Saturday, March 28, 2009

The Free Market, Financial Style

Weekend Edition
March 27-29, 2009

How the Scam Works


Newspaper reports seem surprised at how high banks are bidding for the junk mortgages that Treasury Secretary Geithner is now bidding for, having mobilized the FDIC and Fed to transfer yet more public funds to the banks. Bank stocks are soaring – thereby bidding up the Dow Jones Industrial Average, as if the “financial industry” really were part of the industrial economy.

Why are the very worst offenders – Bank of America (now owner of the Countrywide crooks) and Citibank the largest buyers? As the worst abusers and packagers of CDOs, shouldn’t they be in the best position to see how worthless their junk mortgages are?

That turns out to be the key! Obviously, the government has failed to protect itself – deliberately, intentionally failed to do so – in order to let the banks pull off the following scam.

Suppose a bank is sitting on a $10 million package of collateralized debt obligations (CDOs) that was put together by, say, Countrywide out of junk mortgages. Given the high proportion of fraud (and a recent Fitch study found that every package it examined was rife with financial fraud), this package may be worth at most only $2 million as defaults loom on Alt-A “liars’ loan” mortgages and subprime mortgages where the mortgage brokers also have lied in filling out the forms for hapless borrowers or witting operators taking out mortgages at far more than properties were worth and pocketing the excess.

The bank now offers $3 million to buy back this mortgage. What the hell, the more they bid, the more they get from the government. So why not bid $5 million. (In practice, friendly banks may bid for each other’s junk CDOs.) The government – that is, the hapless FDIC – puts up 85 per cent of $5 million to buy this – namely, $4,250,000. The bank only needs to put up 15 per cent – namely, $750,000.

Here’s the rip-off as I see it. For an outlay of $750,000, the bank rids its books of a mortgage worth $2 million, for which it receives $4,250,000. It gets twice as much as the junk is worth.

The more the banks holding junk mortgages pay for this toxic waste, the more the government will pay as part of its 85 per cent. So the strategy is to overpay, overpay, and overpay. Paying 15 per cent is a small price to pay for getting the government to put in 85 per cent to take the most toxic waste off your books.

The free market at work, financial style.

Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached at

Wednesday, March 25, 2009

Mr. Obama: Fire Geithner & Hire Krugman, NOW!

Left, Paul Krugman. Above: Larry Summers and Tim Geithner advise Obama while crowd outside protests his accepting their advice. (Both graphics from NY Times; the cartoon is from a recent Frank Rich column.)

I sincerely believe that a majority of business-savvy Americans who regularly read the New York Times believe that President Obama should have selected Paul Krugman as his Treasury Secretary. Unlike Timothy Geithner (or chief economic advisor, Lawrence Summers), Krugman was not a part of the rogue operations on Wall Street that brought the world economy to its knees ...AND he was the 2008 winner of the Nobel Prize in Economic Sciences!

Even thought Krugman wasn’t offered this post (and one has to wonder why not), in his New York Times columns and blogs (and an open letter published in RollingStone magazine) Krugman has repeatedly weighed in with free advice. And, with one anomalous exception, his Times articles have been consistently negative on Obama’s bailout and stimulus plans. Below I’ve cut and pasted a few lines from seven recent Paul Krugman columns and one of his latest blogs.

February 8th: “Even if the original Obama plan ... had been enacted, it wouldn’t have been enough to fill the looming hole in the U.S. economy ... Yet the centrists did their best to make the plan weaker and worse.”

February 12th: “Officially, the administration insists that the plan is adequate to the economy’s need. But few economists agree.”

February 19th: “To be sure, the Obama administration is taking action to help the economy, but it’s trying to mitigate the slump, not end it.”

February 27th (anomalous praise): “...I don’t blame Mr. Obama for leaving some big questions unanswered in this budget. There’s only so much long-run thinking the political system can handle in the midst of a severe crisis; he has probably taken on all he can, for now. And this budget looks very, very good.

March 5th: “...there’s a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds.”

March 8th: “...the plan was too small and too cautious.”

March 22nd: “If the reports are correct, Tim Geithner, the Treasury secretary, has persuaded President Obama to recycle Bush administration policy — specifically, the ‘cash for trash’ plan...” “ fills me with a sense of despair.”

March 23rd: “...administration officials keep saying that there’s no subsidy involved, that investors would share in the downside. That’s just wrong.”

But there is still an “elephant in the room” that Krugman is neither writing nor speaking about. However, it was obliquely alluded to in his interview with Amy Goodman on Democracy Now! on Monday.

At one point Amy asked (likely by pre-agreement): “And this issue of counterparties, a word we’re just learning right now, that AIG gets all of these billions of dollars, and they use some of it to pass through to banks once—well, to entities like Goldman Sachs, to UBS, which had to pay a massive fine to the US government, so we’re paying their fine for violating us?”

I won’t reproduce Paul’s answer here, but rather I want to emphasize that the word counterparty, which Amy is apparently just learning, is a terminology used in the discussion of Credit Default Swaps (CDS). And I want to make the point that Krugman has never mentioned CDS in any of his columns ...OR the notional amount of the “fines” that A.I.G. and the big banks REALLY want us taxpayers to pay them for their having “violated us.”

So why didn’t Amy call the “elephant in the room” by its real name: CDS?

Well, once before I’ve argued that the big businesses that own the mainstream media in general, and the NY Times in particular, have likely banned Krugman from ever mentioning such ugly issues as the existence of evidence for widespread election fraud or the existence and significance of CDS, so long as he remains on their payroll.

In an earlier OpEdNews column I have written about CDS and given some links to authoritative sources of information about them. So here I will only explain the connection between the code word counterparty and the true “elephant in the room.” Here below are some passages from an extremely informative article by Thomas Tan:

“[C]redit default swaps are not normal insurance policies, each side can trade them to make a quick profit (spread) if there is a willing counterparty [emphasis added]. Commonly after the original CDS contract is engaged, each side of the original two parties will try to engage another party to further hedge their bet and earn a small spread, pretty soon there are layers of layers of counterparties involved, with total notional amount increasing several fold, and no one knows who they are really dealing with anymore.”

“The market cap of GM is only about $11B. However, based on estimates in the CDS market, there are about $1 trillion in CDSs betting on GM and their bonds. Any change in GM's situation, will create a rippling effect in this $1T CDS community of GM.”

“There are obviously not $1T of GM properties to act as collateral, so you have to trust all parties involved in this wild casino betting that they won't go under water. As a matter of fact, you better pray, because if one goes under, which is a high probability event, it throws a monkey wrench in the whole community, as everyone is trying to rewind and get out at the same time. It becomes a ‘no way out situation’”.

So Tan explains how trading of CDS with the idea of grabbing quick profits can have spun up the notional values of these CDS many times larger than their values when first issued.

Now the initial value of all freshly issued CDS is well enough known to be about $45 trillion, whereas in consequence to their having been extensively traded they are estimated to have ballooned to a notional value of as much as $500 trillion! Putting these numbers into perspective, the U.S. GDP – and the U.S. money supply – is “only” about $15 trillion, the GDPs of all nations in the world sum to approximately $50 trillion, and the total value of world's stock and bond markets is “only” slightly more than $100 trillion.

So, far, far worse than taxpayer bailout funds being used to pay just the bonuses to the very folks responsible for this mess, it is strongly looking as though much of the bailout moneys going to A.I.G., Goldman Sachs, USB, and other big banks may be largely to pay off counterparties to CDS contracts. If so, then the government is using taxpayer money as a down payment on a debt – not of taxpayers’ making – amounting to 3 to 33 times the current U.S. money supply!

Given the impossibility of ever paying such a debt in full without driving the dollar below the Mexican peso, it is high time to declare the taxpayers bankrupt, pay the winning counterparties to the CDS a few taxpayer pennies on the dollar – or better still nothing at all (after all it was the banks, not the taxpayers who were engaged in this reckless form of gambling) – and then restart the economy the way Paul Krugman has laid out.


Post Script: On Monday George Soros published a very instructive column in the Wall Street Journal explaining the perils of CDS and explaining how A.I.G. went wrong, concluding that “CDS are toxic instruments whose use ought to be strictly regulated” by requiring that “Only those who own the underlying bonds ought to be allowed to buy them.” But future regulation will not get us out of the current mess ...that is unless these regulations were to be applied retroactively.

Friday, March 20, 2009

Electronic Voting Ruled Unconstitutional in Germany

German High Court’s Ruling Strikes Down
Electronic Voting Under Principles of Democracy
Signed by and Imposed by USA After WWII

Paul R Lehto, Juris Doctor

Wednesday, March 4, 2009

According to a ruling by Germany’s highest court yesterday, computerized voting machines used by 2 million of Germany's 5 million voters in 2005’s parliamentary elections are unconstitutional because they are not in line with democratic standards and principles -- especially the “publicity” of the vote counting (i.e. transparency, visibility). The court added that “specialized technical knowledge” may not be demanded of observing citizens, and that government-defined checks or audits are no substitute for the constitutional requirement of publicity via observation.

The ruling of Germany’s highest court affirmed the principles required for a constitutional voting system that makes Self-Government possible, which include the following tests:

  1. No "specialized technical knowledge" can be required of citizens to vote or to monitor vote counts. (This is a simple application of democracy’s equality principle combined with an aversion to an aristocracy of experts.)
  2. The constitution requires a bona fide publicly observed vote count. (The court noted that the government substitution of its own check or checks in any amount, or substitution of what we’d probably call in the USA an “audit” is no substitute at all for the constitutional requirement of public observation or “publicity.” Publicity was the term of art favored by Founders of the USA, and the term still used by the German (High) Federal Constitutional Court.)
  3. A paper trail does not suffice to meet the above standards where ballots are not publicly counted on election day, the court holds generally, in its ruling on the NEDAP push-button DRE electronic voting system used in the 2005 Bundestag elections in Germany.
  4. The German Federal Constitutional Court threw out the German Voting Machine Act completely (the analog in the US would be HAVA – the “Help America Vote Act.”) Message to Congress: We don’t need YOUR help, especially since your help comes with concealing the vote counts on computers like optical scans and touch screens so we can’t tell on election night if the counts are genuine results or not.!
  5. CONCLUSION ON THE EFFECT OF THE OPINION’S HOLDING: As a result of these principles, a source in Ireland concludes that “all independent observers” conclude that “electronic voting machines [are totally] banned in Germany” because no conceivable computerized voting system can cast and count votes that meet even just the two most basic requirements of publicity: being both publicly observed and not requiring specialized technical knowledge on the part of the public in order to exercise the right of observation (transparency).
  6. CONCLUSION ON THE OUTLOOK IN GERMANY ITSELF: Moreover, any resumption of any kind of optical scan or touch screen voting of any kind would require the Bundestag to first past a new Voting Machine Act that complies with the constitutional principles set forth in the Courts opinion. About the only kind of electronic voting that would be constitutionally permissible would be that strictly limited to those who need a computer’s help to cast a ballot, because in that case only would the right to vote FAVOR technology such that concerns of constitutional magnitude (quite unlike speed, efficiency or other such business-based non-constitutional values) would come into play and be balance against the constitutional command for publicity/transparency of vote counts and “all essential steps.” A little non-transparency in how individual small numbers of disabled persons cast their ballot is not an “essential step” given the secret ballot, so long as the output of the process is a ballot that can be publicly counted like all the others.

Download full article here.

Excerpts from European and American based media outlets:
International Herald Tribune:
"Federal Constitutional Court upheld two complaints about the use of the machines in 2005. It found they violated provisions requiring that voters be able to assure themselves - without specific technical knowledge - that their vote was recorded correctly."

IT Examiner:
"The court made it clear that a simple print-out or flashy icon displaying what party or person was voted for is not enough. / Not only that, any constraint on the people's right to know cannot be alleviated by having a state institution check machines to make sure they have not been tampered with."

Radio Netherlands reports that elections later this year must be on pencil and paper, counted publicly.

"[Plaintiffs] complained that push button voting was not transparent
because the voter could not see what actually happened to his vote inside the computer and was required to place "blind faith" in the technology."

Here's a link to the national Zogby poll official press release expressing an apparently unprecedented 92% level of support for the proposition that Americans have "the right to observe vote counting and obtain any and all information about vote counting"

This article is (c) 2009 by Paul R Lehto, but may be forwarded and/or posted freely with attribution and all links and footnotes attached, so long as it is on a not for profit basis.