False values and structural blackmail
James Crotty: The creation of speculative bubbles creates false values which leads to huge bonuses
PAUL JAY, SENIOR EDITOR, TRNN: Welcome back to The Real News Network. I’m Paul Jay in Washington, DC. Joining us from Amherst, Massachusetts, is Jim Crotty. He’s associated with the PERI institute there, and he teaches at the University of Massachusetts Amherst. Thanks for joining us again, Jim.
JAMES CROTTY, ECONOMICS PROFESSOR, UMASS AMHERST: Thank you.
JAY: So let me read you a quote from your own paper and then ask you to explain it:
TEXT ON SCREEN: There has been a substantial increase in the market share held by a small number of the largest firms in important financial markets in the last quarter century that has … enabled these firms to use substantial market power to increase revenue, profit and rainmaker bonuses. While speculative "false value" is the main source of money for bonuses, oligopoly-based market power is also a significant contributor to the money pool that feeds excessive rainmaker compensations.
JAY: So, Jim, first of all start with this idea: what is "false value"?
CROTTY: The income that is the source, ultimately, of the bonuses of the rainmakers and financial firms is the rising value of financial assets. So when the stock market’s going up and the value of mortgage-backed securities are going up, the value of complex, bizarre securities based on mortgages like collateralized debt obligations are going up, then every one’s making money. So while the asset values are rising, any securities that you have that you own, any of the mortgage-related securities that these institutions owned, their value is rising because there’s a speculative bubble: everyone’s becoming more optimistic; everyone is borrowing more money to buy assets; there’s no problems. And those variables that influence the value of these products for mortgage-backed securities—that would be interest rates—interest rates are low, housing prices are rising, there are no defaults, and so on and so forth. This is not permanent. This comes from the entire financial system being excessively optimistic based on temporary, debt-fueled, speculative moves. So the value that is created is short-run; it’ll go away as soon as the perfect conditions end. But this is the value which fuels the revenues of financial firms and fuels the pools that bonuses come from.
JAY: Everyone knows the bubble will burst. You just try to make as much money as you can before it bursts, and try to get out before it bursts, and let some other sucker pay for it.
CROTTY: Everybody tries to make as much money while it’s still there, which they do by borrowing more and speculating more. I mean, the financial institutions were responsible for the largest rise in borrowing over the past 20 or 25 years or so. In 1980, financial firm debt was about 20 percent of gross domestic product (the size of the economy), but it was 120 percent by 2007. So it’s not just that your riding the financial boom is—by riding the financial boom, you’re extending and creating an energizing the financial boom. And of course it has to come to an end at some point. But when it comes to an end, you don’t give the bonuses back. That’s the key thing: you don’t give it back.
JAY: Now talk about the importance of how these big Wall Street firms control so much market share. What’s the consequences of that?
CROTTY: The consequence of that is that they don’t compete with each other vigorously along all dimensions of financial market activity. So, for example, private-equity funds charge 2 percent of the value of the assets that they control and get 20 percent of the profits. The same thing is true for hedge funds. You know, they don’t undercut each other on these prices. Three or four commercial banks are the principal initiators of the syndicated loan market for large businesses, and therefore they don’t really compete with each other on prices. So the lack of competition means that the prices that they can charge are much higher than they would be if there was a genuinely competitive market. This then adds, in addition to all these speculative gains, which I refer to as "false values", which Adair Turner, who is the head of the Britain’s Financial Services Authority, called "illusory values"—they’re just bubbles in the boom. These two things together create the money pools that feed the bonus operation, until the bonus operation leads to disaster.
JAY: Now, they know this disaster is coming, so they must also plan for the disaster, and they have to plan at the political level because, in the final analysis, if their rescue is going to be government-bailout, they’d better make sure there’s somebody there that can accomplish it for them and to some extent get public opinion onside for it. So what is that in relationship to where Obama’s at? We know how much Obama was financed, his campaign, by Wall Street. How much planning goes into all of this?
CROTTY: It’s hard to make a judgment from the outside. I would suggest that it isn’t just that the Congress and the Treasury Department and the Fed and the administrations of recent decades have been stuffed and stocked with either people from Wall Street themselves, or people who believed that Wall Street needed to get what it wanted, or people who were getting so much money from Wall Street that they were prepared to believe this. It’s also true that when you let the financial institutions get as big as our financial institutions are—they’re enormous—that when they by their own profit-seeking and bonus-seeking activities bring themselves to the verge of complete financial collapse, the government really has no choice but to rescue them. It’s blackmail. It’s structural blackmail. If they don’t rescue them, then we could get a Great Depression. So they have to rescue them, so that they are structurally blackmailed into rescuing them, and they are seduced, convinced, paid, believed the economists, that in the bubble leading up to the need for a rescue, that the downturn isn’t going to come.
JAY: Well, in your paper (I mentioned this in the first segment of our interview; I’ll quote it again) you say this:
TEXT ON SCREEN: The Obama administration has shown no inclination to tighten the leash on financial firms or to reign [sic] in the bizarre bonus system.
JAY: So in the next segment of our interview, let’s talk about what should that leash look like, what’s on the table in terms of financial regulation, and if you were able to write it, what would you write. So please join us for the next segment of our interview with Jim Crotty.
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