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Jane D'Arista is a research associate with the Political Economy Research Institute (PERI), University of Massachusetts, Amherst where she also co-founded an Economists' Committee for Financial Reform called SAFER (Stable, Accountable, Efficient & Fair Reform) and gave testimony to Congress on financial reform. Jane served as a staff economist for the Banking and Commerce Committees of the U.S. House of Representatives, as a principal analyst in the international division of the Congressional Budget Office. Representing Americans for Financial Reform, Jane has currently given Congressional testimony at financial services hearings. Jane has lectured at the Boston University School of Law, the University of Massachusetts at Amherst, the University of Utah and the New School University and writes and lectures internationally. Her publications include The Evolution of U.S. Finance, a two-volume history of U.S. monetary policy and financial regulation.
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay. And today we're in Hadlyme, Connecticut, with Jane D'Arista. Thanks for joining us, Jane.JANE D'ARISTA, AUTHOR, THE EVOLUTION OF US FINANCE: Thank you for having me.JAY: So Jane is the author of The Evolution of US Finance. And volume one, for those of you that aresome of you I know are preoccupied with thisis the history of the Fed. And this entire book is about the whole development of US finance. And US finance, Jane, is one of the things that has gotten us into the trouble we're in, although we're in a weird moment of a recession. We're told we're in a beginnings of a recovery. Stock market's up, bank stocks are up, bank bonuses are way up, and so is unemployment way up. So first let's start with how did we get into this crisis, which seems to be deepening for most ordinary people?D'ARISTA: It is deepening for most ordinary people, as you say, because of unemployment. But it's not over by any means. Many of us believe that the same things that brought us to this place last year are now building up to give us a second piece of the storm, and that is the speculative activities of our financial sector, which are ongoing. And they involve proprietary trading, leverage, and the funding operations that make it possible to make an enormous amount of money and to inflate the balance sheets of these institutions. What we're seeing now in 2005 through 2007, many of these institutions almost doubled in size globally. Even England points out that at that time the balance sheets of its banks grew by three times.JAY: So give us some examples. What is proprietary trading? And how did it help get us where we are?D'ARISTA: Proprietary trading is when an institution trades for its own account, not for its customers.JAY: So, just so a place like Goldman, normally a pension fund would come, and they say, "Here's $1 billion. Go and make some money for us." So instead of that they're doing what?D'ARISTA: They are buying assets on credit for their own account in order to increase their profits so they can pay those huge bonuses. So proprietary trading does nothing for the customer and it does nothing for the economy. This is just an inside game, a speculative game.JAY: So their answer is, "Well, I'm Goldman Sachs. We're here to make money for people that own Goldman Sachs." So what's wrong with this?D'ARISTA: Well, it gets them into trouble, because in order to make that kind of money, they have to borrow a huge amount of money (that's called "leverage") in relation to their capital. And what we know about that in terms of ten years ago, 'cause we have the data or the information now, Long-Term Capital Management was borrowing almost $100 for every $1 of their own money, their capital.JAY: So give us an example of what one of these kind of trades would look like. D'ARISTA: Well, the very large amount of proprietary trading that was going on 10 years ago, and going on now somewhat differently, is you borrow a low-interest-rate currency somewhere in the world. You buy a currency that has a higher interest rate, and invest in the assets of that higher-interest-rate country.JAY: So you look around for an economy that's in recession that's trying to attract capital, so they have really low interest rates on borrowing money. You turn around and bring it here.D'ARISTA: That's exactly right. In the process, of course, you depress the currency of the country that you borrowed in and you raise the value when you buy another currency (always raises its value). And so then you're getting two things: you're getting a difference in interest rates that is a profit, and a difference in exchange rates that also gives you profit.JAY: Now, you off-camera gave me the example, for example, you might borrow yen at one point and come here and buy T-bills that are paying three or four point.D'ARISTA: That's exactly right. And so you've got a nice spread there. And you've done this, say, three months, and then you get out of the position and you take your money. And then you do it again.JAY: For two or three points to be meaningful, you've got to have a lot of money in play.D'ARISTA: Exactly. So where are you going to get that money? You're going to get it from other financial institutions. In other words, what we had was financial institutions borrowing from one another, borrowing in London, New York, Singapore, wherever, and using this money to speculate. I'm not just the only one who says "speculation." The International Monetary Fund at a given point said the global market has become a casino. These are people who were watching it very closely, and they were absolutely right. So the borrowing-from-one-another part of this game means that you have counterparty problems. You have this web of interconnections within the financial sector: "I owe you money; you owe me money. I don't know how much I owe you; I don't know how much you owe me. And we can't quite figure the whole thing out. It's somewhere on the books." But it's a chain that can unravel. So you have two things going on with proprietary trading: you're blowing up the balance sheets of these institutions on the one hand; on the other hand, you're creating this web of counterparty connections. Anything that disturbs the system, that leads to a lack of confidence'cause all of this is not transparent, nobody knows how much anybody's leveraged or how many counterparties they have, etceterastops the system. It's like the music stops and there's a couple of missing chairs there.JAY: So it's the Ponzi scheme, essentially.D'ARISTA: It is.JAY: It's a confidence game.D'ARISTA: It is.JAY: As long as all the players have confidence, the game will keep going. We can keep playing. And there's so much money, who cares? And at some point, oh-oh, maybe someone's onto this.D'ARISTA: Exactly. So when they lost confidence in themselves, what we had was a run on the financial sector by the financial sector, and it all stopped. It wasn't us running to the bank and taking our money out as it was the Depression. This was a new kind of phenomenon that they were engaged in.JAY: So, essentially, Goldman, or an institution like that, they know how artificial their books are, and if they've loaned money over here to one of the other financial institutions, everybody knows they're playing a confidence game. So at some point they all have to stop because the whole thing has no real underlying value.D'ARISTA: Right. And at the same time what is going on here is that when they do stop and I owe you money, okay, you say to me, "You've given me these assets as margin accounts for the money that you owe me. Well, I think that you need to give me more margin, you need to give me some more assets." If I do that, then I have to take a charge against my capital. In other words, I have to say my whole book is not worth what it was, so this amount has to come out of my capital to balance my books. Having done that, of course, I have less capital and I'm on my way to insolvency. At the level at which they were gambling, insolvency spectacularly fast was upon them, and that was what terrified everybody and which led to all the activity that went on in 2008.JAY: Now, one of the pieces of this, 'cause one of the biggest pieces of what they were bundling and selling and using as supposedly an asset were all the subprime mortgages, especially in California and Florida. And, as we know from this series we just published recently from McClatchy, that one of the ideas was, well, real estate can never go down in Florida and California. So at some point they realized this thing is unraveling, that people just can't keep buying and borrowing when they don't have any real wages and real income.D'ARISTA: Absolutely right. I mean, the reality of what was going on with the household sectorno wage increases, increases in debt. Debt as a whole phenomenon in the United States had gone absolutely past the red bars or whatever warning signs should be there. The household sector had gone from something like 64 percent of GDP in its borrowingand that was high, historically high, in 1997up over 100 percent in 2007. The same had happened to the financial sector: they were up from 64 percent, also, to 114 percent. That was the leverage, that was this enormous putting on of assets that was going on. And all of this, to step back apiece, was because of the role of the dollar. The dollar was the key currency. Money was flowing into the United States from around the world because it was the safe haven, it was where the assets were, and the central banks were putting their surplus earnings on what they sold us into Treasury bills. So you had enormous liquidity, I mean, just in an immense amount of money, and the financial sector was adding to that because they were, as economists would say, monetizing debt. In other words, every time they went through this proprietary trading game and pledged assets, they used existing assets as margin to borrow, to buy more assets and put them on the balance sheet. So now you're just stacking up the balance sheet.JAY: With essentially phony evaluation of assets.D'ARISTA: Right. The subprime problem was exacerbated by the fact that a given pool of mortgages could have some very good mortgages in it and subprime, and nobody knew what was in there, how much was good and how much.JAY: Or cared.D'ARISTA: At the time, they didn't think about it.JAY: I mean, we saw in the McClatchy series that in the 1990s this New Century Real Estate that was one of the ones accumulating a lot of mortgages and then packaging and selling them to Goldman. In the 1990s, 100 percent of these mortgages were being reviewed to see if people could actually pay. By 2006, 10 percent of the mortgages are being reviewed. But they didn't even care.D'ARISTA: That's right. And so what you have is, back in 1984, a piece of legislation that allowed this to happen.JAY: Okay. Next segment of our interview, let's talk about that. Like, we all thought, us ordinary citizens, there's some regulations about all of this. How could the banks go wild? And so let's talk about how that happened. Please join us for the next segment of our interview, "Banks Going Wild," with Jane D'Arista.
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