early Monday at the company's office in North Carolina and with a spokeswoman were not immediately returned.


Private contractors who torture


Besides torture and ill-treatment, civilian contractors are also accused of involvement in wrongful deaths. Last week, the Justice Department announced that was examining the responsibility of CIA officials and contract employees in three suspicious detainee deaths, two in Iraq and one in Afghanistan.

Prosecutorial options in Iraq

To facilitate its outsourcing of the business of war, the Pentagon has extended generous legal protection to civilian contractors in Iraq. Under a June 2003 order of the Coalition Provisional Authority, civilian contractors are protected from prosecution in Iraq for crimes committed as part of their official duties. (The exact, though convoluted, language is: "acts performed by them within their official activities pursuant to the terms and conditions of a contract between a contractor and Coalition Forces or the CPA.")

Since torture is presumably not foreseen in the contract, it is theoretically possible, if unlikely, that the abuses at Abu Ghraib could be deemed to have been committed outside of the contractors' official activities. But the possibility is not all that important, since the June 2003 order also provides that crimes committed during the contractors' free time can only be prosecuted by local officials if coalition administrator Paul Bremer gives his written consent.

I'll tell you what, as soon as people wise up to the clandestine bullshit Bush and co. are doing, the better off this country will be. Until then, the sh!t will keep going until it hits the fan. And eventually other countries that were friends, or other countries that could have been friendly, will end up being enemies, and worse.

And Republicans in our government love war. They're doing a great job ensuring we're going to have a nice plate of war in the future, with a lot of countries.

Edited by SRVT

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