Wrath of McGrath Blog General GULF OIL SPILL: GHOST OF FREE MARKET REAGANOMICS COME FULL CIRCLE, or, How Bankers Insuring the Exxon Valdez Spill Gave Birth 20 Years Ago to the Toxic Investments that Continue to Poison Our Economic Life (and Symbolically, Our Ocean) Today.
GULF OIL SPILL: GHOST OF FREE MARKET REAGANOMICS COME FULL CIRCLE, or, How Bankers Insuring the Exxon Valdez Spill Gave Birth 20 Years Ago to the Toxic Investments that Continue to Poison Our Economic Life (and Symbolically, Our Ocean) Today.
Written by Jim McGrath Wednesday, 09 June 2010 19:10
OVER THE NEXT 20 YEARS, THESE "INNOVATIONS" WERE REPEATED OVER AND OVER WORLDWIDE AS BANKERS, BROKERS AND INSURERS -- MONKEY SEE, MONKEY DO - COPIED HOW TO PASS ON THEIR BAD INVESTMENTS AND RISKS AS CLEVERLY DISGUISED FRAUD TO THE ENTIRE WORLD.
While history does not repeat itself exactly, sometimes the Almighty allows a repetition of an event to illustrate where we have been and why we are there. As Jason Linkin details the hidden history of these ills in The Huffington Post, we clearly see how the Gulf Oil Spill, which is beginning to poison the entire Gulf, reminds and reveals how a similarly horrific incident, the Exxon Valdez spill, 20 years ago, helped create the current economic crisis (enabled by lack of effective regulation, which is itself also partly responsible for the Gulf spill) that we suffer today.
In 1989, faced with the need to finance the Valdez clean up and insure against it, but lacking any real collateral, the financial world cleverly created the initial fraudulent financial innovations which became the CDOs, derivatives, credit default swaps and like instruments that we have all come to know and hate. The creation of something out of nothing for the Exxon Spill was indeed a breakthrough. Not content to create a few mere billions in fraud for an environmental disaster, financial witch doctors throughout the industry developed them further -- morphing them into the bundled poor-investment grade and subprime mortgages passed on as prime assets, with toxic mortgages as "collateral" - and other innovations -- all under the guise of spreading risk (while enhancing the fees and bonuses for the sellers). Financial hocus-pocus grew as it became further complex -- dressed up in false ratings, computerized formulas, spreadsheets based on fancy, all designed to fix the outcome for large bonuses and fees, but to stick the purchasers with junk - - fraud pure and simple. As The Huffington Post article reveals:
"..Exxon managed to get the amount of punitive compensatory damages [for the oil spill] reduced from the hoped-for $5 billion to a paltry $500 million. But, back when Exxon had reason to imagine it might actually have to part with the $5 billion, the oil giant needed to find a way to cover its hindquarters. Exxon found a savior in the form of J.P. Morgan & Co., who extended the beleaguered company a line of credit in the amount of $4.8 billion.
Of course, that put J.P. Morgan on the hook for any potential judgment against Exxon. So the bank went looking for a way to mitigate that risk. Its solution made history, [as told by New Yorker's John Lancaster in a 2009 piece entitled "Outsmarted":]
In late 1994, Blythe Masters, a member of the J. P. Morgan swaps team, pitched the idea of selling the credit risk to the European Bank of Reconstruction and Development. So, if Exxon defaulted, the E.B.R.D. would be on the hook for it--and, in return for taking on the risk, would receive a fee from J. P. Morgan. Exxon would get its credit line, and J. P. Morgan would get to honor its client relationship but also to keep its credit lines intact for sexier activities. The deal was so new that it didn't even have a name: eventually, the one settled on was "credit-default swap."
So far, so good for J. P. Morgan. But the deal had been laborious and time-consuming, and the bank wouldn't be able to make real money out of credit-default swaps until the process became streamlined and industrialized. The invention that allowed all this to happen was securitization.
...What securitization did was bundle together a package of these loans, and then rely on safety in numbers and the law of averages: even if some loans did default, the others wouldn't, and would keep the stream of revenue going, thereby diffusing and minimizing the risk of default. So there would be two sources of revenue: one from the sale of the loans, and another from the steady flow of repayments. Then someone had the idea of dividing up the securities into different levels of risk--a technique called tranching--and selling them off accordingly, so that riskier tranches of debt would pay a higher rate of interest than safer ones. Bill Demchak, a "structured finance" star at J. P. Morgan, took the lead in creating bundles of credit-default swaps--insurance against default--and selling them to investors. The investors would get the streams of revenue, according to the risk-and-reward level they chose; the bank would get insurance against its loans, and fees for setting up the deal.
There was one final component to the J. P. Morgan team's invention. The team set up a kind of offshore shell company, called a Special Purpose Vehicle, to fulfill the role supplied by the European Bank for Reconstruction and Development in the first credit-default swap. The shell company would assume $9.7 billion of J. P. Morgan's risk (in this case, outstanding loans that the bank had made to some three hundred companies) and sell off that risk to investors, in the form of securities paying differing rates of interest. According to J. P. Morgan's calculations, the underlying loans were so safe that it needed to collect only seven hundred million dollars in order to cover the $9.7-billion debt. In 1997, the credit agency Moodys agreed, and a whole new era in banking dawned. J. P. Morgan had found a way to shift risk off its books while simultaneously generating income from that risk, and freeing up capital to lend elsewhere. It was magic. The only thing wrong with it was the name, BISTRO, for Broad Index Secured Trust Offering, which made the new rocket-science financial instrument sound like a place you went to for steak frites. The market came to prefer a different term: "synthetic collateralized debt obligations."
As Lancaster notes: "Inevitably, J. P. Morgan's innovation was taken up by more aggressive and less cautious banks." Oh, you don't say!
Mortgage-based versions of collateralized debt obligations were especially profitable. These C.D.O.s involved the techniques that the J. P. Morgan team had developed, but their underlying assets were pools of mortgages--many of them based on the most lucrative mortgages, the now notorious subprime loans, which paid higher than usual rates of interest. (These new instruments could be pretty exotic: some consisted of C.D.O.s of C.D.O.s, pools of pools of debt.) J. P. Morgan was wary of them, as it happens, because it didn't see how the risks were being engineered down to a safe level. But institutions like Citigroup, U.B.S., and Merrill Lynch plunged in."
THERE YOU HAVE IT, THE STORY OF THE BIRTH OF MASSIVE FRAUD THAT CAUSED THIS CURRENT MESS.
So, while it is hard to imagine that the Gulf spill has a silver lining as our wildlife, fish and waters are being destroyed, we can take solace in the fact that at least it sheds light on the consequences of having let big business do whatever it wishes for a generation. The poisoning our southeastern shoreline is being caused by the greedy desire to cut corners at all costs, enabled by the Reagan Revolution paradigm of no cops on the beat. The federal government's watchful eye consists of one regulator for the entire oil drilling industry. As the oil spreads across the marshes, wetlands, beaches and waters, so the poisonous results of greed, fraud, and financial crimes enabled by this brand of free market philosophy spread throughout our system: toxic assets kept off the books of giant banks claiming profits, which hoard government largesse that allows them to stay in business while contracting the credit supply necessary for small business and the rest of us to prosper. Taxpayers subsidizing these industries, allowing them billions in bonuses, all to continue the same and worse risky behavior that should have already brought them down except for government rescue; and lastly, a near Depression, in which many are waiting for the second phase to work its way and produce more economic pain. All while the top one percent, those corporate thieves that created these tricks, gain more and more income as the income of most American wage earner stagnates.
Need more be said about an economic philosophy disproven by The Great Depression 80 years ago, but revived by a feel-good politician, itching the public's ears by offering us some city on a hill, but instead giving us an illusory prosperity by undercutting American workers, sending our industries to foreign countries, and luring American wage earners to borrow ever more for increasingly tantalizingly complex and technological toys and consumer products, all in order to enrich corporate pockets while enslaving the people by indebting them to the banking and corporate system that grows by leaps and bounds?
IS IT ANY WONDER THE ONLY FIRM THAT MADE HANDSOME PROFITS THROUGH THE FINANCIAL CRISIS, GOLDMAN SACHS, PLAYED THE BIG SHORT-- WAS THE MAJOR BETTOR AGAINST ITS OWN INVESTMENTS MADE UP OF THIS FRADULENT JUNK?
WHEN WILL THE PEOPLE SAY ENOUGH IS ENOUGH, AND DEMAND THAT THIS ILL-GOTTEN GAIN BE CLAWED BACK AND BONUSES RETURNED? WHEN WILL THEY DEMAND THEIR BONUSES, DEMAND THAT THESE BANKS BE BROKEN UP AND DEMAND THAT THESE SHEISTERS PLAY BY THE RULES THEY INSIST OTHER PLAY BY AND SUFFER ECONOMIC PAIN FOR THEIR HUCKSTERISM DISGUISED AS TRUE INVESTING?
WE ARE WAITING. WHILE IT IS OBVIOUSLY ONE RESPONSE THAT WOULD RESOLVE, BY FINANCIAL RETRIBUTION, THIS ILL-GOTTEN GAIN ONCE AND FOR ALL, LET US HOPE A TRULY GREATER DEPRESSION IS NOT THE ONLY ANSWER.
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