"Getting Tough" with Predator Financial Institutions
AIG, Larry Summers and the Politics of Deflection

By F. William Engdahl

Global Research, March 18, 2009

Finally the US authorities have gotten ‘tough’ with the predator financial institutions. The world has been waiting for such decisive intervention since an unending series of Government bailouts of financial institutions began early in 2008 amounting to now trillions of taxpayer dollars. Now, with the world’s largest insurance giant, AIG, the White House Economic Council chairman, Larry Summers has expressed ‘outrage.’ President Obama himself has entered the fray to promise ‘justice.’ US Senators have threatened a law to change the injustice. The only problem is they are all exercising ‘politics of deflection,’ taking attention away from the real problem, the fraudulent bailout. 

The issue is over AIG announcing it was obligated to pay its traders in its high-risk London unit a sales bonus totaling $165 million for the year. Obama Treasury Secretary, Tim Geithner has announced a novel strategy for ‘justice.’ AIG will ‘reimburse’ the taxpayers up to $165 million for bonuses the company is giving employees. AIG will pay the Treasury an amount equal to the bonuses, and the Treasury will deduct that amount from the $30 billion in government (taxpayer) assistance that will soon go to the company. But he said that the Obama administration hasn't given up on efforts to recoup the money from the employees who got the bonuses. Good luck.
Larry Summers is the man directly responsible for the mess. As Clinton Treasury Secretary from 1999-January 2001 he shaped and pushed the financial deregulation that unleashed the present crisis. He was Treasury Secretary after July 1999 when his boss, Robert Rubin left to become Vice Chairman of Citigroup, where Rubin went on to advance the colossal agenda of deregulated finance directly.
As Treasury Secretary in 1999, Summers played a decisive role in pushing through the repeal of the Glass Steagall Act of 1933 that was instituted to guard against just the kind of banking abuses taxpayers now are having to bail out. Not only Glass-Steagall repeal. In 2000 Summers backed the Commodity Futures Modernization Act that incredibly mandated that financial derivatives, including in energy, could be traded between financial institutions completely without government oversight, ‘Over-the-Counter’ as in where the taxpayer is now being dragged. Credit default Swaps, at the center of the current storm, would not have been possible without Larry Summers and the Commodity Modernization Act of 2000. He is now the White House Economic Council chairman, mandated to find a solution to the crisis he helped make along with Tim Geithner, his friend who is Treasury chief. Foxes should never be asked to guard the henhouse.
Theatre of the absurd or deflection?
This all makes great food for tabloid headlines and popular outrage. They can write that elected politicians are finally acting in taxpayer interests. Until we look a bit more closely. Paying $165 million in employee bonuses or any amount for a company that is in the middle of a multi-trillion dollar fraud that is bringing the world economy down with it is ‘outrageous.’
The problem is the tax bailout haemmorrhage will go on. The reason is the Obama Administration like its predecessor refuses to take consequent action with AIG, despite the fact today the US Government owns at least 80% of AIG stock, bought for $180 billion of, yes, taxpayer dollars. To demand AIG ‘pay back the government’ is absurd as the government is in effect demanding it pay itself back with its own money. The latest claim that the Treasury will subtract the $165 million bonus money from the next $30 billion tranche it will give AIG says it all.
Preserving the CDS bubble
The political ‘outrage’ expressed by the Obama Administration is an example of ‘perception management.’ The population is being slylyduped into believing their officials are working in their interest. In reality the officials are channeling growing popular outrage over endless bank bailouts away from the real problem to an entirely tertiary one. The US Government has injected $180 billion since September 2008 to keep the ‘brain dead’ AIG in business and honoring its Credit Default Swap obligations. In effect, they are propping up the casino to continue endless gambling with taxpayer dollars.
The rise of a market in derivatives or ‘swaps’ contracts supposedly to ‘insure’ against a company going into default and not being able to honor its debts, the Credit Default Swaps market, is at the heart of the global financial catastrophe. The market was ‘invented’ by a young economist at JP MorganChase, interestingly enough one of the few big banks recording profit today.
As noted, CDS trading was created free from US Government regulation by President Clinton when he signed the Commodity Futures Modernization Act of 2000 that mandated that financial derivatives not be under government regulation scrutiny. Enron crony and UBS bank adviser, Texas good ‘ol boy Senator Phil Gramm helped pass the laws at a time his wife, Wendy headed the putative regulator, the Commodity Futures Trading Corporation (CFTC). That gave the green light to a derivatives market nominally worth more than $62 trillion in 2008. No one knows the exact size because this is a ‘phantom banking market’ completely private and between banks, so-called OTC for Over-The-Counter, ‘just between us.’
Michael Greenberger who headed the CFTC Division of Trading and Markets in the late 1990’s at the time of the financial deregulation acts, says that banks and hedge funds"were betting the subprimes would pay off and they would not need the capital to support their bets." The unregulated Credit Default Swaps, he says, have been at "the heart of the subprime meltdown. In 1998 Greenberger proposed regulating the growing derivatives market. At the prospect, he says, "all hell broke loose. The lobbyists for major commercial banks and investment banks and hedge funds went wild. They all wanted to be trading without the government looking over their shoulder."
The confidence between banks, the ‘just between us,’ collapsed after the ill-conceived decision by the US Government on September 15 2008 not to save the world’s fourth largest investment bank, Lehman Brothers. By then, there was no alternative but to nationalize and then sort out the mess. Bankruptcy, as the world now realizes, was not an option. But neither was the Henry Paulson TARP ‘casino rescue plan’ and Geithner’s continuation any option.
At the point the Government let Lehman Bros go down only months after saving the far smaller Bear Stearns and also AIG, not even a bank, there was no clear idea who would be saved and who not. No bank could afford to trust any other bank not to be holding just as risky loans as they. The crisis became a global systemic crisis. Notably, the man who participated in the decision to let Lehman Bros fail ‘to teach a lesson’ was then President of the New York Federal Reserve, US Treasury Secretary Tim Geithner.
The US Government has stated that AIG cannot be allowed to fail, that, to use the jargon, AIG is ‘too big to fail.’ The reason the Government says it can’t let AIG fail is that if the company defaulted, hundreds of billions of dollars’ worth of Credit-Default Swaps (CDS) would ‘blow up,’ and US and European banks whose toxic assets are supposedly insured by AIG would suddenly be sitting on immense losses. Quite the contrary, AIG is ‘too big to save’ under current rules of the game that have been written by Wall Street and the privately-owned Federal Reserve, Treasury Secretary Geithner’s former employer.
The CDS fraud
Credit Default Swaps purported, in theory, to let banks remove loan risk from their balance sheet onto others such as AIG, an insurer. It was based on a colossal fraud using flawed mathematical risk models.
AIG went big into the selling Credit Default Swaps with banks around the world, from its London ‘Financial Practices’ unit. AIG in effect issued pseudo ‘insurance’ for the hundreds of billions of dollars in new Asset Backed Securities (ABS) that Wall Street firms and banks like Citigroup, Goldman Sachs, Deutsche Bank, Barclays were issuing, including Sub-prime Mortgage Backed Securities.
It was a huge Ponzi scheme built by AIG that depended on the fact the world’s largest insurance company held a rare AAA credit rating from Moody’s and S&P rating agencies. That meant AIG could borrow more cheaply than other companies with lower ratings
AIG issuing of CDS contracts acted as a form of insurance for the various exotic Asset Backed Securities (ABS) securities being issued by Wall Street and London banks. AIG was saying ‘if, by some remote chance’ those mortgage-backed securities suffered losses, AIG would pay the loss, not the banks.
Then it got really wild. Because credit-default swaps were not regulated, not even classed as a traditional insurance product, AIG didn’t have to set aside loss reserves! And it didn’t. So when housing prices started falling, and losses started piling up, it had no way to pay off.
AIG then issued of hundreds of billions of dollars worth of CDS instruments to allow banks to make their balance sheets look safer than they really were. Banks were able to get their loan risk low not by owning safer assets. They simply bought AIG’s credit-default swaps. The swaps meant that the risk of loss was transferred to AIG, making the bank portfolios look absolutely risk-free. That gave banks the legal illusion of BIS minimum capital requirements, so they could increase their leverage and buy yet more ‘risk-free’ assets.
How could that be allowed? The level of venal corruption in the Clinton and then Bush Administration rivals that of the last days of Rome before its fall from the internal rot of corruption. Banks invested billions in lobbying Washington politicians to get their way.
What can be done?
Fortunately there is a simple way out of the AIG debacle. The US Government can step in and fully nationalize AIG, 100%, kick out responsible management, declare AIG’s CDS contracts null and void and let holders sue the US government to regain value for what were in reality lottery gambles not loans to the real economy. They own 80% so the step is small to 100%. Doing that would end the global market in CDS and open the door for countless legal challenges. But AIG’s counterparties, as we begin to learn, were exactly the big Wall Street players like Goldman Sachs, Citigroup, even Deutsche Bank. They have gotten enough taxpayer bailouts to cover their risk in CDS. Let them recognize risk is the heart of banking, not the opposite.
Myron Scholes, the ‘father’ of financial derivatives, who won a Nobel Prize in economics in 1997 for inventing the stock options model that led to financial derivatives back in the 1970’s, has declared that derivatives and Credit Default Swaps have gotten so dangerously out of hand that authorities must ‘blow up’ the market.
Scholes says derivatives traded over the counter should be shut down completely. Speaking at York University Stern School of Business recently, he said the "solution is really to blow up or burn" the over-the-counter market and start over. He included derivatives on stocks, interest rate swaps and credit default swaps that should be then moved into regulated markets.
The idea is simple and not that radical. A US law banning OTC derivatives and moving them to regulated exchanges would end a colossal ‘shadow banking’ fraud. Banks would not lose much more than already, but the world financial system would get back to ‘normal.’ OTC derivatives are unregulated precisely to hide risk and enable fraud by the banks. It is past time to end that. There is where the US Treasury and other Governments must focus, not on meaningless ‘transparency’ calls or trading bonus ‘justice.’
F. William Engdahl is author of A Century of War: Anglo-American Oil Politics and the New World Order (Pluto Press) and Seeds of Destruction: The Hidden Agenda of Genetic Manipulation (www.globalresearch.ca) . His latest book, Full Spectrum Dominance: Totalitarian Democracy in the New World Order (Third Millennium Press is due in late April. He may be reached via his website,www.engdahl.oilgeopolitics.net.

The Real AIG Scandal. It's not the bonuses. It's that AIG's counterparties are getting paid back in full

By Eliot Spitzer

Global Research, March 18, 2009

slate.com

Everybody is rushing to condemn AIG's bonuses, but this simple scandal is obscuring the real disgrace at the insurance giant: Why are AIG's counterparties getting paid back in full, to the tune of tens of billions of taxpayer dollars?
For the answer to this question, we need to go back to the very first decision to bail out AIG, made, we are told, by then-Treasury Secretary Henry Paulson, then-New York Fed official Timothy Geithner, Goldman Sachs CEO Lloyd Blankfein, and Fed Chairman Ben Bernanke last fall. Post-Lehman's collapse, they feared a systemic failure could be triggered by AIG's inability to pay the counterparties to all the sophisticated instruments AIG had sold. And who were AIG's trading partners? No shock here: Goldman, Bank of America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche Bank, Barclays, and on it goes. So now we know for sure what we already surmised: The AIG bailout has been a way to hide an enormous second round of cash to the same group that had received TARP money already.
It all appears, once again, to be the same insiders protecting themselves against sharing the pain and risk of their own bad adventure. The payments to AIG's counterparties are justified with an appeal to the sanctity of contract. If AIG's contracts turned out to be shaky, the theory goes, then the whole edifice of the financial system would collapse.
But wait a moment, aren't we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes-income taxes to sales taxes-to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden. Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won't be laid off. Why can't Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion capital infusion, and aren't they sitting on more than $100 billion in cash? Haven't we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn't they have accepted a discount, and couldn't they have agreed to certain conditions before the AIG dollars-that is, our dollars-flowed?
The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation.
So here are several questions that should be answered, in public, under oath, to clear the air:
What was the precise conversation among Bernanke, Geithner, Paulson, and Blankfein that preceded the initial $80 billion grant?
Was it already known who the counterparties were and what the exposure was for each of the counterparties?
What did Goldman, and all the other counterparties, know about AIG's financial condition at the time they executed the swaps or other contracts? Had they done adequate due diligence to see whether they were buying real protection? And why shouldn't they bear a percentage of the risk of failure of their own counterparty?
What is the deeper relationship between Goldman and AIG? Didn't they almost merge a few years ago but did not because Goldman couldn't get its arms around the black box that is AIG? If that is true, why should Goldman get bailed out? After all, they should have known as well as anybody that a big part of AIG's business model was not to pay on insurance it had issued.
Why weren't the counterparties immediately and fully disclosed?
Failure to answer these questions will feed the populist rage that is metastasizing very quickly. And it will raise basic questions about the competence of those who are supposedly guiding this economic policy.

The Crisis Will Be Profound and Prolonged

By João Pedro Stedile

Global Research, March 18, 2009

The Bullet

It's been several months since the crisis of capitalism was unleashed on the international level, with its epicenter in financial capital and the U.S. economy. Now we have more evidence that this crisis will be profound and prolonged, affecting all the peripheral economies -- including Brazil.
Many analyses of the crisis have been published in academia and the media. There are all sorts of positions and ideological currents. But they all converge on this diagnosis: it is a profound crisis, worse than the crisis of 1929. It will affect the entire world economy, which has been increasingly internationalized and controlled by fewer than 500 companies. It will be worse, because it combines an economic crisis, a financial crisis (of the credibility of currencies), an environmental crisis, an ideological crisis due to the failure of neoliberalism, and a political crisis due to the lack of alternatives on the part of the dominant class at the center of capitalism or the governments of the periphery.
In the history of crises of capitalism, the dominant classes, owners of capital, and their governments have adopted the same prescription to exit them.
First, they need to destroy a part of (over-accumulated) capital (lacking demand) to make room for another process of accumulation. In recent months, over 4-trillion dollars in paper money have gone up in smoke.
Second, they call for wars. War is a way of destroying goods (weapons, munitions, materials, facilities) and getting rid of the social tension of workers. And it does so in such a way as to also eliminate the industrial reserve army. Thence the First and Second World Wars, and then the Cold War. Now, given the fear of atomic bombs, they stir up regional conflicts instead. The attacks on the Palestinian people by Israel, the provocations in India, and the threats against Iran all fit in this strategy as well. The strategy is to increase military spending and destroy goods.
Third, magnify the exploitation of workers. That is to say, in crises, lower the average wages, and bring down the living standards and thus the costs of the reproduction of the labour force, in order to restore the rates of surplus value and restart accumulation. Hence also the expansion of unemployment, which keeps multitudes surviving only on the basic baskets of goods, etc.
Fourth, a greater transfer of capital from the periphery to the center of the system. This is accomplished by the direct transfer from enterprises in the periphery to their headquarters, as well as through the manipulation of the dollar exchange rate, the payment of interests, and the manipulation of prices of goods sold and bought in the periphery.
Fifth, capital goes back to using the state as the manager of the savings of the population to shift these funds for the benefit of capital. For this purpose, capitalists again valorize the state, not as the caretaker of the interests of society, but as the steward of their interests, to use its compulsory powers and thus collect money from everyone, through taxes as well as savings deposited in the banks, in order to finance their way out of the crisis.
We are witnessing the application of these classic measures, reported in the press every day -- here in Brazil, in the center of capitalism, and in the rest of the world.
But, as with everything in life, there are always contradictions. For each action of capital, the government, etc., there will be its contradiction, which society and workers can recognize and exploit to change the situation.
The historic periods of crises are also periods of change. For better or worse, there will be changes! Crises create openings and rearrange the positioning of classes in society. In Brazil, we are still apathetic, amorphous, listless, watching the description of symptoms of the approaching crisis on television. There was hardly any reaction or feedback from nearly 800,000 workers who lost their jobs just in December 2008. Nor are there comments on the IPEA research showing that, of the 17-million poor families in Brazil in the general register of beneficiaries of government programs, 79% of them are unemployed! For they received some benefits, they are not seeking more jobs, and they are left out of even the statistics of unemployment.
It is vital for the organized sectors of society -- in all existing forms, whether in churches, trade unions, schools, colleges, universities, the press, social movements, or parties -- to do something about the crisis. The first thing to do is to debate the nature of the crisis and find ways out of the crisis, from the point of view of workers and the majority of society. It is urgent to encourage all manner of discussions in all arenas. Paraná Educational TV's initiative to promote this kind of public debate is welcome. But it is still insufficient. The crisis will be long and deep. We need to involve the largest possible number of militants, politically conscious men and women, to discuss the situation, so we can collectively build popular alternatives. Without mobilization and social struggles, there will be no way out for the people -- except for capital. •
João Pedro Stedile is a member of the national coordination of the MST and Via Campesina. The original article "A crise será profunda e prolongada. . ." appeared in the February 2009 issue of Caros Amigos, republished by the Agencia Latinoamericana de Información on 16 February 2009. Translation by Yoshie Furuhashi.