TELOSscope: The Telos Press Blog

Political Divisions and the Financial Crisis

This talk was presented at the 2009 Telos Conference.

As a reader of Telos for over 35 years, I’ve admired Paul Piccone’s courage in investigating areas considered verboten on the Left, specifically: Telos‘s critique of Soviet power and the prediction of its demise, Telos‘s ongoing examination of custom, tradition, and religion in political thinking, and Telos‘s re-assessment of populism, decentralization, federalism, and the New Class.[1]

My presentation this morning looks at political divisions and the financial crisis. The underlying hypothesis is that the financial crisis cannot be genuinely solved by the traditional workings of the market and the state because the prominence of the logic of both sectors has now overwhelmed the process of internalization and a new balance must be reasserted.[2]

Part 1: Structural Forces Creating New Political Divisions

Since August 2007, the United States has experienced one of the largest governmental economic interventions in its history. It was NOT the president and the courts, but the Treasury Department and the Federal Reserve that have led this intervention: they had the resources, they had the regulatory flexibility, and they had the dealmakers to pull it off.[3]

As of today two men, the Treasury Secretary and the Federal Reserve Board Chairman, in effect control much of what is left of our collapsed financial system. Their initial approach consisted of individual institutional deals that put significant taxpayer money at risk. The theme has been public subsidies to private corporations under the rubric of supporting the public good with minimal public disclosure or debate.[4]

When these deals did not result in financial stabilization, the U.S. Treasury proposed to purchase $700 billion of toxic financial instruments, threatening systemic collapse if Congress did not agree. But despite its initial insistence that this toxic debt buyout was imperative, the U.S. Treasury reversed course again and settled on initially injecting $125 billion of taxpayer money directly into the 9 largest U.S. financial institutions. The apparent strategy of the U.S. Treasury was, when in doubt, spend to support existing entrenched interests—while those same interests used taxpayer money to cushion losses in their portfolios of downgraded debt.

As the financial crisis unfolded, some of the government’s most prominent individual institutional deals included the forced sale of Bear Stearns, the fifth largest U.S. investment bank, to J.P. Morgan Chase at a cheap price while guaranteeing Bear Stearns’s shakiest assets and then allowing Lehman Brothers, an even larger investment bank, to fail. The U.S. Treasury and the Federal Reserve first claimed it was allowing Lehman to go under to send a message that badly managed Wall Street firms would not automatically be saved, but when financial chaos ensued, switched their story to say they did not have the legal authority to rescue the firm.

The Treasury and the Fed also privately assured Morgan Stanley that it would be supported, took over Washington Mutual, the largest thrift in the country, and forced the sale of Wachovia Bank to Wells Fargo, with a tax subsidy from the IRS. They guaranteed over $291 billion of Citibank’s toxic assets, they nationalized two government sponsored enterprises (Fannie Mae and Freddie Mac), they took over the country’s largest insurer (AIG), began to bail out the auto industry as well as GMAC, and gave taxpayer guarantees of $118 billion to Bank of America’s toxic assets.

In addition to those individual deals, the Federal Reserve created through emergency regulation:

(1) a commercial paper funding facility to buy short-term notes directly from companies in order to ensure their short-term financing;

(2) a temporary money market investor funding facility – to buy assets from financial companies in order to bolster money market mutual funds;

(3) a term securities lending facility where firms give the government their questionable collateral and it gives treasury bonds in exchange (for a 28-day term); and

(4) a term asset backed loan facility where the Federal Reserve offers low-cost 3-year funding to any U.S. company investing in securitized consumer loans (school, auto, credit card, small business). This offer includes hedge funds which have never been able to borrow from the U.S. central bank before.[5]

The total amount of taxpayer money at risk through capital injections, lending facilities, and loan guarantees of the Federal Reserve and U.S. Treasury is conservatively estimated at $1 to $3 trillion.

Part 2: Description of the Political Divisions Themselves

Taken this context, the most significant, though usually latent, political division in the U.S. now is between the U.S. taxpayer, on the one hand, and, on the other hand, the centralizers. The Centralizers include key segments of both major political parties and a cadre of financial and industrial firms whose intellectual elites are intimately linked, primarily through the revolving door, to career bureaucrats at the Federal Reserve and the U.S. Treasury.

This division became manifest for a few brief hours on September 29, 2008, in the first Congressional vote on the $700 billion bailout. A majority of the House of Representatives (228 to 205), spurred on by enraged taxpayers who flooded their office with phone calls and e-mails, voted against this alliance of state centralizers that includes specifically the Bolshevik wing of the Republican Party (i.e., Paulson, Bernanke, and their friends in the financial industry), the traditional statist wing of the Democratic party (i.e., Barney Frank, Nancy Pelosi, Harry Reid, and their friends in the financial industry), as well as then Presidential candidates Obama and McCain and the usual media sycophants.

But, 96 hours later, Congress reversed itself and the manifest division between taxpayers and the centralizers once again became latent through its retranslation into the more comforting and familiar narrative of Democratic (state solutions) vs. Republican (market solutions)—a narrative, I believe, that helps to obscure the equal responsibility of both public and private sector elites for this financial crisis.

Part 3: The Cultural Climate Leading to These Types of Political Divisions

What are the major cultural conditions leading to the reemergence of state centralization and appropriation? Robert Skidelsky wrote a three-volume biography of John Maynard Keynes. In his introduction to volume 2, The Economist as Savior: 1920-1937, Skidelsky points out that Keynes wrote during a time when attempts to justify ethics by religion or tradition were seen as offensive to reason. In such a culture, Skidelsky, echoing Alasdair Macintyre, argues that when values are personalized and privatized, public discourse then shifts to means or techniques—the one area in which rational agreement might still be achieved.[6]

Skidelsky believed that the simple message of Keynes’s economics was: when a society’s self-governing mechanism breaks down, it needs more government from the center. This is the managerial response to the breakdown in values—it is the manipulation of social relations in the interest of stability. For Keynes, when money becomes an object of desire, rather than a means to satisfy desire, the end result economically is the triumph of making money over the triumph of making things.[7]

As Keynes stated in the relatively famous Chapter 12 from his book General Theory of Employment, Interest and Money, “Speculators may do harm as bubbles on a steady stream of enterprise. But this position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”[8] These words of Keynes, written in 1936, capture nicely the essential bubble dynamics of the American economy that existed between the mid-1990s and 2007, when the over-expansion of non-productive credit, specifically debt instruments, eventually led to the meltdown of the world’s major financial systems.

Keynes’s more implicit cultural critique—the breakdown of market self-regulation due to a breakdown in self-restraint and long-run thinking caused by the power of money—also implied the necessity of some type of outside intervention to remoralize the economy. At the time, Keynes chose the state for that role.

Part 4: Public and Private Sector Responsibility for These Political Divisions

Since 2008, a coalition of self-interest between private sector financial and industrial players and the leadership of the U.S. Treasury and Federal Reserve has continued unabated.

The interaction of J.P. Morgan and Goldman Sachs with AIG and, in turn, the Treasury and Federal Reserve provides an illuminating case study of the following trail: (1) the creation of new debt instruments; (2) the distribution of these instruments to the broader financial community; and then (3) when this private debt blew up, it became generously transformed into U.S. taxpayer obligations.

AIG (American International Group), at the height of its power, was a huge multinational insurer. The company had subsidiaries in over 130 countries, employing 116,000 individuals. In 1987, Hank Greenberg, the head of AIG at the time, decided to launch a new business unit based on suggestions from a team of advisors who formerly had worked at Drexel Burnham Lambert, the failed investment bank associated with Michael Milken and junk bonds.[9]

The new unit was called AIG Financial Products. In the first few years of its existence, this unit made simple deals in hedging currency and interest rate risk. But its future product offerings were about to change dramatically. Young bankers working in the derivatives division of J.P. Morgan in the mid-1990s invented a product that came to be known as a CDO or collateralized debt obligation. A collateralized debt obligation is a security backed by a pool of corporate loans, bonds, subprime mortgages, or other assets such as credit-card debt. These securities are given different risks and returns and then sold to various investors like college endowments, pensions funds, investment banks, and insurance companies.

In early 1998, a year or so after inventing the CDO, J.P. Morgan went to the AIG Financial Products Unit, now based in London, with a new idea. J.P. Morgan suggested that AIG should try writing a type of insurance on these CDOs. The London unit agreed. The insurance products became known as senior security credit default swaps (because of their AAA ratings). By 2005 it was estimated that AIG’s Financial Products Unit had a portfolio of over $500 billion of such financial securities. The London unit of AIG had essentially agreed to provide this so-called insurance to financial institutions holding CDOs. In essence, the seller, AIG, guarantees the credit-worthiness of the financial product.

For example, Goldman Sachs paid a premium to AIG to insure their CDOs for a period of 4 or 5 years. Through such a hedging strategy, Goldman potentially made money whether the CDO appreciated or depreciated in value because first, AIG promised to pay Goldman Sachs if the CDO defaulted and, in addition, agreed to transfer collateral to Goldman Sachs if the value of the CDO declined.

This is exactly what began to happen in 2008. First the company’s method for valuing its Swaps portfolio came under attack. Then the value of all of AIG’s debt structure was downgraded. This action allowed counterparties in the credit default swap contracts to demand first $14.5 billion and then later up to $34 billion in collateral—pushing AIG to the edge of bankruptcy.

In essence, AIG had been promoting its Credit Default Swaps portfolio as an insurance product, which it wasn’t. If it were, it would have been regulated and required to have more adequate reserves. With completely inadequate estimates of loss exposure and hence insufficient reserves, a frenzied weekend of talks in mid-September of 2008 culminated in the first Fed-backed rescue of AIG. At that meeting, held at the Federal Reserve Bank of New York, were the nation’s most powerful regulators led by Treasury Secretary Henry Paulson and, soon-to-be new Treasury Secretary Timothy Geitner, but only one representative from Wall Street—Lloyd C. Blankfein, head of Goldman Sachs. Interestingly enough, Goldman Sachs was a key member of AIG’s derivatives club and supposedly had close to $20 billion in risks tied to AIG. Goldman was also an important customer for AIG’s credit default swaps and often acted as intermediary for trades between AIG and other clients.

Later that day, a two-year $85 billion loan to AIG was made available. This deal was initially more punitive towards AIG. But by November 10, that loan had morphed into a potential $173 billion facility with more generous terms for AIG and a more ingenious way of protecting counterparties like Goldman Sachs. As part of this new $173 billion facility, a separate investment vehicle was set up to deal just with credit default swaps. $30 billion of U.S. taxpayer money and $5 billion of AIG money is being used to acquire $70 billion of CDOs.

So, essentially, these CDOs are being acquired at about 50 cents on the dollar, which is much higher than any market rate and a way to overpay for the CDOs—thus providing a subsidy to the holders of these securities. And, since it is highly unlikely that there will be any profits, the U.S. taxpayer will lose the entire $30 billion, period, while AIG will have been able to cancel the contracts and thus take possession of the original collateral it had posted on those contracts.[10]

I believe what is going on technically in this type of loan deal is the looting of the U.S. taxpayer. According to Nobel Prize winners George Akerlof and Paul Romer, in their 1994 paper “Looting: The Economic Underworld of Bankruptcy for Profit,” an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense. Owners are given an incentive to pay themselves more than their firms are worth and then default on their debt obligations.[11]

This is precisely what happened to AIG. Senior management cast a blind eye at the Financial Products Units when it was earning outsized profits while taking risks that would have normally driven AIG and its major counterparties into bankruptcy. Instead, the government stepped in to semi-nationalize AIG and allow it to go broke for profit, while simultaneously saving powerful counterparties—all at the U.S. taxpayers’ expense. This is the type of selflessness our political and economic elites understand—one that they can arbitrarily inflict on us for their benefit.

Part 5: The De-Centered Self vs. The Sovereign Self

In 1936, Keynes assumed that when society’s self-governing mechanisms broke down, politicians and government bureaucrats were still capable of making wise decisions in the public interest, even if the financial community was not. He also apparently saw the state apparatus as a relatively unexploited resource with participants who still believed in individual excellence in a setting of public duty.

But, based on the world history of the past 73 years, the benevolence and wisdom of either the state or major market players now seems, at a minimum, highly questionable. Economic looting has been supported and engaged in by both private and public sector elites with the most recent consequence being a massive rise in public sector debt to support the collapse in value of private sector debt. What the new Obama regime now brings to the table is a disorganized industrial policy overlaid against a corrupt political economy: in other words, a potential license to steal.

Keynes believed that a remoralization of the market might be accomplished through public sector interventions, as a guiding hand, helping to spend money on those things which make for the “good life.” But in 2009, such public-sector maneuverings look increasingly likely to compound private-sector corruption with a dose of its own incompetence and scamming capabilities, with the additional risks of a potential public-sector sovereign debt default, a currency collapse, and future explosions of deflation, inflation, or both.

The world today seems even more bereft of moral guidance than at the time Keynes was writing. This means that the demand for governmental intervention to supposedly fill the moral and economic void will be even more irresistible. Ironically, I believe, what the country needs now is massive resistance to further governmental intervention, not a plea for its acceleration. Such resistance can only take place through individual human agency once again reasserting itself. The brief spontaneous taxpayer revolt of the morning of Sept. 29, 2008, indicates a residue of such resistance. But the forces aligned against such a reassertion are significant.

The centralizers have positioned themselves as our new saviors offering us the necessary moral and material guidance. Reigning intellectual traditions, in finance theory for example, also reinforce our sense of individual passivity. The market is presented as all powerful, with individual behavior determined solely by market forces. In addition, the mathematical models of finance assume that markets are efficient, that agents are rational, and that they have access to all the available data. Furthermore, newly created debt instruments are simply viewed as perfect hedging vehicles which help to make the market complete and even more efficient. To believe that we really do live in a world of complete and efficient markets is to accept an intellectual construct that has served as the foundation for this recent bout of speculative excess. Stated another way—it is to chase an impossible dream.[12]

If, instead, we see ourselves as active participants in a world of incomplete but reasonably efficient markets that are part of a specific history of banking, economics, and capitalism, then perhaps we have anchored ourselves in the real world. And perhaps such anchoring is necessary as a first step in creating a moral vision for ourselves—a vision that can eventually discipline both the market and the state.

In the late 1960s, the New Left overestimated the conformist nature of cultural traditions and underestimated the extent to which these same traditions gave one the strength of character to rebel in the first place. It also assumed that their respective character structures were somehow immune to the internalized impulses of the market and the state which tended to support a more isolated, unconstrained individualism. When the New Left deteriorated into political egotism and dogmatism, it did not recognize that this collapse was partially linked to internalized norms of behavior which it thought it had either transcended or were unnecessary.

Paul Piccone had always assumed that responsible citizenship required autonomous individuals who possessed rich inner resources that were the foundation for functioning internal control mechanisms. He held out the hope that a radically decentralized political structure might be capable of producing a diversity of geographical spaces within the country where strong communities with rich traditions might reemerge and continue to nurture these same internal control mechanisms that would, in turn, discipline market and state bureaucracies.

However, close to 20 years have passed since he articulated this populist strategy, and during that time, the forces of first the market and now the state appear to again reign supreme both internally and externally. In fact, I believe the scales of internalization may have now tipped toward an unconstrained self-assertion, with only the most fragile links to something beyond that.[13]

The type of space that is capable of disciplining these two out-of-control forces of modernity must now be created within the human mind itself rather than in geographical spaces throughout the country. Support for such a move comes from both 2000-year-old meditative practices and traditions as well as recent research in neuroscience and neurobiology indicating that conscious intent may be capable of modifying neural pathways.[14]

Through focused attention on our respective internal streams of consciousness, the emotional impulses of unconstrained behavior can be observed and identified and choices made, over and over again, whether to go with such impulses or to check them.[15] This process of internal checking creates a space within the mind for the potential reemergence of a subjectivity of internalized cultural traditions that link the individual to other individuals, groups, and communities. This eventual realization of self through incremental steps toward selflessness is the type of individuality capable of disciplining the market and the state and, in the process, strengthening ourselves and our democracy.

Notes

1. See, for example: Telos 84 (The Future of the USSR), 88 (Populism vs. The New Class), 103 (Special Issue on Populism I), 113 (Toward a Liturgical Critique of Modernity), and 134 (Special Issue on Politics and Religion).

2. The evidence for this assertion is the individual behavior patterns in both the public and private sector that have led to the collapse of our financial system.

3. Steven M. Davidoff and David T. Zaring, “Big Deal: The Government’s Response to the Financial Crisis,” November 24, 2008.

4. Ibid.

5. Steve Randy Waldman, “Expenditure vs. Investment—Thinking Clearly,” Interfluidity, December 2, 2008; and Kathleen Pender, “Government Bailout Hits $8.5 Trillion,” November 26, 2008.

6. Robert Skidelsky, John Maynard Keynes: The Economist as Savior 1920-1937 (New York: Penguin Books, 1992), pp. xv-xxix.

7. Ibid.

8. Ibid, p. 556.

9. Andrea Felsted and Francesco Guerrera, “Inadequate Cover,” Financial Times, October 7, 2008, p 11; Gillian Tett and Andrea Felsted, “Non-Core Blows to AIG’s Heart,” Financial Times, September 17, 2008, p.2.

10. Yves Smith, “AIG: The Looting Continues (Banana Republic Watch),” Naked Capitalism, November 10, 2008.

11. Ibid.

12. Interview with Bill Janeway, “New Hope for Financial Economics,” The Institutional Risk Analyst, December 17, 2008.

13. Bernard Madoff and the former governor of Illinois, Rod R. Blagojevich, have become prominent symbols of such unconstrained behavior.

14. See Robert K.C. Forman, “A Watershed Event: Neuroscience, Consciousness and Spirituality Conference, July 2-4, 2008 Freiburg Germany,” Journal of Consciousness Studies 15, no. 8 (2008): 110-15; and Claes G. Ryn, A Common Human Ground: Universality and Particularity in a Multicultural World (Columbia: Univ. of Missouri Press, 2008), pp. 40-41. The inner check which Ryn discusses is basically a restraint upon impulse—a process that desperately needs strengthening taken the unconstrained self-assertion exhibited in our financial crisis.

15. Ibid.

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