What’s Wrong with the World

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Plutocracy and the crisis of usury.


Two recent reports in The Wall Street Journal really put flesh on the bones of my argument about what has become of the real estate and finance sectors of the American economy since this crisis of usury began. One might almost fancy these articles were written uniquely for me, so neatly do they support my contentions. (Though, as I’ll try to note throughout this post, not always so neatly.)

To summarize, my argument is that the pattern of real estate development in America has been driven for two decades or more by a very peculiar system of finance; one which depends mostly on various instruments of speculative debt, and one which, it turns out, can only be maintained, in a pinch, by intervention from the state.

Put another way, the dislocations and shocks of the past year or so have produced some striking revelations and as well as some transformations. One of the former is the revelation that this sort of speculative real estate development cannot be sustained; and one of the latter is the decision by policymakers to substitute for the private capital that once financed real estate development, the public capital of the commonwealth.

The real estate market has been socialized to such an extent that talking about a free market in it is errant silliness.

Those bald and polemical summaries set down, I will proceed to lay out in brief the evidence provided by the two recent lengthy reports from the Journal (which I encourage the reader to carefully read in full), and then add some sketchy notes of my own at the end. That I am approaching all this finance talk from the view of the simplest layman should be plain to anyone who really knows this stuff.

“The biggest spur to deal-making among banks,” begins the report by Damian Paletta in yesterday’s paper: “isn't private-equity cash or foreign investors. It is the federal government.”

In this report the Federal Deposit Insurance Corporation is the focus. “Through more than 50 deals known as ‘loss shares,’ the FDIC has agreed to absorb losses on the detritus of the financial crisis — from loans on two log cabins in the woods of northwestern Illinois to hundreds of millions of dollars in busted condominium loans in Florida.”

The report continues: This sort of deal, which puts the FDIC on the hook for the majority of the worst loans but keeps the bank from which they originate still alive, “is largely a response to the number of bank failures of the past 18 months, which has stretched the FDIC's financial and logistical resources.” The agency is short on cash. But nevermind that. When you have a huge credit-line with the folks who monopolize the printing press, “short of funds” isn’t as much of a problem as it seems.

And, to be fair, not all of these rescue exposures by federal authorities have been losses. “On a range of rescue programs run by the Federal Reserve, such as loans to investment banks and purchases of mortgage-backed securities, the Fed earned $16.4 billion through the first six months of 2009.” The FDIC made a cool $7 billion on fees alone — fees associated with “guaranteed debt issued by banks.” (That last may be a reference to the astonishing program where Goldman Sachs and General Electric were allowed to issue corporate debt with the FDIC’s backing. The common conjecture has it that regulators, reasoning that the commercial paper market absolutely had to supported, settled on the novel artifice of granting its major players the ability to raise capital at risk-free rates.)

Two examples of these loss-share agreements:

On Aug. 14, Alabama's Colonial Bank collapsed, felled by bad commercial-real-estate lending. The FDIC, assuming its traditional role, brokered a sale of the bank's deposits to BB&T Corp., ensuring that customers wouldn't see any interruption. It also agreed to help BB&T buy a $15 billion portfolio of Colonial's loans and other assets by agreeing to absorb more than 80% of future losses. Under the deal, the most BB&T can lose is $500 million, the bank says, and that is only in the unlikely event that the entire portfolio becomes worthless. The FDIC is on the hook to cover the rest.

In June, Wilshire State Bank, a division of Wilshire Bancorp Inc. in Los Angeles, agreed to buy $362 million in deposits and $449 million of assets from failed Mirae Bank, also of Los Angeles. The FDIC agreed to assume most future losses on roughly $341 million of those assets, largely commercial real estate and construction loans in Southern California.

“After we understood how [the loss-share] works, we were literally overjoyed,” says one banker; meanwhile, an FDIC official is quoted with similar enthusiasm: “It’s a great opportunity for banks. It's a great opportunity for us.” A banker who specializes in distressed assets puts the matter succinctly: “From a turnaround guy's perspective, I've never had this kind of downside protection.” He is protected on the downside by the government.

What sorts of assets are being protected against loss? “Typical assets include loans on commercial real-estate developments, condominiums and single-family homes.”

Now, it is worth recalling that the FDIC is funded in part by subscription fees from the banks themselves. The agency dates from the Great Depression and is pretty highly-regarded in what it does, especially from the perspective of individual depositors whose accounts switch banks over a weekend with no change or loss. That subscription-based fund is what is sorely depleted; but behind that is a $500 billion line of credit from the Treasury.

What’s going on with a great mass of these toxic assets is that they are deflating. These are properties with mortgages in default, or with mortgages massively larger than their value. The environment is deflationary: debt is gaining value even as the properties which were purchased with that debt are losing value. Moreover, the welter of innovations in finance — what Bloomberg News called the biggest American export of the 21st century — which made possible the investment of capital from around the world into US real estate, were almost exclusively debt securities: bond-like instruments attached to bundles of mortgages, or derivatives sold as insurance on mortgage bonds.

In a word, what’s going on is that government agencies are absorbing the loss (or at least a great portion of the loss) of speculative over-development in American real estate.

The second Wall Street Journal report gives the reader a glimpse of the plutocracy at work. It begins with a stark summary: “The U.S. recovery is a tale of two economies. At one extreme of Corporate America is a cadre of companies and banks, mostly big, united by an enviable access to credit. At the other end are firms, chiefly small, with slumping sales that can't borrow or are facing stiff terms to do so.”

A big corporation has direct access to capital markets: it can issue debt or stock to investors. If it’s really big and important, it might even be able to issue government-backed debt. Or perhaps it can sell its “detritus” directly to the Federal Reserve, the Treasury, the British Treasury, or some other governmental agency engaged in quantitative easing. In any case, if you are big, you have options.

If you are small, however, you are probably dependent on bank credit, which is hard to come by these days and very expensive when found. A Duke Professor explains the plight of the smaller firm, using a grim syllogism: “If you're not making money, you need to borrow money; [but] you need to be creditworthy in order to borrow, and if you're not making money, you're creditworthiness isn't very strong.”

Then the Journal shows us the plutocracy.

Some of the nation's largest banks could, in fact, emerge from the crisis stronger than they entered it. While they have suffered huge losses on complex financial products, and are still facing mounting loan defaults, they were stabilized with tens of billions of dollars of taxpayer money. In the second quarter, the seven largest commercial banks earned more than $14 billion, even as thousands of smaller banks were in the red.

Big lenders are currently enjoying an advantage in their “cost of funds” — the raw material of a bank, which is in the business of borrowing cheaply and lending at a higher rate. The handful of banks with more than $10 billion in assets were paying 1.18% to borrow money in the second quarter, the FDIC said in data issued Thursday. By contrast, banks with $100 million and $1 billion in assets were paying 1.97%, a big difference in a business where tenths of a percentage point translates into millions of dollars in profits.

Usually it is the other way around — small banks pay less. But large banks have always obtained a much larger share of their funding from sources other than deposits, such as borrowing short-term from other banks at the federal funds rate, which is largely set by the Federal Reserve. With the Fed holding that rate near zero, large banks are benefiting more than smaller banks.

Some big banks, like J.P. Morgan Chase & Co., U.S. Bancorp, PNC Financial Services Group Inc. and BB&T Corp., have cemented their megabank status by gobbling up rivals that were seized by regulators. As of June 30 the three largest banks — Bank of America, Wells Fargo, and J.P.Morgan — collectively had $2.3 trillion in domestic deposits, or 31% of the industry total, according to the Federal Deposit Insurance Corp. Two years earlier, the top three had only 20% of the industry total.

Now if those four paragraphs don’t leave you seething, it is to be wondered at whether you are capable of outrage at all. The first instinct of any self-respecting man with even a modicum of sympathy for the free enterprise system, upon reading that litany, is to cry out “It is not Capitalism if failed enterprises can never fail!” These are the banks that failed. They gambled and they lost their shirts. According to market discipline, they should have been roughed up and thrown out the casino on their ears. Instead, they prosper; and the less reckless perish.

And what sort of system is it where failed enterprises prosper? What sort of system is it where the fact of the eventual rescue was baked into the cake of expectation? What sort of system is this, where the small entrepreneur is forbidden access to capital, even as his taxes are surely to rise; and the big corporation is rescued and then coddled? “Too big to fail” looks more and more like the doctrine of a plutocracy.

It is probably simply a facet of man’s fallen nature that commercial republics are uniquely vulnerable to the corruption of plutocracy. The natural decay of a commercial republic, we might almost say, is into an aristocracy of wealth, a plutocracy. Plutocratic elements as always present in republics; and have certainly long been present in America. The whole system known as lobbying, which has exploded into greater size and importance with every intervention into the economy by the state, is itself plutocratic through and through. A senator leaves office, only to be hired to the lobby the very committee he once chaired. Men shift employment from interested industry to presiding committee with astonishing facility. We’ve all seen it. And it is easy to forget (or dear liberals forget it constantly) that lobbying only became important in conjunction with the meddling of the government in the private sphere. What point would there be to lobby the Legislature if it had no influence on your business?

So of course plutocracy can come as easily from state intervention and capture of the market, as it can from the simple capture of government by commercial interests.

In the instance of American real estate, it is hard to say for sure who was the controlling mind behind it, the state or the commercial interest; but in any case we arrived at plutocracy.

And a great many have raged impotently against it ever since the crisis of 2008 brought it to our attention is a really shocking way.

Alas, it is idle to rage at the rescue of the plutocracy without understanding why there was need for a rescue. We might all agree that plutocracy is a miserably inferior form of government when compared to the proud republican traditions that is ours; we might all agree that it is a degradation and a surrender (though we should never be so reckless as to suppose that there are not still worse forms of government than plutocracy); we might all yearn to give our representatives a piece of our mind about the plutocracy.

Granted all this, this manly and justified outrage, still it is idle to rage against the plutocracy’s rescue in 2008 without inquiring as to why there was need for a rescue.

There was need for a rescue because much of the real estate development in America of the past quarter of a century was facilitated and encouraged by a massive structure of financial chicanery by which risk was made to magically disappear off the balance sheets of the world’s finance banks. But no magic can actually remove the risk; and off at the end it was the governments of the world that had to absorb the risk. It was the taxpayers who staked their plutocracy its rescue.

That is the heart of the usury crisis. It was usury that proved too big to fail. It was usury that had to be rescued, because so much wealth was tied up in it. It is usury that, by its failure, has given such power to the plutocracy.

So the first task before us, as I see it, is to understand what has happened. And I submit that one thing we need to understand from what happened, is that real estate development in American can never again, until circumstances change dramatically, be supposed to be characterized as a free market. It would be better to think of it as a government program.

Comments (9)

Seriously? Lehman is gone. Countrywide is gone. Indymac is gone. Wachovia is essentially gone. Merrill is gone. How are enterprises not being allowed to fail? BB&T and JP Morgan and Wells Fargo flat-out managed their assets better than the banks they're buying.

Joe, most of these were absorbed into the remaining ones. The question is, what happened to their stockholders? Are the stockholders left with useless pieces of paper, or have they been converted? I don't know the answer, because the stories I've read about this have been totally unclear about the process.

Paul, good post. If we can correct the financial world, it will go a long way toward needed reform. Do you think that there is a way to make corrections without getting to rock-bottom first, and then revolution?

I do not think serviceable reforms are beyond our power. What we need is prudence and wisdom.

I believe that Barclays now has Lehman's NYC operations, and received TARP funds as a counterparty to the AIG detonation, which came hard on the heels of Lehman's bankruptcy. Bank of America owns Countrywide. US Treasury has a big stake in BoA. Etc.

This difficulty in discerning where government ends and private banking enterprise begins is right at the heart of my argument above.

That's certainly a valid point.

Seriously? Lehman is gone. Countrywide is gone. Indymac is gone. Wachovia is essentially gone. Merrill is gone. How are enterprises not being allowed to fail? BB&T and JP Morgan and Wells Fargo flat-out managed their assets better than the banks they're buying.
Joe, there was this thing called the Troubled Asset Relief Program and related measures such as mark-to-fantasy accounting that prevented the failure of those "good" banks you are citing... The government did let a few businesses fail and others sort of fail. But not the worst ones, just the earliest ones, before they realized that too many failures would bring down the house of cards entirely. By the way, those troubled assets were never actually bought and are still on the books, just not being marked to market as they had been prior to our little emergency where "inconvenient" accounting rules go bye bye.

The Washington Post has a similar article on the increasing concentration of money in the largest banks:

A year after the near-collapse of the financial system last September, the federal response has redefined how Americans get mortgages, student loans and other kinds of credit and has made a national spectacle of executive pay. But no consequence of the crisis alarms top regulators more than having banks that were already too big to fail grow even larger and more interconnected.
It's too bad the regulators aren't smart or good enough to be able to do their jobs adequately. Everyone with that kind of expertise in modern society is... working for the Big Banks and getting rich off of the upside of banking while the taxpayer is exposed to the most of the downside.


Have you read about this? The banks have, with judicial consent, gotten away with a lot of fraud or possible fraud on foreclosures.

The rule of law has been dead for quite some time, and the only way to get it back is to restore the traditional anglo-saxon system based on the sheriff and the public collaborating to enforce the law, and there being no legal protection for any officials, even judges, who won't obey or enforce the law properly.

I did read a bit about that. Appalling.

Jct: Yes, it's the crisis of usury. As Africans use cell-phone minutes as currencies, the banks get no usury. As Arabians use cell-phone credits to pay for transactions, the banks get no usury. As LETS timebanks are started around the world, that's more action where the banks get no usury.
Of course, these are the death throes of the usury slavery system as their debt shackles disintegrate and fall off. I'm just surprised that it's happened so peacefully with no one shooting their bankers once they realize how they had been conned to death by the mort-gage death-gambles.
See http://youtube.com/kingofthepaupers

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