| "The new science [of economics] is used in an attempt to demonstrate that in the imaginary 'market economy,' invented as a response to Marx, the markets are self-regulating, tend to the production of equilibrium (that is optimal, moreover), and hence merit consideration as the expression of a trans-historical rationality."|
January, 2012, Monthly Review
As the price of liberty is eternal vigilance, we must work to understand the political-economic realities of our society. We can comprehend political and economic factors if we look at their essence.
Many of the so-called "classical" economic and political writings, such as Hobbes' Leviathan or Adam Smith's Wealth of Nations, are so full of outmoded concepts and convoluted arguments that the modern-day student finds them almost unintelligible.
Politics and economics are only dismal when presented in a way meant to obfuscate ideas and confuse readers.
The cabal that seized economic and political power in the United States in the first decades of the twentieth century, doesn't want American citizens to understand the workings of the political and economic systems. They deliberately obfuscate and muddle any discussion of politics and economics, keeping workers ignorant of what scams they're perpetrating.
At times, these tactics of bewilderment become apparent to the perceptive student of world events. In August of 2007, one of the cabal's head economic confabulators, Robert Samuelson, made it clear that the world financial structure was not meant to be understood. In an article entitled "Is the Global Economic Boom in Peril?" Samuelson made this interesting statement:"Anyone claiming to understand today's world financial system is either delusional or dishonest."
This is an interesting statement to make in the context of an article pretending to explain certain aspects of the world financial system. What he intended to convey was a warning that the common person could not hope to understand the non-Federal Reserve System, the Wall Street crap shoot, or their accompanying scams. It's not intended that the investor understand what he's doing, he's just supposed to put his money into the maw of the Big Money swindle and keep his mouth shut.
Contrary to Samuelson and other capitalist confabulators, the world economic situation can be simply and aptly described as capitalists looting workers' money through bailouts, wars, nefarious IPOs (think Facebook), and general corruption. In May of 2012 a 12-year old Canadian girl demonstrated that even a very young person can understand what's going on economically and politically by simplifying the details.
In this series, we'll examine the essence of economic and political ideas and practices, simplifying them so they become understandable.
Economics is the description and analysis of the production, distribution, and consumption of:
- Goods (fish, cooked meals, ships, fire-starting bow, etc.)
- Services (carpentry, fishing, cooking, etc.).
| We usually think of economics in relation to a large culture such as the United States. But to simplify, we'll refer to a fictional economy, that of the ship-wrecked Robinson Crusoe and his friends, Friday and Sunday, who live on a desert island. Crusoe has skill in building boats, but he's not adept at fishing from the ocean shore. |
Friday is an expert spear fisherman, but lacks the skill to build large boats. Sunday, a female native, is skilled in cooking, which includes fire-starting. The three find that they can exchange goods and services to their mutual benefit, thus creating their own desert island economy.
Desert Island Economy
Has these goods and services
which he wishes to exchange
Wants these goods and services
Building large boats
Fish and meals cooked
Large boats and meals cooked
Cooking (including fire-starting) skill
Large boats and fish
Crusoe and his two friends are now exchanging goods (boats, fish, cooked meals) and services (boat building, fishing, cooking), so the services becomes a means of barter and the goods become a means of exchange--money.
Money is simply any object used in the exchange of goods and services. Over the centuries, many objects have been used as money: cattle, beads, gold, silver, paper currency, entries in financial records. A medium of exchange must be seen by all members of an economy as possessing value. For example, Crusoe finds some old currency on the wrecked ship, but it has no value to him or the other two.
Goods and services are the products or activities of labor--the expenditure of physical or mental effort.
The desert island economy also has means of production: Crusoe's axe which he rescued from the wrecked ship, Friday's hand-made spear, and Sunday's hand-made oven and fire-starting bow. A means of production is any object or process which is used to make goods or carry out services. The three members of this economy could own these means of production in one of several different ways:
- Each individual owning his own means of production: Capitalism
- All of the individuals owning the means of production in common: Commonwealth
- A combination--some means of production owned privately and some shared: Mixed
An Expanding Economy
As this desert island economy begins, it is fairly simple, so the three members feel that they own and use things in common. But their simple economy soon begins to expand.
- Crusoe also finds lumber, rum, a saw, a gun with cartridges, and a telescope on the wrecked ship; he can build simple traps to catch rabbits and squirrels for meat
- Friday can provide not only fish but fresh water which he carries in coconut shells from a nearby stream and he can make rope from rough leaf fibers
- Sunday can make clothes and shoes from weaving fibers from certain island plants and she can smoke fish for storage
After completing the boat, Crusoe is able to take Friday around the perimeter of the island and select the best fishing spots. Friday and Sunday tell Crusoe that there will be a rainy season where they will not be able to fish or trap or gather, so they begin to lay provisions in store. Sunday finds a good-sized cave where they can store all the food and other goods they need.
Since Friday and Crusoe are usually busy fishing, trapping, or gathering, the three agree that Sunday will serve as the person in charge of organizing and maintaining the store of goods in the cave.
Sunday has become a storekeeper and performs one of the services of a banker: keeping custody of the means of exchange (money).
- A storekeeper is simply one who has charge of accumulating, organizing, and distributing goods; in complex economies, the distribution is carried out through exchange of money.
- A banker is a person who is in charge of the custody, exchange, loan, or issue of money
Sunday is now receiving some of the goods and services of Friday and Crusoe for performing the services of storekeeper and banker.
As the population of the island increases, trade with other islands is established, which requires political structures to organize and control the inter-island commerce.
Politics is the art or science of winning and holding control over a group or nation, either through influence or force. In our simple desert island society, direction and control of group actions could take place in one or more of these ways:
- The three could simply let things take their course, electing to have no formal government, setting up a form of anarchy
- Crusoe, Sunday, or Friday could assert that he or she was the ruler, thus establishing a monarchy--a form of rulership whereby a queen or king, empress or emperor holds absolute or limited power, usually inherited.
- The three could agree that they would vote on all activities, thus creating a commonwealth, government by the people for the benefit of the people.
- One of the three could take power by force, either psychological force or violence, thus establishing a dictatorship.
- If one of the three came to have a larger share of the money and used wealth to take control of the desert island society, that would constitute a plutocracy.
A More Complex Society
As the population of the desert island expands, the economic and political situation becomes more complex. When the population reaches a certain size, the inhabitants of the island decide to set up an executive group, individuals elected to direct and control activities on the island. They decide that they need a written statement of the policies which the government and the citizens will follow: a constitution and a body of laws. The islanders then elect representatives to create new laws and regulations as they are needed, setting up a legislature, and they elect individuals to administer the laws, establishing a judiciary.
They choose to establish a police force to maintain law and order on the island and they set up a military force to protect their island from foreign invaders. They decide that each islander will pay to support the activities of these government agencies, establishing taxation.
Our goal is to make political-economic terms and events understandable, so ordinary citizens can regain a grasp of what is going on around them. We've seen that most books on politics or economics do little more than obfuscate terms and befuddle the reader.
Robinson Crusoe's simplified desert island society contained all of the features of a more complex society:
- A government: composed of the executive, legislative, and judicial branches
- Taxation: required payments of citizens to support their government
- Police and military forces: to maintain domestic order and provide protection from foreign invasion
- Economy: a system in which goods and services are exchanged
- Goods and services: products or acts of labor
- Labor: the expenditure of physical or mental effort
- Money: any agreed means of exchange--including salt, cattle, pigs, goats, tobacco, gold, iron, paper currency, metal coins, and bank debt
- Storekeeping: the accumulating, organizing, and distributing of supplies
- Banking: the custody, exchange, loan, or issue of money
- Capitalism: each individual owning his own means of production
- Commonwealth: all of the individuals owning the means of production in common
The Invention of the Technology of Banking
As we saw, Sunday, our desert island lady, performed only the first of the services of banking: keeping custody of the money or means of exchange: fish, game, fibers, rope, tools, etc. Let's take a look at how "full-service" banking was invented and by whom.
In 604 B.C.E, the Babylonian ruler Nebuchadnezzar decreed that gold would be the medium of exchange in his empire. The Babylonian temples contained strong rooms where people brought their gold and other precious items for safekeeping by the temple priests. The customers were given small clay tablets as receipts for their valuables.
The priest-bankers demanded that the people pay twenty percent interest for guarding their valuables--not a bad racket. Some Swiss banks today charge interest for securing deposits. But most modern banks pay depositors interest on the money they keep in their accounts.
The Babylonian priests, never letting the grass grow under their feet, discovered that most of the people depositing valuables for safekeeping seldom came to reclaim their gold and other precious items. Instead, the people began using the clay receipt tablets as a means of exchange--money.
Now, thought the priests, the people believe that the clay tablets are backed by gold and other valuables, yet the deposits are seldom if ever claimed. We can issue ten times as many clay tablets as are backed by gold and grow rich. The priest-bankers issued clay tablets unredeemable by gold, loaned out the clay tablets at interest and were soon living the life of luxury.
The crafty Babylonian priests had invented all the features of modern full-service banking:
- Custody of money: gold and other precious objects in safekeeping in the temple vaults
- The issuing of currency (something in circulation as a means of exchange): clay tablets
- The charging of interest: money charged by banks for securing a depositor's money or money charged for a loan
- The loaning of money: loaning of clay tablets at interest
- The issue of fiat money: money not convertible into a commodity (such as gold or silver) of equivalent value--un-secured clay tablets
But let's not forget old Nebuchadnezzar, he invented two important stratagems which have lasted through the centuries:
- The technology of war
- State fiscal policy
The Invention of the Technology of War
Nebu and his fellow-dictators discovered that war was the best way to gain and maintain control over a nation's people and the most profitable way to make money.
War as a technology is highly efficient, because it totally uses up most of the goods (munitions, armaments) and services (men and women in military forces) it involves. With many technologies, for example, the manufacture of goods, machinery and tools are not completely used up, they merely depreciate over time. War materiel is destroyed, requiring a constant re-supply, necessitating a "military industrial complex" to furnish the objects and personnel involved.
The technology of war became a major part in a ruler's arsenal. So in 1514 when Machiavelli formulated his advice to rulers in his book The Prince, one of his axioms was: "A [ruler] ought to have no other aim or thought, nor select anything else for his study, than war and its rules and discipline. . ."
The Invention of State Fiscal Policy
Beginning with old Nebu (perhaps even before) the ruler or rulers of a state decreed what the official policy would be as to money and finances. In most centuries and in most countries, this has meant that only the rulers of a state are allowed to issue money and everyone in that state--and economically related states--must use the money created.
The power to issue currency and coins and to set a nation's fiscal policy resides either in a monarch, the elected officials of a state, or a private group of financiers. In 1666, the profligate King Charles II and a corrupt Parliament sold the British fiscal powers to the East India Company ( a group of financiers). The East India Company established the policy that goods could only be purchased by the colonies, including America, by goods of exchange (tobacco, timber, fish, furs, rum) or coins.
As the American colonies moved out of barter into a more complex economy, they had a dire need for currency, "bills of exchange." The colonists had very little in the way of coins, since most of their exports were traded for goods, not coins. So with the encouragement of men such as Benjamin Franklin, the colonies began to issue their own currencies to facilitate domestic and foreign trade.
The importance of American domestic currencies is not often emphasized in American history books and we are not made aware that one of the major reasons for the revolt of the American colonists against the British is that the English Parliament in 1751 and 1763 made it illegal for the American colonies to issue currency. Had Americans accepted this British mandate, domestic trade would have ground to a halt and the colonists reduced to barter, a very inefficient method of exchange.
After the United States was established, a national bank was chartered in 1791: the Bank of the United States. Only about twenty percent of the national bank was actually owned by the government, the rest by foreign investors. It soon became clear that the Bank was being operated for the benefit of foreign investors, so the Bank's 20 year charter was not renewed by Congress in 1811.
A second national bank was given a federal charter in 1816, but like the first one, it too was largely controlled by foreign investors through such front men as John Jacob Astor, Stephen Girard, and David Parish, a New York agent for the Vienna branch of the Rothschild money interest. This second national bank was controlled by Nicholas Biddle who administered it according to the aims of its foreign owners and contrary to the welfare of Americans.
In 1836, President Andrew Jackson vetoed the bill which would have renewed the national bank's charter which expired that year. In his veto message, President Jackson said:"The bold efforts the present bank has made to control the government, the distress it has wantonly caused, are but premonitions of the fate which awaits the American people should they be deluded into a perpetuation of this institution or the establishment of another like it."
Americans were well rid of the foreign-dominated second national bank. But they were left in the vulnerable position of having no national bank to further their interests. The foreign financiers, especially such moneyed groups as the Rothschilds, saw their opportunity and soon sent their agents to America to begin setting up state banks. The Rothschild's primary agent in America was August Belmont, who established a large bank in New York City, but also a large number of state banks in the south. The Rotshchilds and other European financiers loaned money to state banks at high rates of interest and controlled loan decisions.
Many of these state banks, were also supported by state bonds. The state of Mississippi, for example, sold $5 million in bonds with which to subscribe a third of the $15 million capital of the Union Bank. The promoters of the Union Bank made ill-advised loans and within a short time the bank failed. The state officials in Mississippi realized that the foreign financiers had hoped to reap windfall profits and had been largely responsible for the failure of the Union Bank, so these officials refused to repay the money owed the foreign vultures.
The European financiers bought up "repudiated" southern state bonds and then began to use their financial power to have the United States federal government compel the southern states to pay off the disputed claims. The Rothschilds and the other foreign financier groups also thought they might be able to use their money power to force the U.S. federal government to assume the debts of the southern state banks as federal obligations. At its inception, the newly-formed United States had assumed the debts of the colonies; so the foreign vultures thought they might be able to force the federal government to pay off the southern states' debts. The issue of "states' rights" versus a "strong central authority" became a national crisis point and the American civil war was the result.
When reviewing the technology of war above, we saw that this is a very profitable stratagem for rulers. The Rothschilds and other European financiers had exacerbated the discord and hostility between the North and the South. Knowing full well that war was their best means of reaping huge profits, these vultures did everything in their power to instigate an American civil war. They worked both sides of the street, as usual.
The Union commissioned Jay Cooke to act as selling agent for its bond issues and Cooke arranged with August Belmont, the New York agent of the Rothschilds, to sell Union bonds in Europe. In 1861 the Confederacy sent James M. Mason to England and John Slidell to France to borrow money. Slidell was a nephew of Belmont's wife. In Paris, John Slidell entered into negotiations with the Erlanger company, confidential representatives of the Rothschilds. Slidell's daughter married Erlanger's son. Even though most investors in confederate bonds lost their shirt, the Erlangers reaped huge profits.
The American Civil War cost the Union about $3.2 billion and the Confederacy close to $2 billion, all money loaned on interest. August Belmont, the Democratic National Chairman, sabotaged the Democratic presidential candidate, Horatio Seymour, through derogatory statements made in his New York World newspaper, assuring the election of the Republican candidate, General Ulysses S. Grant.
The so-called Credit Strengthening Act of March 18, 1869 was passed immediately upon the assembling of the new Congress elected in the 1868 election. It was the first act passed by that body and signed by the new President Grant. The passage of that Act was equivalent to the payment to the Rothschilds and their banker satellites in America and abroad of at least $275 million over and above the amount they otherwise would have received in the form of interest and principal for the bonds they owned or controlled.
At least since the American presidential election of 1868, the financiers who rule this country have made sure that they have hand-picked presidential candidates in both the Democratic and Republican parties. Whichever party wins, they have their puppet in power.
"The structure of financial controls created by the tycoons of 'Big Banking' and "Big Business' in the period 1880-1993 was of extraordinary complexity, one business fief being built on another, both being allied with semi-independent associates, the whole rearing upward into two pinnacles of economic and financial power, of which one, centered in New York, was headed by J. P. Morgan and Company, and the other in Ohio, was headed by the Rockefeller family. When these two cooperated, as they generally did, they could influence the economic life of the country to a large degree and could almost control its political life, at least on the Federal level."
Carroll Quigley, Tragedy and Hope
The Invention of the Permanent State of War
As we've seen, the rulers of the United States have found war to be their biggest profit-making scheme. Thus the windfall profits for the Rothschilds and their satellites in the Civil War. As the Rothschilds were joined by the Morgans and the Rockefellers in exploiting America in the early years of the 20th century, they decided to create a private enterprise which would possess the power to set national fiscal policy and issue money. In 1913, the Federal Reserve System was created. Having set up this private national bank, the American rulers proceeded to start the next profit-making war in 1914: World War I.
After the end of World War I, there was a short period of rebuilding war-torn Europe. Beginning in the 1930s, American and European financiers backed Hitler and World War II was the result. Europe was again devastated and, this time, so was Japan and other parts of Asia. So began the rebuilding of Europe and Asia, with money from the international financiers loaned at interest.
Also, immediately after World War II, the rulers came up with a new invention: a permanent state of war called the Cold War. A steady supply of armaments and personnel was now required as America competed with the Soviet Union in an "arms race."
It was decreed that America's new enemy was the Soviet Union and its satraps: East Germany, Poland, Czechoslovakia, Hungary, Romania, Albania, and Bulgaria. The U.S. had its NATO allies, but its real client-states were its Asian satellites: Japan, South Korea, Thailand, South Vietnam, Laos, Cambodia, the Philippines, and Taiwan.
The United States rulers turned the country into an imperialist military state, supporting foreign dictators in national struggles for independence:
- Indochina against the French
- Malaya against the British
- Indonesia against the Dutch
- Philippine guerillas against American puppet Ferdinand Marcos
- South Korea against American puppet dictator Syngman Rhee
- 1960: Koreans overthrew Rhee - Americans put in Park Chung-hee, first of 3 army generals who would rule from 1961 to 1993
- Americans tolerated a coup d'etat by General Chun Doo-hwan in 1979 and covertly supported his orders that led to the killing of several hundred, may several thousand, Korean civilians at Kwangju in 1980 (probably far more people than the Chinese Communists killed in and around Tiananmen Square in 1989)
- Chiang Kai-shek and his son Chiang Ching-kuo in Taiwan
- Ngo Dinh Diem (assassinated on American orders), General Nguyen Khanh, General Nguyen Cao Ky, And General Mguyen Van Thieu in Vietnam
- General Lon Nol in Cambodia
- Marshals Pibul Songgram, Sarit Thanarat, Praphas Charusathien, and Thanom Kittikachorn in Thailand (where they were essentially caretakers for the huge American air bases at Udorn, Takli, Korat, and Ubon)
- General Suharto in Indonesia (brought to power with the help of the CIA and overthrown with the help of the Pentagon's Defense Intelligence Agency)
- 1981: U.S. launched Vietnam-style operations in Central America, supporting insurgency against a Sandinista government in Nicaragua sympathetic to Castro's Cuba; U.S. supported cocaine trade of Nicaraguan counter revolutionaries, the "Contras"
Now this "permanent state of war" scam has been extended by the Bush I, Clinton, Bush II, and Obama administrations in their creation and extension of the Gulf War, the invasion of Panama, the Afghanistan war, and the war against Iraq. Obama is mandating increased expenditure on the military and has decreed a permanent state of war against terrorism.
Corrupt Economics: Subprime Mortgages 1
Along with the technology of war and state fiscal policy scams, modern capitalism has contrived a number of swindles to steal money from workers. We'll take a careful look at one of these rackets called subprime mortgages, since they have caused capitalism to collapse.
A major cause of the general collapse of the U.S. economy is deregulation, which began with the Reagan-Bush I regime and continues today. The regulation of financial institutions (bank, mortgage company, etc.) put in place during Franklin D. Roosevelt's first term in office has been systematically destroyed by Bush I, Clinton, Bush II, and Obama and their lackeys such as Phil Gramm and John McCain. The subprime mortgage swindle and other frauds have been made possible by the almost total lack of oversight by government agencies over financial institutions.
When a person wishes to buy a house, he goes to a bank to get a loan to purchase the property. The loan on the house is called a mortgage, which is a debt for the amount loaned, let's say $100,000 plus the interest on the loan, let's say 7%. In issuing loans, a bank simultaneously creates an interest-bearing asset--a loan held in its own portfoli--and a liability on its own account in the form of a demand deposit that obligates the bank to honor the borrower's demand for funds.
When you take out a loan from a financial institution, the bank or mortgage company doesn't print any currency, mint any coins, or move precious metals to a vault. It simply records figures in your computerized account representing the loan amount. In fact, the institution has loaned you nothing except figures on a computer file and yet from that moment you start paying interest on money that has never and will never exist in physical substance.
In deciding whether to issue this credit, financial institutions typically perform some assessment of the borrower's creditworthiness based on criteria such as how much cash and other assets the borrower owns, past credit history, and the institution’s expectations regarding future market conditions that impact the borrower's ability to earn sufficient income to fulfill all contracted debt payments. Since the financial institutions had a new scam in mind, they were only interested in producing as many mortgages as possible. So they told unwary loan applicants that they qualified for a home mortgage loan when, in fact, they didn't quality. They conned borrowers into taking out mortgages that they didn't understand and had no possibility of repaying. The ultimate result was that workers lost their homes by default and financial institution hoodlums made millions in profit.
In an earlier era, financial institutions held onto mortgages and made profit from the interest the borrower paid for the loan--an amount at least equal and usually exceeding the loan amount. The borrower, that is, paid back the principal--original amount of the loan ($100,000)--plus the interest--an amount equal to or more than the original amount: $105,000, resulting in the borrower paying $205,00 for a $100,000 loan. In the “new” world of twenty-first century finance, financial institutions issue loans and then typically sell these assets to other financial institutions that combine the loans into large pools, creating new classes of interest-bearing assets. "Securitization" refers to this process of transforming formerly illiquid (computer-entry only) loans held in the financial institutions’ own portfolios into marketable (negotiable) assets traded on secondary bond markets.
The financial institutions typically sell the loan packages to either a government-sponsored entity (GSE) such as Fannie Mae, Freddie Mac, or the government-insured Ginnie Mae, or to Wall Street investment banks (Goldman Sachs, Citibank, JPMorgan Chase). These financial institutions combine the loan packages into even larger pools and then issue a type of bond (IOU) known as a mortgage-backed security (MBS). The financial institutions realize profits on the fees they charge for services provided related to these MBSs. MBSs are highly liquid instruments and are one of the largest financial asset classes by outstanding volume currently bought and sold on U.S. capital markets.
One of the major disadvantages of MBSs is the difficulty--if not the impossibility--of specifically determining their monetary value or the amount of income they yield. They're created as non-transparent packages that persons assumed would continue to increase in value as the housing market expanded. When the housing market collapsed, beginning in 2005, MBSs became unsellable, leading to the collapse of those institutions holding them: New Century Financial, American Home Mortgage, Bear Sterns, Merrill Lynch, Fannie Mae, Freddie Mac, Lehman Brothers, Washington Mutual, and the end is not yet in sight.
One of the other major difficulties was that financial institutions concocted a plethora of exotic and increasingly complex financial instruments "engineered" from the payment streams thrown off by MBSs. The most prevalent of these new classes of engineered financial assets are known as collateralized debt obligations (CDOs), whose rapid growth between 2000 and 2006 lies at the root of the current subprime crisis.
A CDO is created when a government-sponsored entity or Wall Street investment bank buys up a large pool of subprime mortgages. Payment streams are then carved up and distributed to various "tranches" (sub-classes of debt) distinguished according to their level of exposure to losses from defaults occurring in the underlying mortgage pool. If First Commonwealth Bank, for example, has the most money in the CDO, then it receives a higher percentage of the interest received from the CDO, and, in turn, loses the least if the CDO defaults.
Investment banks also set up a new type of bogus bookkeeping operation known as structured investment vehicles (SIVs) that provided an additional apparatus for buying up mortgage loans that were restructured into CDOs and then placed into "off-balance sheet accounts" (accounting dodges).
MBSs and CDOs encouraged wild, unregulated speculation in the mortgage market far beyond the rate of income from these bogus instruments. Irresponsible speculation in the mortgage market was made possible when the Federal Reserve lowered interest rates following the bursting of the dot-com bubble in 2000 (that wiped out $5 trillion in market value of technology companies). The Fed (Federal Reserve System) feared that the massive write-down of the (nominal) value of the portfolios of dot.com financial speculators would pull the entire economy into a downward spiral. To avert such a scenario, between late 2000 and June 2003, the Federal Reserve cut the federal fund rate--the rate banks charge one another for overnight loan--by 550 basis points, or from 6.5 to 1.0 percent. While the reduction in the interbank loan rate failed to halt the stock market decline, it did reduce the cost of consumer and mortgage credit, resulting in the new home mortgage bubble.
Enter the Fraudulent Subprime Loan
As financial institutions stopped buying these fraudulent loan packagings (MBSs, CDOs, and SIVs), unscrupulous lenders began to target working-class households with low to moderate income and a prior history of credit problems--the subprime mortgage market. Most of the families targeted as patsies were people of color: African Americans were 2.3 times more likely and Hispanics 2 times more likely to receive subprime loans than white households. Subprime loans have interest rates that are several points higher than standard prime mortgage debt to compensate investors for the greater risk associated with holding this type of debt. To entice low-income households to take out subprime loans, lenders attached a host of sweeteners:
- Lowered interest payments over the first several years of the loan
- Interest-only mortgages, which only required borrowers to pay interest charges and were often set at seductively low introductory "teaser" rates
- Negative amortization loans that capitalized unpaid principal into the base value of the loan
- Adjustable rate mortgages
- No-down-payment loans, lending up to the full value of the home
- Allowing borrowers to state their income on loan applications without lenders requiring any supporting documentation
- Subprime borrowers were told not to worry about higher payments as their mortgages reset, given that they could always refinance into a more standard fixed rate loan at a later date
The major credit agencies that were supposed to provide prudent monitoring and evaluation of the quality of the growing pools of mortgage debt--Moody's, Fitch, and Standard and Poor's--received a hefty share of the vast subprime profits from financial institutions, so they abandoned their responsibilities and gave indiscriminate AAA (highest) ratings to bogus debt agencies and instruments.
Heedless homeowners began to see their houses as financial assets that would provide recurrent opportunities to convert rising equity values into higher levels of personal consumption, because they assumed they could indefinitely withdraw the equity from their homes and refinance their mortgages.
By late 2005, it became increasingly clear that the subprime housing scam was heading toward general economic collapse. Prices of houses across America flattened out as the Fed increased interest rates to fight inflation. "Teaser rate" loans began to reset to payment amounts larger than borrowers could pay. Homeowners began defaulting on their loans and panic began spreading among hedge and pension funds and the larger insurance companies that had bought this bogus debt. The scam artists initially claimed that the crisis would hit only the subprime market but it quickly became apparent that the swindle would negatively impact the entire economy. One of the major crisis points was that no one could be sure where the bad debt was being held, since the fraudulent instruments (MBSs, CDOs, and SIVs) were distributed across a vast number of investment portfolios.
"On April 2, 2007, New Century Financial, the largest U.S. subprime lender, filed for Chapter 11 bankruptcy status. American Home Mortgage followed suit by filing for Chapter 11 status in early August. This was followed in rapid succession by several high-profile meltdowns in Europe, with the UK-based Northern Rock Bank and BNP Paribus, the French banking group, both taking major hits to their mortgage-backed portfolios. Countywide Financial, the largest mortgage lender in the United States, only narrowly avoided bankruptcy by arranging to take out an $11 billion bank loan." 2Because financial institutions were uncertain about the size and scale of their exposure to bogus subprime loan instruments, they stopped granting short-term loans on the interbank capital market and began to hoard funds, leading to a complete credit meltdown.
The U.S. and European central banks tried to solve this credit meltdown by providing additional money to financial institutions ($30 billion in the United States, $138 billion in the case of Europe) and encouraged banks to make use of the discount window where banks borrow directly from the central bank. Even lowering interest rates to ridiculous levels, expanding the types of assets the Fed would accept as collateral for short-term loans, "auctioning" loans to banks by accepting MBSs and other structured debt obligations as collateral, pledging a $200 billion line of credit to the major Wall Street investment banks that allowed loans to be secured against a wide range of structured financial instruments, securing JPMorgan Chase’s purchase of Bear Stearns--all these desperation measures failed to resolve the credit crunch.
Instead of allowing the bad subprime debts, and the institutions holding them, to fail--as should happen if the so-called "free market system" were operating--the capitalists are using the credit meltdown as a pretext for frightening empty-headed Americans into believing that the economic sky is falling down. Henny Penny American dupes have allowed their congressional representatives to give $700 billion in tax-payer money to the failed "free market" system that brought the current economic collapse on itself.
The difficulty is that this boondoggle of giving Wall Street billions for their crimes against the working class will not in the least solve the problem of the total collapse of capitalism.
What ultimately must happen is that a commonwealth economic-political system--for the benefit of all citizens--must displace fascist capitalism. The current one-party dictatorship ruled by the cabal must be replaced by a commonwealth polity.
1 Partially adapted from Karl Beitel's "The Subprime Debacle," May, 2008, Monthly Review
2 Karl Beitel, "The Subprime Debacle," May, 2008, Monthly Review
- Money as debt:
- Eliminating the Monopolization of Money
- The Privateer Gold Pages
- Secrets of the Federal Reserve by Eustace Mullins
- Federal Reserve System: Legalized Counterfeiters