Corporate America still doesn’t get it

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Let’s admit it. We saw it coming. I am talking about the recent financial crisis that hit us, which can only be described as an economic Tsunami. It is the worst economic debacle since the Great Depression of the 1930s. The U.S. economy is still wrestling with its effects. One tenth of the work force remains unemployed. Trillions of dollars of potential income have been lost; the lives of millions have been damaged, in some cases irreversibly, by mass unemployment. Millions more have seen their retirement savings wiped out. Perhaps millions of people will lose essential health care because of the combination of job losses and draconian cutbacks by cash-starved state governments. And as noted in the New York Times by Dr. Paul Krugman, Nobel Laureate in economics, this disaster was entirely self-inflicted.[1] This Tsunami was not brought about by nature or a spike in international oil price, but by dysfunctional nature of our own financial system.

These banking institutions were giving out loans to individuals that did not qualify for the loan amount and could not afford to pay back. Just consider a real case: a hotel employee in the New York City, whom I know very well, makes $20,000 per year in his job as a manager responsible for managing the breakfast booth. He bought a single unit home for $450,000. After paying down-payment on his house, he has to pay $3200 per month on home mortgage. His wife does not work. That is, he is the single bread-earner in the family. Still, his mortgage company had no problem in approving his application and granting the loan to buy that house in Queens, NY. It does not take a genius to see that the person should not have qualified for the loan. But like millions of such cases, his loan application was approved in 2007. Individual compensations in pay-raise and bonus in those lending institutes were based on big short-term profits tied to how much loan was approved and how fast, and not based on common sense, simple math to analyze justification of such loan amounts, let alone long-term projections. Credit risks associated with such mortgages in the housing sector were simply overlooked and ignored. Government regulatory agencies also failed to do their task in adjusting their regulatory practices to address financial markets of our time.

With such insane practices, it was only a question of time when the housing bubble would burst leading to the collapse of the real estate market, which would start the ripple effect in other sectors that are linked to it. And that is what happened in 2007-2009 with the collapse of the housing bubble: the values of securities tied to real estate pricing plummeted, which damaged financial institutions globally. People started questioning bank solvency and investors lost confidence that affected the global stock markets, where securities suffered large losses during late 2008 and early 2009. Eventually, to protect bank interest, credit availability for a borrower or investor declined. Economies worldwide slowed during this period as credit tightened and international trade declined. With declining sale of products like the consumer goods, companies laid off workers, who, in turn, could not buy new products. Individual consumers bought only what they could afford and required. Nice-to-have items were a luxury that few could afford.

What is unfortunate in this mess is that for a screw-up in the Wall Street a garment worker in Bangladesh can suffer. Almost everything is linked today because of the globalization of world economy. Thus, when an American potential buyer does not buy home, he/she does not require all the furniture and other amenities that come with it, which are produced in places like China and other developing or underdeveloped countries. So, when a factory closes in China or Bangladesh because of less order or demand, its employees face massive lay-offs. In the housing sector, with less foreign cheap labors required for construction jobs, construction companies in the host countries must now return migrant workers to their native countries. Bottom line: what happens to economy in prosperous countries does affect every Salimuddin and Kalimuddin in other parts of the world.

Timothy Geithner, the U.S. Secretary of the Treasury, placed significant blame for the freezing of credit markets on a "parallel" banking system, also called the shadow banking system.[2] These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls. Paul Krugman agrees with the diagnosis and says, "As the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that they were re-creating the kind of financial vulnerability that made the Great Depression possible–and they should have responded by extending regulations and the financial safety net to cover these new institutions."[3] But such regulations were missing not only with shadow banking system whose implosion caused the credit crisis but also with the derivatives market.

As early as 1997 Federal Reserves Bank Chairman Alan Greenspan (once recognized as a financial avatar of sort) had fought to keep the derivatives market unregulated. The Republican conservatives did not like government regulations. The Securities and Exchange Commission was made a laughing-stock! American investor, businessman and philanthropist Warren Buffett famously referred to derivatives as "financial weapons of mass destruction (WMD)" in early 2003. It goes without saying that if George W. Bush had shown a small fraction of doggedness to the "financial WMD" that he showed for the non-existing Iraqi WMDs, we would have been spared of this current financial crisis.

Over the years too many things have gone wrong with America. She became more conservative which in turn strengthened the Republican power base that spearheaded the deregulation movement. The financial institutions by and large became deregulated becoming more powerful than the government. As a result, those working in the finance sector became the greatest beneficiaries of this faulty arrangement. Two years ago, I was simply shocked to learn that a 25-year old employee, fresh out of a graduate school with a master’s degree, of a (now failed) financial institute in the Wall Street was making more than $150,000 a year. A full professor (with a Ph.D. degree) in most state universities does not even make half that salary until after a decade of teaching. A government attorney makes $140,000 a year on retirement. As rightly noted in his Op/Ed column, dated 15 January, 2010, by Dr. Krugman, "From the late 1970s on, the American financial system, freed by deregulation and a political climate in which greed was presumed to be good, spun ever further out of control. There were ever-greater rewards –” bonuses beyond the dreams of avarice –” for bankers who could generate big short-term profits. And the way to raise those profits was to pile up ever more debt, both by pushing loans on the public and by taking on ever-higher leverage within the financial industry. Sooner or later, this runaway system was bound to crash."[4]

As we became more socially conservative as a nation, we elected folks that sounded more religious. Fox TV started replacing our favorite channels at home for information, and so did Rush Limbaugh, Sean Hannity and other radio talk show hosts that replaced the NPR when we’re on the road. We let the neoconservatives with their twisted ideology and ignoble agenda to decide our foreign policy. We let the industrial military complex to raise its almighty Pharaonic head and dictate our defense policy. We became an empire without an emperor. Sure, we have democracy, an elected president, the Senate and the House of Representatives. But more and more our elected folks in the Capitol Hill behaved as if their life depended on powerful lobbies whose interests and goals were at odds with our priorities –” domestic and international alike. They behaved like an Amen Corner, mortgaged to the whims and wishes of a savage, expansionist, settler regime that is run by war criminals in Tel Aviv and Jerusalem. We opted for war, instead of sitting across a negotiation table. We even fought proxy wars on behalf of the settler regime. As the wars dragged on, and terrorism was brought into our own backyard, our ego and pride was hurt, and we felt insecure at home.[5] We wanted revenge. Tons and tons of blood. Thanks to Bush and Cheney, we got dragged into vicious cycle of war abroad without doing cost-benefit analysis. So, now we have our armed forces in harm’s way where they can’t win, no matter how many forces we deploy. It is costing us now one million dollar a soldier deployed overseas. The current cost to station 68,000 U.S. troops in Afghanistan is just over $68 billion. We spent billions of dollars in upgrading airport security systems, and yet, our machines can’t stop an amateur would-be bomber from getting into our planes. Worse still, we have been robbed of our memory; we refuse to remember. We blame Obama for the evils of Bush, who trashed the U.S. constitution and international laws.

On the home front, our appetite for things bigger and expensive grew exponentially. People got used to living in larger houses with more expensive amenities. Many Americans even bought the gas-guzzling Hummer. Easy credit made all those possible. In 1981, U.S. private debt was 123% of GDP; however, by the third quarter of 2008, it was 290%. It was no accident that in 2007, top five financial institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007. As a result, Lehman Brothers was liquidated, Bear Stearns and Merrill Lynch were sold at basement-sale prices, and Goldman Sachs and Morgan Stanley became commercial banks, subjecting themselves to more stringent regulation. With the exception of Lehman, these companies required or received government support. Fannie Mae and Freddie Mac, two U.S. Government-sponsored enterprises, owned or guaranteed nearly $5 trillion in mortgage obligations at the time they were placed into conservatorship by the U.S. government in September 2008. These seven entities were highly leveraged and had $9 trillion in debt or guarantee obligations, an enormous concentration of risk. And, yet they were not subject to the same regulation as depository banks.

The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007 to 2010 with roughly two thirds from loans and the remainder on securities. The IMF estimated that in the last three years, the three major banks – Citigroup, Wachovia and Bank of America lost $124, 77.4 and 68.3 billion, respectively. [6]

September of 2008 was a panicky, defining moment in this crisis when in just one week people withdrew $144.5 billion from money market accounts versus $7.1 billion the week prior to it. In a dramatic meeting on September 18, 2008 Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke met with key legislators to propose a $700 billion emergency bailout. Bernanke reportedly told them: "If we don’t do this, we may not have an economy on Monday." [7] But that was not enough to arrest the downward slide of economy. Between June 2007 and November 2008, Americans lost an estimated average of more than a quarter of their collective net worth. By early November 2008, the S&P 500, a broad U.S. stock index, was down 45 percent from its 2007 high. To offset this decline in consumption and lending capacity, the U.S. government and U.S. Federal Reserve have committed $13.9 trillion, of which $6.8 trillion has been invested or spent, as of June 2009. In effect, the Fed has gone from being the "lender of last resort" to the "lender of only resort." [8]

Even today, after all those government bailouts of the financial institutions the Wall Street and the CEOs in the corporate America simply don’t get it. In a sickening display of brazenness and damn-care attitude they are rewarding themselves with tens of billions of dollars this year as year-end bonuses. Goldman Sachs is expected to pay nearly $20.2 billion as employee compensation for 2009, matching the 2007 record. In one recently-bailed out financial institute the average bonus paid to its employees is reported to be more than $600,000. Forget about most Americans, even President Obama does not make that kind of salary from his job in the White House. Ordinary Americans are furious and so is Obama. He decided to impose a fee (Financial Crisis Responsibility Fee) on the country’s largest banks, insurance companies and broker-dealers to recover some of the money spent bailing them out. He said, "My commitment is to recover every single dime the American people are owed. And my determination to achieve this goal is only heightened when I see reports of massive profits and obscene bonuses at some of the very firms who owe their continued existence to the American people…We want our money back, and we’re going to get it." He also said, "If these companies are in good enough shape to afford massive bonuses, they are surely in good enough shape to afford paying back every penny to taxpayers."

As expected, the banking industry — among the most powerful lobbies in Washington — is already launching attacks to stop Congress from enacting the proposal. It has the conservatives, the Republicans, to now lobby on its behalf. The Republican lawmakers –” the very people that had brought this financial crisis upon America before Obama took office – are now showing the early signs of Alzheimer! Forgotten, rather conveniently, are the Bush-Cheyney days. Blame it all on the new chief and his party!

But American people had enough of those greedy bad guys of the Wall Street and Amen Corner playing with their jobs and lifesavings. Some of the financial institutes are aware of the negative public mood, and are, therefore, taking more cautious steps. To quell public furies, some are conditioning payouts to future performance criteria, which will bring some stability of the banking system –” where pay has typically been linked to encourage high-risk, fast-reward schemes that paid bankers handsomely, regardless of the long-term performance of their investments. Still, many lawmakers in the Capitol Hill are justifiably upset, where the House Democrats on January 14 proposed imposing a 50 percent windfall tax on bankers’ bonuses. Even such measures may not be enough to satisfy taxpayers. As suggested in a recent New York Times editorial, Congress should pass a one-off windfall tax on bonuses. Surely, banks could not have made profits in 2009 had it not been largely underwritten by taxpayers, who pumped in billions of dollars of capital, covered losses from the collapse of the American International Group and guaranteed the debts of Fannie Mae and Freddie Mac. The Federal Reserve lent hundreds of billions against shoddy collateral that no one else would touch and the Federal Deposit Insurance Corporation guaranteed loans worth hundreds of billions more. For the sake of long-term financial stability, Congress should also pass President Obama’s proposed big bank fee –” intended to recover, over 12 years, the $117 billion that the administration estimates it will spend on financial bailouts. That should discourage banks that are already too big from getting even bigger and posing a larger threat to the overall economy. [9] Last month, the House passed the financial-reform bill, which allows for putting some regulation back into the finance sector. The government must now ensure that the financial institutes are closely monitored and fined heavily for any misstep.

And yet, all these measures may not be enough to energize the weak economy and reinvigorate consumer confidence. What frustrates most Americans is that bankers, as is evident from their recent testimony at the official Financial Crisis Inquiry Commission, showed a stunning failure, even now, to grasp the nature and extent of the current crisis. They have no clues as to what can help the economy either.

The interest of most Americans would be better served by ignoring any advice coming from these supposed wise men of the Wall Street, who have no wisdom to offer. They are greedy fools!

Notes:

[1]. http://tinyurl.com/ylxgpye

[2]. Reducing Systemic Risk in a Dynamic Financial System, Federal Reserve Bank of New York, June 9, 2008,

[3]. Krugman, Paul (2009). The Return of Depression Economics and the Crisis of 2008. W.W. Norton Company Limited.

[4]. http://tinyurl.com/ylxgpye

[5]. See this author’s book: "Democracy, Politics and Terrorism – America’s Quest for Security in the Age of Insecurity" for a detailed exposition of the subject of terrorism, Amazon.com;

[6]. http://tinyurl.com/yzwzlh3

[7]. http://tinyurl.com/yg38q4k

[8]. http://tinyurl.com/ygqp5u7

[9]. http://tinyurl.com/ykmnqlt

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