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OpEdNews Op Eds    H2'ed 2/2/09

"Too Big to Fail": A Bailout Hoax

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Message Ismael Hossein-zadeh
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Using the “too big to fail” scare tactic, the US government has kept a number of terminally ill Wall Street gamblers on an expensive life-support system that is estimated to cost taxpayers $8.5 trillion [1]. In light of the fact that (according to IRS Data Book) there were 138 million taxpayers in 2007, this figure represents a burden of $61,594.20 per tax payer. Or, to put it differently, it represents a burden of $28,333.33 per man, woman and child for the entire US population.

This massive giveaway of public money has been devoted to a wide range of fraudulent programs, including asset purchases of insolvent institutions, loans and loan guarantees, equity purchases in troubled financial companies, tax breaks for banks, assistance to a relatively small number of struggling homeowners, and a currency stabilization fund.

The rationale behind this unprecedented taxpayer rip-off is that the current economic crisis is largely due to the ongoing credit crunch in financial markets; and that government injection of money into financial institutions will help unfreeze the credit market by absorbing toxic assets off their balance sheets.

Despite the massive infusion of public money into the coffers of Wall Street giants, however, the banking industry has shown no interest in lending. Government’s showering mega banks with taxpayers’ money is thus very much like throwing people’s money into a black hole without any questions asked as to where it all ended up, or how it was spent. Not surprisingly, the credit crunch continues unabated and economic conditions deteriorate out of control.

The question is why? If “illiquidity is the core economic problem,” as policy makers argue, why is then the government’s injection of enormous amounts of liquidity failing to unfreeze the credit market?

The answer is that government policy makers, Wall Street financial gamblers, and the mainstream media are misrepresenting the ongoing financial difficulties as a problem of illiquidity or lack of cash. In reality, however, it is not a problem of illiquidity or lack of cash, but of insolvency or lack of trust and, therefore, of hoarding cash. The current credit crunch is a symptom, not a cause, of the paralyzed, unreliable financial markets.

John Maynard Keynes, the well-known British economist, attributed this type of credit crunch to what he called “liquidity trap,” not lack of liquidity, implying that under market conditions of widespread insolvency and distrust lending comes to a standstill not because money is scarce but because it is hoarded, or “trapped,” as a safe instrument of preserving assets.

The theory of “liquidity trap” has been corroborated by empirical evidence from the Great Depression of the 1930s, as well as from the recent financial difficulties in Japan—known as “Japan’s lost decade.” It is also evidenced in the current credit crunch in global markets.

There is strong evidence that major money-center banks (such as Citigroup and Bank of America) that have received huge sums of the bailout money are technically bankrupt, but they are not declared as such out of a fear that it may cause turbulence in global financial markets. “Here is the ugly, unofficial truth that neither Wall Street nor the government will acknowledge: the pinnacle of the US financial system is broke—with perhaps $2 trillion in rotten financial assets on the books. Nobody knows, exactly. The bankers won't say, and regulators won't ask, or at least don't dare tell the public” [2].

By virtue of years of Wall Street’s expanding bubble, which came to a burst in the late 2007 and early 2008, these banks managed to accumulate huge sums of fictitious capital on their balance sheets. However, since there is no transparency and the extent of toxic assets thus accumulated is not disclosed, nobody really knows the amount of the worthless assets that are hidden in the books of major Wall Street banks and brokerage houses [3].

One thing is certain, however: the amount of these toxic assets is in terms of trillions or (as some experts point out) tens of trillions of dollars [4]. There is simply not enough money—in the United States or in the entire world—to bailout these toxic assets. Although not many people know of this fraudulently kept secret, the banks of course know it. And that’s why inter-bank lending has come to a standstill, as the banks do not trust each other or, for that matter, businesses and consumers.

This explains what happened to hundreds of billions of bailout dollars that government bestowed upon Wall Street mega banks: they simply grabbed the loot and stashed it into their coffers, without dispensing a single penny of it as credit to businesses or consumers.

It also explains the continued freeze of credit markets and the ongoing financial or market stalemate: neither the giant financial institutions (in collusion with government policy makers) are willing to accept the consequences of their gambling policies and submit to their deserved fate of bankruptcy; nor is there enough money to bailout all of their toxic assets.

Either of these two options could remove the massive toxic assets from financial markets and restore confidence in lending. But since the former alternative is not acceptable to the powerful financial interests and the latter option is not feasible due to insufficient money to buy a ton of worthless assets, the oppressive debt overhang continues to keep credit markets frozen and the economy paralyzed—hence, the persistent stalemate and prolonged crisis.

In a subtle but real sense, this stalemate is a reflection of two opposing forces: on the one side stand the competitive forces of market mechanism that require exposure, transparency and the cleansing of the balance sheets of the insolvent mega banks. On the other side stand the monopolistic power of these financial giants, supported by government policy makers, that is preventing the forces of competition from determining the value of their toxic assets.

The apparent rationale behind the refusal to acknowledge the bankruptcy of Wall Street mega banks is that they are “too big to fail,” implying that admission of their failure may cause major turbulence in global financial markets. A closer examination of this claim reveals, however, that it is more of a scare tactic designed to protect the powerful interests vested in these financial giants than a genuine rationale to protect national interests.

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Ismael Hossein-zadeh is a professor of economics at Drake University, Des Moines, Iowa. He is the author of the newly published book, The Political Economy of U.S. Militarism His Web page is
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