What cannot endure will not endure. The financial crises that have been blowing up for years, and at a stepped-up pace since 2007, cannot go on indefinitely. Their origin is distant, but they also result from an accumulation of various errors. They are mainly due to expenditure exceeding income and to borrowing hand over fist, even for no good reason, on ever shakier fundamentals.
While laying the groundwork for this article, I noticed that I would have to use a relatively new denomination—trillions of dollars—to talk about debt.
Everyone is realising we have gone too far. The coffers are depleted. It is time to be more reasonable. The excessive spending of the past has created a huge overhang, and no one knows how new borrowing can be financed.
Each crisis lays bare new weaknesses in the financial system. A few months ago the euro was still considered a hard currency, but the problems of Greece have challenged many such convictions. Economists and governments moan about low saving rates resulting in a lack of investment. Yet people who live on their savings have been fleeced. Their investments yield nothing and are taxed to death. If they bought subprime securities out of need for a higher yield, chances are they have lost everything.
All this has severely shaken the confidence of investors, who already know that tomorrow will not be like yesterday. America, Europe and Asia will still exist, but the important thing from now on will be the health of each borrower, the financial situation of each country and the solvency required to finance its growth (or possibly even its survival). In a word, the times ahead do not look pretty.
Eighty years of Keynesian monetary policies have led to "quantitative easing", i.e. to negative interest rates created by the technocrats who run the central banks. After turning their countries into Weimar Republics by printing more and more money, they will all need a currency commissioner like Hjalmar Schacht to save them from hyperinflation. Let's just hope they don't turn their regimes into Third Reichs in the meantime.
No one wants to predict the reactions of voters, who constantly clamour for more bread and games to forget the looming disappointments that could give rise to black swans.
Angela Merkel has just prohibited short sales of certain sovereign debt securities. While that may be conscionable on moral grounds, economically and politically it is shocking in a supposedly free-enterprise environment. A government that prohibits can also coerce! The move is reminiscent of compulsory bond purchases.
For the moment the United States, with its semblance of economic recovery, looks better off than Europe. And despite its problems the dollar remains by far the world's major reserve currency.
Moreover, there is no denying that when Americans have a problem, they do everything in their power to solve it. Sometimes they do even more, if necessary, regardless of the possible consequences. These can be dealt with later, once the first problem is licked.
Europeans are infinitely more complicated. Before even coming to grips with an issue, they already want to avoid the consequences of any remedial measures that they might be forced to take. The upshot is that they always do too little too late.
Governments, public corporations, financial institutions, consumers—everyone is over their head in debt.
Yet a huge part of the blame for the debacle of the past three years lies squarely with the United States. By more or less shoving free trade down everyone's throat, America paved the way for globalisation. This is what has destroyed jobs and driven down wages in the developed countries, hobbling economic growth and gouging tax revenues.
Moreover, it was a ridiculously low federal funds rate, reduced to 1% in the early 2000s by former US Fed Chairman Alan Greenspan, that opened the floodgates for subprime mortgages and the worst financial disaster ever, in 2007-08.
When that crisis broke in mid-2007, estimates of the face value of securities backed by subprime mortgages ranged from $1 trillion to $1.3 trillion. Actually the total value of CDOs (collateralised debt obligations) and other mortgage-backed securities exceeded $7 trillion, and the repercussions were devastating. Like a disease overrunning a body's already weakened defences, subprime infected the entire global banking system. There were also many victims among small and medium-sized investors, even outside of the United States.
The name should have resounded as a warning that this was not triple-A debt. But between the fees raked in by distributors, the corruption of the rating agencies and the yields that this paper provided to investment companies desperate to shore up their profit and loss statements, there were lots of reasons to go for it anyway. Creative types even invented synthetic versions of subprime, with no underlying portfolio of mortgages, that guaranteed the same yields as the original junk. These were ear-marked for money managers who wanted to position themselves against subprime debt, namely by selling it short to investors who were still lapping it up as a good bet. That was ethically wrong of course, from a professional standpoint, but it generated a double commission for the investment bankers and ensured that one of every two clients concerned would make a profit.
Where were the risk committees, credit committees and others who should have taken the hour or two needed to read the prospectuses? That and an ounce of common sense would have sufficed to see through Wall Street's slicing and packaging antics. But financial comptrollers were satisfied with the AAA credit rating. Only 2% of shareholders' equity would be immobilised. The extra yield would sweeten their bonuses.
The other two big disasters were just as foreseeable as subprime.
For years it had been no secret that Fannie Mae and Freddie Mac were paying millions to lobbyists. Fannie was even described as the Democrats' trash bin. (I sent a funny e-mail on Fannie to friends in December 2004.) The company should have been delisted from the New York Stock Exchange after failing to present audited financial statements for three years.
The bailout of Fannie Mae and Freddie Mac had awesome consequences, for America in particular. The national debt leapt by about 50% to over $14 trillion (excluding the debts of other "government-sponsored enterprises"). Compared with the country's net worth, estimated at about $70 trillion, that is an unsettling level.
As far as the other disaster, American International Group, is concerned, people knew that it was not run by choir boys. That much was obvious in a memo by the company's audit committee reproduced in the Herald Tribune in June 2002. (It made me wonder how such a text could have been included in AIG's annual report!) The AIG rescue was vitally important as the company had insured loans, claims and subprime debt securities in the portfolios of hundreds of regional banks, and these would have been hit hard by AIG's collapse. The credit line extended by the government amounted to $180 billion.
The US financial sector, which generated ever juicier profits between 1990 and 2005, became the biggest source of funds for lobbying. This led among other things to the gradual repeal of the Glass-Steagall Act of 1934, designed to prevent a recurrence of the 1929-1932 Crash and Depression. The resulting regulatory vacuum was soon filled by financial engineering and by mergers and acquisitions, giving rise to monsters, predictable conflicts of interest and exaggeration in every segment.
Indeed, one may well wonder if there was any economic substance to the earnings reported during that heyday. Perhaps they were merely the result of overly optimistic accounting or of wishful thinking about the value of dubiously contrived products that in the end were worthless. The billions swallowed up by the financial industry cannot only be due to errors of judgment made by donkeys with seven-digit salaries.
The American constitution has two strange features. One is that government spending is approved by the Committee on Appropriations, an arm of Congress and not of the administration. The 35 members of this committee, taken from the House and the Senate, decide who wins federal contracts and how much they will be paid. A windfall if there ever was one!
The constitution's other oddity provides for the existence of lobbyists to tell Congressmen why the country needs new laws in the interest of particular professions and sectors of the economy, or to adapt to changes in society.
From day one, lobbying became an above-board form of bribery and influence-peddling. It contributed to the advent of political action committees and other pressure groups. And since campaign funding is limited, it encouraged the creation of slush funds. The amounts received (in the billions) are shrewdly divided up among the members of Congress, with about 60% going to the party with the majority of seats and the rest going to the opposition (although this also depends on personality and influence). Everyone benefits from this system, and to this day neither side has ever organised a protest. Nowadays the party line counts less than it did in the past: laws, amendments and appropriations are all passed by a majority, whether this is made up of members from the right, the left or the centre.
The average cost of a campaign to be elected to the Senate is estimated at $7 million, and at about $2 million for a seat in the House. So naturally, the foremost concern of any new Congressman arriving in Washington is to get re-elected and to finance the next campaign. A lot has been written about this scandalous state of affairs, but all the informed people I have ever tried to talk to on the subject have cut me short, saying, "No country, America included, is perfect. Politics is politics, and there's nothing anyone can about it."
Actually, the US administration does not fight with the legislators (who practically all belong to the highest bidder), but rather with the money at the disposal of the nation's economic forces and special interest groups, which give liberally to both parties.
We are all equal. But as the old saw goes, some are more equal than others. I have often had the impression that in America this is true of a tiny elite, perhaps 1-2% of the population, provided they have access to smart lawyers.
I remember having lunch with a member of this thin upper crust many years ago. I asked him what he thought about the risk of an antitrust suit against Microsoft. He looked at me as if I was still wet behind the ears and said curtly, "Microsoft has twice as many lawyers on their payroll as the Justice Department, and their lawyers are the best. They'll delay it until it becomes secondary."
(To America's credit, it can be said that the country strives to be, and is, egalitarian where opportunities are concerned.)
During the fuss about the SEC suit against Goldman Sachs this spring, an article on 21 April in the Financial Times put it more diplomatically that I would, saying that if you are the second-biggest campaign contributor the safest course is to buy off everybody.
Gerald Cassidy, one of the biggest US lobbyists ever, wrote that "giving was part of [the] job and in the same spirit, taking was part of nearly every senator or congressman". Someone else said, "These donations are not good government. It's to thank friends, and to make new friends. It opens up channels of communication."
Here we have another case of the camel's back (or rather, of the golden calf). If American democracy remains in the clutches of money and of Wall Street, in particular, the United States is doomed to lose its pre-eminence in the G20.
Jon Corzine, a former CEO of Goldman Sachs, spent $60 million of his own money to become senator of New Jersey. Although a record, it was "only" equivalent to the bonus paid to his successor at GS, Lloyd C. Blankfein, in 2007.
Goldman Sachs has become a state within a state, with ramifications in everything connected to America's financial system, Congress and administration. Logically it should be carved up into several independent entities, like the empire of John D. Rockefeller when its power became intolerable.
But as Senator Bob Dole once said, "Poor people don’t make campaign contributions."
The above quote and other references in this article were taken from the press and from Robert G. Kaiser's book So Damn Much Money on lobbyists.
Georges C. Karlweis
Former Vice Chairman and Managing Director of Banque Privée Edmond de Rothschild, Geneva.
Beetwen 1960 and 2000 he travelled to the United States nearly 200 times. He also served on the board of Bank of California, San Francisco and took part in the establishment of the world’s first fund of hedge funds, in 1969.