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Michael Greenberger: Lack of capital for productive investment starving global economy

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. When I read the financial press these days, I don’t think I’ve ever seen so many people so freaked out, op-eds, articles, analysis all talking about the underlying fear of investors of not just what’s happening in Europe but of global recession, global meltdown. Fear seems to be the principal factor governing most of what I’m reading. So why are they so scared and why aren’t we hearing more about all of this in the mass media? Now joining us to talk about all of this is Michael Greenberger. Michael teaches at the University of Maryland School of Law. He was director of division trading in markets at the commodities and future trading exchange commission from ’97 to ’99, working with Brooksley Born. Thanks very much for joining us again, Michael.


JAY: So why are they so scared? How dangerous a moment is this?

GREENBERGER: Well, it’s a very dangerous moment. And I think we’re in a 50/50 proposition of whether we’re going to go over the cliff into a second steep recession or worse, or whether we can save the bacon, so to speak. Look, this problem all started by bets that were placed by big banks, big hedge funds, big private equity firms, wealthy investors in the 2006-2008 era. There were lots of problems that caused the 2008 meltdown, but the foremost one, if you read, for example, the Financial Crisis Inquiry Commission or you read Michael Lewis’s book The Big Short, was that wealthy investors decided they wanted to figure out how to bet that the subprime market–a market which essentially was built on the proposition that poor people could pay off mortgages when they were not in traditional terms creditworthy–a lot of very smart people said those people aren’t going to pay their mortgages off. How do I bet that they won’t and I win without dirtying my hands in this mortgage market? And smart investors–John Paulson, the Paulson fund, is the foremost one–decided that they would go to big investment banks and say to them, I want to play fantasy subprime mortgage. I don’t want to buy any of these mortgages, but I want to pick out mortgage investment vehicles that I am convinced will fail, because they’re built on the proposition that people without money will pay their mortgages. And just as I would go to a horse race and bet that a horse would win, people like Paulson wanted to go to the window and bet hundreds of billions of dollars that those who thought they were going to get paid off for lending money to subprime investors would not get paid. So they created bets that had fancy names designed to confuse the average taxpayer. The fancy name is a synthetic collateralized debt obligation. All that means was Paulson went to a bank like Goldman Sachs and said, find me a sucker who will agree that these subprime investments will be paid off, and I want to bet that they won’t. I don’t want to own them, just like in fantasy baseball you don’t own any baseball players, but when those investments collapse, I want to get money.

JAY: And Goldman gets a big fee for finding the sucker.

GREENBERGER: Well, Goldman not only gets a big fee for finding the suckers. There was an allegation that the SEC made in 2010 that Goldman actually defrauded the suckers into taking the opposite end of those bets. Be that as it may, there were a lot of people who were quite ill-informed and dazzled by concepts that housing prices would always go up, or highly negligent triple-A ratings given to junk investments in this market, and said, sure, I’ll bet this. Now, the interesting thing: it wasn’t just a bet; it was an insurance policy. People like Paulson paid, like, a 0.5 percent premium to bet against the failure of this market. If the insurance policy paid off, Paulson in effect got the entire windfall representing the failed investments even though he didn’t own it. But all he had invested was a fraction of the amount of money that he was insuring. And they were very ill considered. The poster child here is AIG, who made $400 billion of these bets, betting that the market would be held up, taking these bets in by people like Paulson. And then, when housing prices went down, when people lost jobs, when the mortgages didn’t get paid, the insurance was triggered, and essentially the Paulsons of this world were insuring others–people’s risk. It would be as if I was going to a very torn down area in city and wanted to get fire insurance on houses I did own, and then the houses disappeared, I collect the fire insurance. In the real insurance market you can’t do that. But this was a market that was deregulated by Congress. People like–institutions like AIG and Lehman made these bets. When the bets were called, they had no capital to pay them off. Why?

JAY: Right. So let’s jump forward to today, if we can. So they pass this bill, Dodd-Frank. It’s supposed to address this. It’s all put into the realm of writing–I don’t know; hundreds is it?–of regulations that–the regulations seem to be tied up by lobbyists. So is it fair to say the fundamental things that helped trigger all this have not been really addressed?

GREENBERGER: What–the Dodd-Frank resolution to this is you can’t have these bets that nobody sees. They have to be transparent. If they’re transparent and people can see them, the people who bet that the subprime market would survive against people like Paulson were akin to betting that a Little League team would beat the New York Yankees. If that’s a transparent transaction, CNBC, Fox Business news, economists, observers are going to say, that’s a crazy bet that’ll never get made. Secondly, Dodd-Frank requires that the bettors have a lot of capital, that for example if AIG bet $400 billion, they probably would’ve had $400 billion in capital set aside. They never would’ve done that. So Dodd-Frank interferes with this betting atmosphere. But the problem is the Republicans in Congress are defunding the agencies trying to promulgate these rules. Wall Street is putting millions and millions of dollars at work fighting the promulgation of these rules in the rulemaking process so corrections aren’t being made. In the meantime, when there was a capital shortfall by the AIGs, Lehman, Merrill Lynch, Goldmans in 2008, the American taxpayer made that up. And the thought was the American taxpayer put these banks back in the shape they need to be in. The problem is those banks are zombie banks. They don’t have enough capital–not just true of our banks, but the European banks who’ve lent money to Ireland, Greece, Portugal, Spain. So there is a shortage of capital present now to sustain all kinds of contractual commitments that have been made. The Greek governments got into the European Union using clever derivatives sold to them by Goldman Sachs that made it appear that their debt was one half of what it was. They get admitted to the European Union, and a decade later, voila, they have serious debt problems that were masked by financial phoniness. And that’s true of Greece, Ireland, and now it’s infecting Spain and other countries. This was all started by financial hooligans. We now discover these countries don’t have the monies to sustain themselves. We put them on austerity programs. Poor people get hurt. There are riots in the streets. And they’re really–what we have here is we blew a multi-trillion dollar hole in the world economy. Some of that was made up by taxpayers who were innocent bystanders in all this. But the fact is there wasn’t enough capital put to work, and we will likely have countries going into default, banks who have lent them money going into default, European banks going into default, and American banks, who have all these derivative ties to the European banks, having these problems as well. And then you get, on top of this, S&P, who, by the way, in 2006 was labeling these junk subprime investments AAA rated, now is playing around with the triple-A rating of the United States. The downgrade sent a shock through the world, and there is instability. There’s a great belief that the European Union has not developed a plan to avoid defaults of a large number of their countries, and if they default, the banks who’ve lent the money will default, and the US banks who are interconnected with the European banks will be in trouble too. And that’s why anybody who understands what’s happening thinks that there are severe shortages. There just isn’t enough money to go around. In the old remedy of printing money is being stopped, basically, by people saying no, no, you’re not going to print money, we’re going to make people give up all their social benefits. That’s causing instability of its own, and that’s why people are very nervous right now.

JAY: If the European banks and even some countries start to default, we’re into even perhaps as serious or more serious than the 1930s. What public policy do you think is urgently required? What should people be demanding?

GREENBERGER: Well, let me just say, first of all, by the way, there are now bets on whether these countries will fail by people who are not lending the monies–the countries any money. So these are the so-called naked short bets on Greece, Ireland. And the people who’ve issued those bets probably don’t have the capital to pay them off. So there–if there are defaults, those bets are going to get triggered. But in terms of policy right now, the economy needs to be stimulated. Progressives have allowed stimulus to become a dirty word. As we sit here today, there is a bipartisan agreement among reasonable minds that there needs to be short-term stimulus around the world putting people back to work doing jobs. There is serious deficit problems across the world. Those issues have to be dealt with in the long term. We need to have growth, number one, and then, in the long term, deal with our debt problems. Now, the other critical thing is the Republicans continuously tell us this is like a family, and when families get into debt, they have to do something about it; countries should do the same thing. What the Republicans are saying here is that the breadwinners in the family should not participate in saving the family from its financial crisis. That is to say, those who can afford to pay more to keep our country stabilized and to keep the Western world stabilized are not being asked and are being protected against paying their fair share. I think the American public is starting to get this, and I think there will be a consensus formed that millionaires and billionaires get benefits from this country, and if they don’t pay their taxes, a financial deluge is not only going to affect the poor and middle class, but will sweep up the wealthy and wealthy institutions as well. So we’ve got to–we have money available to fill these capital shortfalls, but the way the Republicans and conservatives want it now is: don’t make those who are benefiting most from society pay their fair share. And that is a critical, destabilizing problem.

JAY: I guess the problem is there’s too many of them believe apres moi la deluge–after me, let the deluge come. Right now that seems to be the prevailing psychology.

GREENBERGER: Yeah. But you’re starting to see Warren Buffett, for example, and a lot of other responsible, wealthy investors are beginning to understand that the deluge here is not going to overlook wealthy people. So I think we’re beginning to see that you can’t create a gated community around wealthy people and see everybody fall off the cliff. If there’s going to be falling off the cliff here, we’re all going to fall off the cliff.

JAY: If the course doesn’t change. And we’re looking at unemployment numbers significantly higher than what we’re seeing right now.

GREENBERGER: Well, yes. And, of course, as you know, the unemployment number is much higher than the official unemployment number when you take into account people who are working part-time, people who want to work but have given up work. Yes, if we don’t get these things straightened out, the capital shortages have meant that we are not growing our industries, we’re not manufacturing, we’re not inventing, we’re not doing medical discoveries. We’re–all we’ve relied on is paper that banks generate and the transaction costs they get off that. We have to have real job growth. The only way–I think there is a reasonable consensus nownot only of progressives but reasoned conservative economists and business people, that we need a short-term stimulus. We’ve got to throw money in, get people back to work, get the economy righted, and then go to work reducing the deficit. But we–what has been lost in the discussion is that we have lost the Western world’s commitment to job growth, industrial growth, manufacturing growth, and science growth. Nothing is being done to improve our standing in that regard. The only thing that is growing is banks generating paper that represent betting. And that is what our problem is right now.

JAY: Thanks very much for joining us, Michael. Thank you for joining us on The Real News Network.

End of Transcript

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Michael Greenberger

Michael Greenberger is a professor at theUniversity of Maryland School of Law, where he teaches a course entitled "Futures, Options and Derivatives."Professor Greenberger serves as the Technical Advisor to the United Nations Commission of Experts of the President of the UN General Assembly on Reforms of the International Monetary and Financial System.
He has recently been named to the International Energy Forum’s Independent Expert Group that provided recommendations for reducing energy price volatility to the IEF’s 12th Ministerial Meeting in March 2010. Professor Greenberger was a partner for more than 20 years in the Washington, D.C. law firm of Shea & Gardner, where he served as lead
litigation counsel before courts of law nationwide, including the United States Supreme Court.