WHY THE FED FINANCIAL RESCUE PACKAGE WILL FAIL

Washington lawmakers are still trying to figure out who exactly will pay for the US$900 billion-plus rescue package proposed by the Treasury Department and the Federal Reserve Bank. But the package itself does not address the most fundamental issue which led to the crisis in the first place: a total breakdown in the integrity of asset valuations.

 

The pricing logic on which the US government will purchase bad debt from faltering financial institutions has not yet been disclosed. In fact, currently available information suggests that no verifiable pricing mechanism will be publicly available at all. By all accounts, Treasury or Fed officials will determine debt prices on a case-by-case basis. And that is precisely why the entire rescue package is doomed to fail; as bond risk spreads this coming week will show, the chaos and uncertainty surrounding asset valuations will continue, and even intensify.

 

The underlying fact is that no group or institution in particular is responsible for the crisis.  It is the capitalist system which is imploding, in its totality. The rapidly changing structure of the global economy is ensuring that the true worth of American labour will remain depressed well into the next decade. As a consequence, family incomes are not only capped; for a large majority, incomes are declining in real terms, given the sharp hikes in food and oil prices. Since the overall capacity to service housing, credit card and other types of consumer debt is severely restricted, it is virtually impossible to see what key value drivers will improve the quality of mortgage paper in the foreseeable future.

 

 Nobody has recommended taking remedial action to rectify either the impaired status of asset valuation techniques or the flawed system of credit ratings. When told that an asset is worthless unless it can generate sustainable cash flows, an advisor to presidential hopeful Barack Obama indicated that the policy of constructive protectionism will eventually upgrade inflation-adjusted family incomes which, in turn, will underpin home values. A John McCain surrogate claimed that more oil drilling will, almost immediately, change the course of the US economy. In reality, neither protectionism nor drilling will resolve anything.

 

Not that Wall Street insiders are unaware of the need to revamp asset valuation methodologies; what they lack is the will, and what they fear is the explosive political impact of a programme which will directly challenge the qualifications of real estate brokers, appraisal specialists, bank managers, certified accountants, project engineers, corporate monitors and financial analysts. The lack of quality at all levels of the valuation matrix was far from apparent as long as asset prices were rising, year after year. Today, as the surpluses supporting housing debt servicing have disappeared, for a variety of well-grounded reasons, the serious weaknesses within that matrix stand exposed. The rescue package, in brief, simply reflects the fact that a new era of state capitalism has begun with a vengeance. In its true form, the free market has collapsed.

AIG, and the Collapse of the Global Capitalist Economy

Theme: The chaos today on Wall Street bears no resemblance to earlier meltdowns, primarily because it comes at a time when the five-decade-old process of global capital accumulation has stalled, and because risk insurance coverage providers, who remained pillars of that process, are now finding out that their risk assessment and actuarial methodologies were premised more on hope and optimism than verifiable substance.

 

It is not about regulation and de-regulation, as Washington lawmakers would like you to believe. It is also not about the inability to control derivative transactions, as self-styled experts are claiming on your television sets. In fact, if the facts are closely scrutinized, the alarm bells are all ringing the wrong jagged tune. What we are facing today is the complete lack of comprehension of the very nexus which triggered the most remarkable phase of capital accumulation following the Second World War.

 

The post-WW II universe was shaped entirely by a capital accumulation process which guaranteed huge surpluses for the United States, Western Europe and Japan, and which was inherently the cause of sustained poverty throughout the developing world. In the late-1990s, however, the capital equilibrium began shifting; production-cost arbitrage and outsourcing began directing cash to countries like China and India. But western economies confronted that equilibrium shift by continuing to create huge debt-based wealth, mainly through fundamentally flawed asset valuations, through unrealistic credit ratings and through rampant speculation.

 

Today, the capacity of large segments of American corporations and consumers to service debt is almost negligible. Valuations did not lead to cash flows and profits. Credit ratings failed to fully comprehend impairments in business models. And, as if to drive the inevitable final nail in the debt coffin, the risk insurance sector, without which the modern-day capital enterprise is a non-starter, is now destined to walk away from the wealth bubble in a matter of a few short weeks and months.

 

The nexus of capital, debt and insurance (and militarism, for that matter) is currently in crisis mode. American International Group (AIG), for example, will need more than US$150 billion as cash margin for its credit default swap contracts to offset the downgrades in its own credit ratings; other risk reinsurance entities, including European majors, are expected to emerge from the woodwork with serious counterparty deficits within this month. Banks like Washington Mutual and Wachovia, as other examples, are still not disclosing the foreclosure-to-sale risk inside their property portfolios. Elite Wall Street institutions, like Citibank and Morgan Stanley, are reported to be undertaking, as a matter of top priority, worst-case revaluations of all American and foreign assets appearing on their balance sheets.

 

The evidence is overwhelming: this crisis is like no other in American history. It is not a question of a loss of confidence but that there are no grounds for confidence at all.

 

As long as the global economy created genuine capital surpluses in the American capitalist structure, valuations were a non-issue, since ongoing and increasing demand for assets invariably generates its own momentum in terms of perceptions of value and future value. And exceptionally high debt levels are not considered prohibitive in the face of valuations being proven, repeatedly, at points of liquidation. But the unique combination of industrial growth and impoverishment in the emerging markets has rapidly eroded the foundations of the post-WW II capital accumulation process. Cash demand for American assets, as a consequence, has dried up, and debt can no longer underpin over-valuations.

 

So exactly what credit quality was AIG insuring? Surely, the underlying nexus propping up the global capitalist economy did not lend itself to actuarial mathematics. Nor did the hopelessly inadequate property valuations, often provided by unqualified appraisers on American main streets, support any credible asset definitions. By all accounts, default swap prices were predicated on the mere belief that any potential degradation of American assets was both manageable and, at worst, a cyclical phenomenon.

 

To offer a simplistic explanation, a credit default swap provider is required to make immediate cash reserve provisions in the event that the credit rating (issued and updated by the established credit rating agencies) of the provider is downgraded; quite clearly, the bigger the downgrade, the bigger the cash reserve requirement.

 

Therefore, in view of the fact that Standard & Poors, Moodys and Fitch have all lowered AIG credit ratings during the last few hours, the American financial system is due for a significant shake-up this week. Similar credit events will then follow in Europe and Japan. The less said about the impact on the third world, the better.