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08.08.2008

August 01, 2008 (the date of publication in Russian)

Andrey Kobyakov

FINANCES AS THIEVERY. Part 2

"The invisible hand of the market" empties pockets of lawful citizens

Part 1: (http://www.rpmonitor.ru/en/en/detail.php?ID=10494)

THE TEMPTATION OF DEREGULATION

Deregulation, primarily in the financial sphere, has become a real scourge of the mankind in the end of the XX and the onset of the XXI century.

The experience of the latest decades has proven that financial deregulation has got nothing in common with the rational organization of economic life, as well as with community life. On the contrary, deregulation and its implications are distinctly anti-social. It is irrational, counterproductive, and fraught with catastrophes.

The reality illustrates increasing doubtfulness of the ongoing processes of deregulation and alienation of crucial branches of economy from efficient public control. Deregulation of the financial sector in early 1990s has created the above described "casino economy", leading to the crash of the stock market and becoming a preface for the crisis of global finances. Meanwhile, deregulation of the energy market threatens to paralyze the basic sphere of economy and cause catastrophic disruptions of energy supply for industrial and consumer needs. Abolition of earlier restrictions creates a temptation for super-profit, based upon increasingly risky operations.

In 2001, the world was impressed with the phantasmagoric bankruptcy of Enron Corporation. On its highest point, Enron's securities were estimated in $100 per share, the company being rated in the first seven largest US corporations in turnover and gross income. In November 2001, three months after the scandal, Enron's stock was evaluated in not more than 25 cents per share – cheaper than mail stamps. It was found out that the company had been concealing its huge losses from public for five years, conveying all the unsuccessful operations to deliberately established daughter companies, and continuing to expose amazing "profitability" to stockholders and creditors. "Effective managers" and "creative engineers of bookkeeping" were granted huge salaries, prizes and bonuses from shareholders, calculated in billions of US dollars. Meanwhile, ordinary employees whose pension arrears were invested in the company's stock were not allowed to sell their shares until pension age.

As a result of the catastrophic meltdown of the stock's quotations Ц in 350 times between August 2000 and December 2001 Ц these pension arrears, estimated in the best times in $1.2 billion, practically evaporated. Other investors of the corporation encountered ten times larger losses.

Jeffrey Skilling, Enron's CEO, had claimed that in order to be successful, the company should get rid of "hard" assets like industrial buildings, machinery and equipment, as physical assets allegedly bind the cash that should be preferably used in trade operations. In accordance with his concept, Enron abandoned industrial projects, becoming instead a huge trading platform selling all kinds of products Ц from energy delivery to high speed data traffic, from computer chips to advertising space.

As one analyst correctly admitted at that time, Enron was not more an energy trader but "a financial speculative balloon with a gas pipe in his side". Real economy thus became a hostage of virtual finances.

Can one kilo of walnuts weigh 10 kilos? Yes, in case it is weighed on Neptune. Some experts suggested that Enron's bookkeeping was based on this distant planet. According to the company's annual accounts, its gross income increased from $13.3 billion in 1996 to $108.8 billion in 2000. Thus, the annual surplus exceeded 57% Ц even more than that of Cisco Systems, the flagship of "new" [Internet] economy.

With the number of personnel of 19,000 employees by late 2000, the revenue exceeded $5.3 million for a person in Enron. It is 3 times more than in the prestigious Goldman Sachs, 8 times more than in Microsoft, 11 times more than in Citigroup and 19 times more than in IBM! This ostensible success was achieved due to "innovative" bookkeeping system Ц which, in fact, was based on large-scale swindle.

How did it happen that the auditors overlooked the machinations?

Immorality and greed are contagious. Enron was audited by Andersen, one of the four most famous auditing accountant firms in the world. In the process of investigation of 2001, it was found out that Andersen's managers deliberately camouflaged the financial wrongdoings of Enron's leadership. The explanation was simple: the auditor also capitalized from consulting assistance ordered by the same Enron.

How did it happen that the supervising bodies overlooked the swindle?

This fact is of a merely political nature. Enron, one of the largest political lobbyists, excessively sponsored election campaigns of major US Republican politicians. The company was especially generous to Senator Phil Gram, a close friend of George H. W. Bush. Curiously, his spouse Wendy chaired the Commodity Futures Trade Commission (CFTC). In 1993, the Commission decided to withdraw the operations in short-term electric energy contracts from the sphere of federal control and regulation. Five weeks later, Mrs. Gram changed her job, parachuting into the board of Enron, and surfacing there as a co-chair of the company's committee on corporate audit.

This curve of career hardly requires comments.

Thus, deregulation fosters acquisitive instincts, inspires for new schemes of swindle, and encourages corruption. Thievery expands like a malign tumor, steering the socio-economic organism to death.

The scandal around Enron's bankruptcy was supposed to be illuminative: some of the top managers were jailed, others lost their business reputation. In some particular aspects, corporate bookkeeping was put under more strict control. However, the exposure of Enron's top management could not be described as a "triumph of justice", as that was not a single case. It would be naive to think that Enron was the only corporation running machinations of that scale and deliberately displaying falsified figures of income. In fact, the real problem is a deepening process of "enronization" of economy where financial fraud has become a rule for major global corporations, and similar facts were subsequently exposed in the cases of Xerox, Cisco, WorldCom, Yukos, Parmalat, UBS, Mechel et al.

Still, the Enron scandal was a landmark case. It not only indicated the end of the flight-forward decade of the 1990s, with its financial pyramids and roulette economy. The Enron scandal exposed the back side of the postindustrial world order where everything is in fact virtual: reputation of corporate bosses and state officials, social concerns of legislators, imitation of audit by interested auditors, imitation of regulation by interested regulated authorities, the bias of economic statistics, and the immorality of stock analysts convincing investors of attractiveness of securities in their allegedly objective advice. Altogether, the picture exposed the prosperity of thievery, bigotry and hypocrisy.

 

UP THE STAIR LEADING TO THE INFERNO

The currently ongoing crisis in the United States is just another chapter of the same fairy tale about salutary deregulation and liberation from control.

Curiously, it is even hardly possible to determine the current crisis. At its onset, it performed as the crisis of low-liquidity and high-risk credits in subprime mortgage. However, the fire promptly encompassed a bloodline of mortgage-related derivatives and composite credit instruments. It was followed with the crisis of confidence in banking, and the ensuing meltdown of bank liquidity. By summer 2008, the description of the crisis could not be restricted to the sphere of mortgage. The credit problems culminated in the practical bankruptcy of Bear Stearns, the fifth largest investment bank of the United States, in which the Federal Reserve had to hurry for rescue along with the Treasury and JP Morgan Chase. Simultaneous bailout schemes were introduced in Great Britain, and injections of billions of cash by the European Central Bank have become daily practice.

It "unexpectedly" appeared that the list of potential bankrupts could be continued with a number of other financial groups from the global system's top elite. Lack of liquidity and problems with "undercapitalization" were admitted by financial monsters like Goldman Sachs, Merrill Lynch, Morgan Stanley and Citigroup. The efforts of these and other banks to attract cash from Chinese, Singaporean and Arab state funds under humiliating conditions indicate that the situation in the Western banking sector is really dire.

During the last year, official losses of various private financial institutions comprised Ц even according to moderate estimates Ц at least half a trillion of US dollars. Upon closer view, the losses may appear far larger.

Meanwhile, the mortgage sector displayed more signs of trouble. Bankruptcies and overdue payments became normal not only for the borrowers with a poor credit history but also for the creditworthy majority of the American middle class. During 2007, the number of houses sold in auctions for expense of unpaid mortgage loans has doubled. Millions of families found themselves before the perspective of being dispossessed. Meanwhile, the demand in real estate trade is collapsing; prices are declining, undermining the well-being of households; crediting banks are facing new problems.

In the last month, the market was shaken with the news of increasing problems encountered by major mortgage agencies Ц namely, Fannie Mae and Freddie Mac, with the possibility of bankruptcy. The two companies used to provide financing of approximately one half of all the US mortgage loans, accumulating guarantees and obligations related to mortgage loans for a sum exceeding $5 trillion, and therefore, their bankruptcy may result in a stalemate of the whole system of crediting construction, and therefore, of the construction business. The potential losses of investors of these companies' obligations (which include the Government of Russia) can be terrible.

For many years, Fannie Mac and Freddie Mac had been a subject of pride of US federal agencies, as the mechanism of their work used to guarantee all the sides of mortgage deals from possible risks. The two companies used to play a crucial role in support of US housing programs and mortgage business. Purchasing mortgage notes from banks, they accumulated them into pools, thus diversifying local risks, issued bonds against the accumulated notes, and used the attained income for reproducing the cycle. Their activity has been vital for guaranteeing permanent inflow of credit sources into banks for the needs of mortgage. It is noteworthy that the two agencies had been established by the US Congress, the state serving as the ultimate guarantor of their business. For that reason, bonds issued by the two companies in a huge amount had the highest investment rating and were popular among most conservative institutional investors like banks, insurance companies, pension funds, as well as government funds of other countries across the globe.

However, the disease of deregulation affected the two companies as well. The levers of control were loosened, while the top management of companies was instructed to "commercialize" and concentrate on possibly higher incomes Ц naturally, for the joy of private shareholders. This decision on "commercialization" contradicted to the very essence of their destination and role of guarantors of stability of the investment process in US housing industry. The scheme of "inflation of the bubble" and the mechanism of the ensuing crisis was the same: deregulation Ц unbridled rapacity Ц risky decisions Ц irresponsibility Ц collapse.

The decline of housing and the credit problems have already caused a recession of the US economy. The US stock market is dominated with decline of quotations and "bear" sentiment. Paper assets are devaluating, investors escape to "safe havens", including commodity markets. Eventually, major commodity prices soar, steering the global economy in the condition of "stagflation" fraught with transformation into a full-scale global depression.

The current crisis is already described as not just unprecedented in terms of character but the most devastating in terms of effect. Meanwhile, all the presently implemented and proposed countermeasures are reduced to the increase of speed of the global (preferably USD-) printing machine. Yet being the deputy of the "great and terrible" Alan Greenspan in the Federal Reserve, governor Ben Bernanke used to appease investors with a specific joke: in case of trouble and "liquidity crisis", he promised to "start dropping money from helicopters". That is what "Mr. Helicopter" is doing today as a chairman of Federal Reserve. Meanwhile, devaluation of the US currency pauperizes its holders, "redistributing wealth" in favor of the most immoral and irresponsible subjects of global economy. Thievery, as said above.

Probably, US authorities will manage to invent some measures of support of the affected homeowners, to save millions from the destiny of transience, and patch some holes, but the system itself is becoming more and more vicious with every year. Meanwhile, real cardinal measures for rational reorganization of the global economic system are not taken.

(To be continued)


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