A reader of my French blog has taken the trouble of translating my most recent Friday video in English. Many thanks to him!
NEWS is conveyed by letter, word or mouth
and comes to us from North, East, West and South” (Witt’s Recreations)
. . . but mostly from the Paul Jorion blog now that we have the Internet.
I want to talk to you about the stock market, because the stock market has been rising in France and in the United States. I am obliged to reflect upon this, because, as I have mentioned to you, I have agreed to prepare an afterword to a new edition of several works of Proudhon concerning stock-market speculation. It is important to understand what is happening at the moment. Does it mean that the economy is improving? To that end we need to look back at the events of the past two years.
In the summer of 2007 we witnessed the drying up of inter-bank credit, by which is meant that the banks stopped lending to one another. I remind you that the reason for this is that there was a depreciation, which began to become quite spectacular from February of 2007, in the value of securities consisting of large collections of individual mortgage debts, because many people were no longer able to keep up their monthly repayments. Consequently, the value of these securities plunged. In the summer an air of general suspicion arose from the fact that banks did not want to reveal whether they possessed these products, which could no longer fetch a price, because there was now no market for them. Everyone in the world of finance suspected everyone else of possessing these products and thus of possibly being insolvent. An unwillingness to lend developed, as no one could be depended on now to be credit-worthy.
I shall remind you of the first measure that was thought of to deal with this problem: the creation of what were known as ‘bad-value banks’ or ‘bad banks’. The possibility was envisaged of putting toxic derivatives into a form of quarantine so that the banks could get them off their balance sheets. So ratios of solvency were worked out, to see whether they were above or below the threshold of solvency. What happened, as has recently become known, is that the British, who were in much the same position as the Americans, came to the conclusion that it was impossible, as it would be too expensive.
The second idea, which was adopted in previous crises, is known as ‘privatization of profits with socialization of losses’. This solution, which had always worked very well before, means that the private sector gets whatever profits there may be when things are going well and then, when things go badly, the state, i.e. the taxpayer, forks out to cover the losses. The novelty in the crisis in which we find ourselves now is that this classic solution can no longer be considered, as that too would have cost too much, the level of debt which had been incurred having exceeded the capacity of states to absorb it.
So it was decided to adopt a direct approach which would be less expensive and which consisted in giving money to the banks to help them out of their difficulties. Together with this go what are known as ‘stress tests’. You will have heard of the ‘stress tests’ that have been carried out on banks in the United States and are to be carried out in Europe too in order to determine which banks may be declared to be solvent. This is nothing but a big public-relations exercise, in fact, as these ‘stress tests’ are actually normally carried out all the time. They have always been carried out everywhere in point of fact. So this great pantomime has taken place to persuade people that the banks are now in better health following the recapitalization exercise and that they are now out of trouble.
What has not been taken into consideration is that in the background the economic situation has been continuing to deteriorate. The deterioration resulted from problems in the financial sector, which have led to redundancies, and created a state of affairs in which there are fewer and fewer people who are drawing salaries which are adequate for the purpose of keeping up their monthly mortgage and credit-card payments. The situation in the American property market has continued to deteriorate, not only in the residential sector but also in the commercial one. Problems are developing concerning credit-card loans and all the other loans that build up in American households, student loans, health costs and so on and so forth. So, after having made all of these ‘stress-test’ declarations following the recapitalization of the banks, circumstances have changed for the worse to such an extent that, if the ‘stress-test’ calculations had been carried out all over again, it would have been found that the banks had again fallen below the threshold determined by the solvency ratio. So what could be done?
There was, in fact, only one solution. Because results had been adversely affected by the depreciated value of toxic securities when they appeared on the surface, all that was left to be done was to start telling lies about the value of these products. ‘Mark to Market’, i.e. valuing them at prices which real transactions would have resulted in – the market price of these products – would have meant valuing them at prices which would have been too low. If these prices had been mentioned in the results of the businesses, these financial institutions would almost all have been seen to be what they were in reality, insolvent!
There was only one possible approach to adopt, and this was to modify these figures to make them seem better than they actually were. The solution which was conceived of for this is what is known as ‘Mark to Model’, i.e. a system of model quotes, which means that, instead of using market prices, one conjures up a scenario in which it appears that all is well in all the markets and then one sells these products on just as they were sold on before. This does not solve all the problems, of course, because, if in the background people are still not managing to meet their monthly repayment obligations, the prices of these products will still go down. But the idea is that this will all sort itself out in more favourable economic circumstances so that the prices will be a lot better.
Was it permissible to do any of this? No, it was not, because rule 157 of the FASB (the Financial Accounting Standards Board), the US institution concerned with accounting rules, prohibited it. So what did they do? The American Bankers’ Association put in place something that they called the Fair Value Coalition. This organization was allocated $27 million, which was used to pay members of the US Congress concerned with the Finance Commission to get these politicians to invite the FASB people to appear before them to be told that they would have to change this rule, and this is what happened, in March.
Is all of this public knowledge? Yes, it is! It was all discussed on the front page of The Wall Street Journal. On the front page of The Wall Street Journal there was even an article which even went so far as to specify the exact sums of money which were paid by the American banks to these members of Congress who are on this finance committee to get them to take this decision. One should add that this sort of thing is not against the law in the United States. These are considered to be contributions which the business community makes to the electoral campaigns of these politicians. So what do these politicians say when they are reproached for having sold out to Wall Street? They issue press statements to say that they have indeed received these sums of money but that this has not influenced their decisions! Mr. Kanjorski, the congressman who was at the forefront of the battle and who was the most forceful member of the committee at its meetings, insulting, as he did, practically all the representatives of the FASB, received over a period of two years the sum of $704,000. I repeat that this is not secret information. It was on the front page of The Wall Street Journal!
So that proposal went through. What has it made possible? The banks have gone back up over the solvency ratio. Why? Because they fixed the prices of these toxic assets not at any old price but in accordance with calculations made on the basis of a model which was established to put everything back so as to permit these products to be sold “at a more reasonable price”, as the American Bankers’ Association put it. So, when they tell us now that the stock markets are doing well, it is indeed true that that is so. But in what context are they doing well? In the context in which the figures are not truly what they are represented to be!
Did they have any choice in all of this? No, they had no choice, because, if they had continued to calculate things as they were doing before, and, given that the money available to governments for the purpose of assisting the banks is limited, there was only one way to prevent the banks from being shown to be insolvent, and that was to adopt the procedure which they opted for, which was to falsify the figures!
What is the problem with all of this? Everyone would have seen that the banks were insolvent. They could hardly let all the banks go bust. Something had to be done. They could have nationalized all these banks and wiped the slate clean. They preferred that pressure be put on the FASB to change the rules, and since then everything has been done in a fog of deception and distortion of reality. On this basis stock markets are doing well. But what is the danger in all of this? The danger is as follows. When it is said that it is important that the banks get back to circulating money between one another so that there is a supply of credit, etc. and that it is imperative that there be confidence in the system, what is meant by confidence? That simply means that a bank needs to know if the other banks that it is dealing with are solvent or not. But now they no longer know, because they have all been told that they may put on their balance sheets whatever figures they care to put there.
So, even though things are bad at the moment, stock markets can still do well, because everyone knows that that is the established state of affairs at the moment. But when a recovery begins, confidence will be needed. However, transparency has been sacrificed. Transparency is needed, though, so that people can know exactly what it is they are dealing with, etc. There is more to it than that, as we know. As Proudhon observed, there is a lot of insider knowledge that makes things work. We also know that volumes are created at present by means of program trading which operates essentially for the purpose of moving money about from here to there and back again to take advantage of the fact that people can benefit from merely creating liquidity, even if that liquidity is being eaten up as part of the same operations, and so on and so forth. But, when things start moving again, if they ever do, everyone will need to know what is what and whom to have confidence in for what purposes. Unfortunately, however, the strategy which has been adopted makes this impossible. Transparency has been suppressed, because falsification was necessary, and that was necessary because the only alternative to it was nationalization, which was not wanted.
So what is going to happen when a recovery takes place? Only one solution is possible. They will change direction. Another $27 million will be found to re-instate the ‘Mark to Market’ arrangement. Why? Because, when a new financial bubble develops, market prices are more optimistic and everything seems to be going well again. So that things do not continue in this way we must demand that this system be brought to an end.
In America, even though many people have buried their heads in the sand there, and in Europe it is being observed that this state of affairs has got out of hand. Even people whom one might have thought of as having a vested interest in what is happening at present in the United States, as well as people such as myself, are saying that a proper recovery is not possible given the present condition of the system. If it is not modified, there will be no transparency, and consequently a proper recovery will not take place. This system cannot proceed as it is. It is broken. We need to find something else.