PART 4
Fannie Mae is one of the world's largest issuers of debt securities, the leader in the $5 trillion US home-mortgage market. Fannie Mae's debt obligations are treated as US agency securities in the marketplace, which is just below US Treasuries and above AAA corporate debt. This agency status is due in part to the creation and existence of the corporation pursuant to a federal law, the public mission that it serves, and the corporation's continuing ties to the US government. It benefits from the appearance, though not the essence, of being backed by government credit.
Fannie Mae debt obligations receive favorable treatment from a regulatory perspective. Fannie Mae securities are "exempted securities" under the laws administered by the US Securities and Exchange Commission to the same extent as US government obligations. Also, Fannie Mae debt qualifies for more liberal treatment than corporate debt under US federal statutes and regulations and, to a limited extent, foreign overseas statutes and regulations.
Some of these statutes and regulations make it possible for deposit-taking institutions to invest in Fannie Mae debt more liberally than in corporate debt and mortgage-backed and asset-backed securities. Others enable certain institutions to invest in Fannie Mae debt on par with obligations of the United States and in unlimited amounts. Fannie Mae uses a variety of funding vehicles to provide investors with debt securities that meet their investment, trading, hedging, and financing needs. Fannie Mae is able to issue different debt structures at various points on the yield curve because of its large and consistent funding needs. As the Treasury retires 30-year bonds, agencies have stepped in to fill the void.
The privatization of Fannie Mae and Freddie Mac was an ideological move. It was financially unnecessary and government credit could have funded the entire low-, moderate- and middle-income housing-mortgage needs with no profit siphoned off to private investors. These agency debt instruments played a crucial role in developing and sustaining the credit markets in the US.
In fact, the funding risk of both agencies was questioned by the Wall Street Journal last February 20 in an editorial about Fannie Mae's and Freddie Mac's safety, soundness and financial management, characterizing both agencies as risky, fast-growing companies that "look like poorly run hedge funds", "unduly exposed to credit risk with large derivative positions", and that they "use all manner of derivatives" and "are exposed to unquantified counterparty risk on these positions". Such concerns would have been avoided if both agencies had been funded with government credit, and the cost of housing to low-, moderate- and middle-income Americans would have been lower.
A government credit economy is different from a private debt economy in its sustainability. The Japanese economy stagnated for more than a decade primarily because it shifted from a government credit economy to a private debt economy in the name of financial liberalization and market fundamentalism. The Japanese version of London's Big Bang started the Japanese private debt bubble that subsequently infected all Asian economies.
The Big Bang in London refers to deregulation on October 27, 1986, of London-based securities markets, an event comparable to May Day in the US, marking a major step toward a single global financial market. May Day refers to May 1, 1975, when fixed minimum brokerage commissions ended in the US, ushering in the era of discount brokerage firms and the beginning of diversification by the brokerage industry into a wide range of financial services using computerization and advanced communication systems. This started the offering of new genres of financial products and the emergence of structured finance that made possible a new private-debt economy that turned quickly into a global debt bubble. As the US reaped the fleeting benefits of dollar hegemony, a budget surplus accompanied with sovereign debt reduction merely pushed more debt on to the private sector to feed the debt bubble.
The most fundamental aspect of a private-debt economy is that it cannot sustain a slowdown, even a soft landing. If Greenspan had been better versed in debt economics, he would have understood that a debt bubble, unlike the conventional business cycle, cannot survive the slightest deflation. Inflation is the oxygen for a debt bubble.
Greenspan's attempt to engineer a soft landing by raising interest rates to fight pending inflation pre-emptively only accelerated the debt bubble's burst. His only option was to prevent the debt bubble from forming by tightening credit quality years ago, but he chose to rely on the market to exercise its discipline. He rejected the suggestion of such Wall Street gurus as Henry Kaufman to raise margin requirements. Instead of discipline, the market gave him an insatiable appetite for addictive debt, which he had previously called "irrational exuberance".
Once the bubble was on its way, Greenspan was on top of a debt tiger that he could not get off without being devoured by the beast. It was not the New Economy, it was not the unprecedented productivity that gave the US its decade-long boom. It was debt. Without debt, there would have been no New Economy, no dotcom industry, no telecom explosion, no structured finance, no budget surplus and no current account deficit or its flip side, capital account surplus.
The 1990s was the debt decade. Much of the technology was invented prior to the beginning of the decade of finance capitalism and became widely applied through debt in the form of vendor finance. The communication revolution was built on debt that had been accumulated in the last decade. The greatest invention of the 1990s was more and more sophisticated debt instruments.
Greenspan warned in December 1996 about "irrational exuberance" when the Dow Jones Industrial Average (DJIA) was at 7,000, that inflation down the road was inevitable unless the Fed started to raise Fed funds rate pre-emptively. Yet as rates rose, the DJIA rose to 12,000 by 2000, because inflation as measured by the government failed take into account the wealth effect.
The reason for this was twofold. Inflation was kept low by imports and inflation was measured mostly by rising wages but not by rising asset value. Stock prices doubled and real-estate prices tripled, but the economy officially did not register inflation because of low wages and cheap imports. As stock prices rose, the price to earnings ratio skyrocketed. As the economy inched toward technical full employment with 4 percent unemployed, Greenspan reflexively raised the interest rate to cut off anticipated wage-pushed inflation. The high interest rate adversely affected the earnings of debt-ridden companies. To boost earnings, companies cut employees, which started the downward spiral.
Since July 1997, the risks of protracted global asset deflation caused by the aftermath of excessive private debt have become reality, first in the emerging markets and now in the United States. Neither the IMF nor the Group of Seven (G-7) have been able to deal effectively with the twin problems of the artificially strong but debt-driven dollar and the spreading manipulated devaluation of other national currencies around the globe.
For the affected nations, the combination of mountains of foreign-currency debt and massive short-term capital flight through stock-market collapses, exacerbated by IMF conditionalities of high interest rates, austerity measures that insisted on reduced government deficits and sharp currency devaluations coupled with asset deflation, have led to tragic destruction of hard-earned wealth and a severe drop of living standards.
Certainly market forces in a runaway-debt economy have not created Adam Smith's "universal opulence which extends itself to the lowest ranks of the people". The only trickling down has been poverty and misery. In a world of 6 billion people, only about 1,000 currency traders and a small circle of rich investors in their hedge funds seem to enrich themselves further through the unbridled manipulation of the free financial market. Even in advanced economies, workers are misled to accept low wages as a trade-off for stock options that become worthless when the debt bubble bursts.
Corporations seduce share owners with fantasy capital gains based on debt to replace regular dividend payouts. When market capitalization of major corporations inflated by debt can fall by 90 percent within a matter of months while top executives can cash out at peak prices and resign with severance packages worth tens of millions of dollars, there is no other way to describe the situation than reversed Robin Hood: robbing the poor to help the dishonest rich.
This view is now shared by increasing numbers across ideological spectrums. Economist John Kenneth Galbraith's famous description of trickling down prosperity was if you feed the horse enough oats, the sparrows will some day benefit from its droppings. In finance capitalism, the poor sparrows are crushed by the wheels of the carriage of debt that the horse pulls.
If debt is dilapidating, foreign-currency debt, mostly dollar debt, is deadly. Thus those governments that had been misled by neoliberals to borrow massive amounts of foreign currency unnecessarily and subsequently dutifully implemented IMF prescriptions, such as Brazil, Argentina, Turkey, South Korea and Indonesia, saw their economies destroyed to the point where recovery may now take decades, if ever, and only if the poisonous IMF medicine is quickly rejected.
The IMF has now admitted that it made a "slight mistake" in dealing with the Asian financial crisis of 1997. It might have been slight for the IMF, but the cost to the economies of Asia was horrendous. Trillions of dollars of hard-earned assets and economic capacities have been destroyed, lost forever. In fact, lives have been lost, children malnourished, families ruined, governments fallen and ethnic animosities intensified. The cooperative partnership among neighboring countries has been undermined and regions destabilized. This is the direct result of predatory lending followed by predatory IMF rescues. The operations were technically successful but the patients died.
Since World War II, the term "capitalism" has been gradually displaced by the more benign label of the free market. Capitalism ceased to be mentioned in most economic literature. In the process, economists also squeezed out of official dialogues the word "capitalism", the once-traditional name for the market system, with its subjective connotation of class struggle between owners, through their professional managers, and workers, through their trade and industrial unions, and with its legitimization of the privileges that go with various levels of wealth.
The word "capitalism" no longer appears in textbooks for Economics 101. A Harvard economist, N Gregory Mankiw, author of a popular new textbook, Principles of Economics, told the New York Times: "We make a distinction now between positive or descriptive statements that are scientifically verifiable and normative statements that reflect values and judgments." A whole new generation of economists have grown up thinking of "capitalism" only as a historical term like "slavery", unreal in the modern world of market fundamentalism.
Capital, when monetized in dollars, is in essence credit from government. Capitalism in a money economy is a system of government credits. Thus a case can be made that in a capitalistic democracy, access to capital and credit should be available equally to all in accordance with national purpose and social needs. The anti-statist posture of neoliberalism is not only logically flawed, but its glorification of a private-debt economy will inevitably lead to self-destruction.
Henry C K Liu is chairman of the New York-based Liu Investment Group
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