Sunday, September 21, 2008

US is going to be neo-USSR..what u say?

One of my most fav. article by S. Gurumurthy
If the ongoing debate initiated by Martin Wolf, associate editor and chief economic commentator in Financial Times and Prof. Nouriel Roubini, professor of economics at New York University, is to be given a title, that could be this.
Wolf, whose Wednesday columns in FT are discussed by fifty most influential economists of the world, is a mainline economic thinker. Roubini, who has held different positions in US government, now occupies important seats in academia and runs Roubini Global Economics [RGE] Monitor, an influential Web site.
In July 2006 itself, Roubini had predicted that US was in recession. But, like others had, Wolf had ignored Roubini for nearly 20 long months. But, as the unfolding events were proving Roubini right, Wolf wrote [FT, February 18, 2008] that Roubini deserved to be taken seriously.
March towards disaster
Wolf also held Alan Greenspan, who had dismissed the housing issue “as not a bubble but a froth”, wrong. Wolf pointed out how Roubini has [on February 5, 2008] predicted a 12-step march towards a ‘catastrophic’ financial and economic outcome as a “rising possibility”.
In his column, Wolf recalled Roubini’s 12-step recipe for disaster, including:
Housing recession that wipes out family wealth of $4-6 trillion, forces a million to surrender house keys to lenders, and turns home builders bankrupt;
Home loan losses that exceed the estimated $250-300 billion and, together with consumer loan losses, spread credit crunch across;
Top-rated credit insurers get downgraded, causing a further $150 billion loss;
Commercial property market melts;
A large bank goes bankrupt;
Big losses in leveraged buyouts, with hundreds of billions of dollars of bank funds stuck;
Corporate bond defaults force losses of $250 billions on credit default swap insurers and bankrupt many;
With meltdown of hedge funds delinked from central banks, further collapse of the stocks force huge fall in security prices;
Acute illiquidity dogs financial markets with jump in concern about solvency; and
“A vicious circle” of deep recession makes financial losses “more severe” and “financial losses and meltdown” make the recession “even more severe.”
Roubini estimates $1 trillion loss in the meltdown. “Is this scenario at least plausible?” asks Martin Wolf, and answers, stunningly, “It is”. [This was on February 18. But the loss meter in March projects $3 trillions loss!] If this “nightmarish scenario” lasts for six quarters, Roubini warned on February 5, it would be too late for other nations to devise ‘policies’ to ‘de-couple’ from US.
But can the US Fed head off this danger? Roubini says ‘no’ for many reasons. Two of them are important. One, the Fed can deal with liquidity, but, not solvency, which is the real issue. Two, the transactions-oriented financial system itself is in deep crisis. This second one is critical and needs some explanation.
Derivatives in control
The world of finance which Roubini calls as transaction-oriented system looks a bizarre, dollar jungle now. A peep into this mind-boggling labyrinth will unnerve even the most diehard among optimists. The world of finance today is controlled by derivatives. What is a derivative? ’Derivatives are financial Weapons of Mass Destruction [WMD]’, ‘now latent’ but ‘are potentially lethal’. This is not socialist Fidel Castro, but, capitalist Warren Buffet speaking recently (on March 10, 2008). Yet, the most among those who count in the world seem unaware of this WMD. ‘Politicians, senior executives, regulators, even portfolio managers have limited knowledge’ about it, says an expert Web on derivatives. Derivative is a financial instrument whose value is not its own, but derived from something else, on some underlying asset or transaction, such as commodities, equities (stocks) bonds, interest rates, exchange rates, stock market indexes, why, even inflation indexes, index of weather!
The CDOs (collateralised debt obligations), by which the underlying US local subprime loans were palmed off to other continents, was, till the fraud was not out, a reputable credit derivative. So derivative is not only a WMD but also an ICBM, an Inter Continental Ballistic Missile, that hits across continents!
Also, the virtual derivative economy is gradually decoupling itself from the actual in quality as well as size. Hundreds of exotic derivative products have been innovated and innovations by the best minds are continuing.
Mind-boggling size
The population of these beastly financial products has grown to gigantic levels that is beyond the competence of any system, mind, or force to deal with. The sheer collective size of these modern financial beasts is terrifying. According to the Bank of International Settlements [BIS], the aggregate derivative positions of banks grew from $100 trillion in 2002 to — believe it — $516 trillions in 2007, that is over 500 per cent in five years!
Yet they do not appear in bank or corporate balance sheets. Some of the vital actuals seem pygmies in comparison to these virtuals. The total derivatives are more than ten times the global GDP [$50 trillion]; some seven times the world’s estimated real estate value [$75 trillions]; more than five times the world’s stock values [$100 trillions]; more than 33 times the US GDP [$15 trillions] or the US money supply [$15 trillion]; 172 times the US federal budget [$3 trillion] — it can go on. The size of the virtual economy is indeed petrifying. Worse, it unpredictably targets, yet accurately eliminates, the distant and the unwary as the CDOs did.
A decade earlier, Long Term Capital Management [LTCM] a hedge fund co-promoted by two Nobel laureates, collapsed. Its loss of $5 billion was peanuts compared to the trillion dollar-plus loss that is forecast now. Yet the LTCM fall nearly snuffed out the global monetary system. The derivative economy was much smaller then. When billions could devastate the world market then, what could trillions not do now? It is so huge now that, no one, not even all governments and central banks in the world put together, can control this huge and growing population of derivatives. This is what Akio Morita, the former Sony Corporation chairman, told the Group-7 leaders as far back as 1993, when the size of the derivative population was far less. With the derivatives growing so malignant, it is not the actual finance which controls its derivative, but, the other way round – the virtual controls the actual. What, if this off-balance-sheet virtual architecture collapses?
It is so fragile that it can. Martin Wolf warns “the connection between housing bubble and the fragility of the financial system has created huge dangers, for the US and for the rest of the world.” If a collapse starts, it is beyond any known power’s power to stop or repair it. The balance sheet of the whole world is too small for it and the actual will too meet the fate of the virtual.
Roubini’s caveat regarding transaction-oriented financial system being in crisis and Warren Buffet’s warning about derivatives as financial WMDs, expose how fragile is today’s virtual financial architecture, which is several times the actual.
A way out?
What is the way out? And is there a way out at all? There are ‘ways out’, claims Martin Wolf, but, warns, ‘they are poisonous ones’. Wolf says, “In the last resort governments resolve financial crisis. This is the iron law.” And adds, “The US public sector is coming to the rescue.” Public sector? To the rescue of world’s most efficient financial market? In the freest economy in the world? Yes. And Wolf hopes, “In the end, they will succeed.” This was Wolf on February 20, 2008. The state in US as the answer to the mess created by the free market? Confession indeed from a diehard capitalist!
Some 18 years back, market was touted as the answer to the mess created by the state in USSR. A 360-degree turn now. Read on, it is more interesting.
Nationalisation of losses?
In his later article on March 11, 2008, Wolf says, “The government would have to mount a rescue. The most plausible means of doing so would be via nationalisation of all losses.” Nationalisation? And of losses? In free market US, which pontificates on privatisation of public sector and government works the world-over?
But how to nationalise only losses? To keep the ownership with those who lost others’ money? Roubini also says that some market observers are already talking about nationalisation of the US banking system — first covert and then explicit — as the next step to the financial meltdown.
Obviously the US Government is seen as the saviour for the faltering — or better, collapsing? — financial market of the US. So, massive state penetration of Wall Street seems inevitable. And it is already happening. And that will be a topic by itself.
What then is its consequence? If the banking system in US, which holds the Capital of capitalism, is nationalised, what will be left of capitalism in US? Capitalism without Capital ’C’? If US nationalises capital, will US capitalism remain market capitalism or become State Capitalism? Will the US be US then? Or will it become a neo-USSR? No seer is needed to give the answer. It’s obvious.

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