GM in America, Land of the Subprime?

The joke is on us. If you thought the subprime mortgage market collapse was "funny," then the auto market collapse is even funnier. GM, as it turns out, was no less subprime than home owners in Arizona who borrowed beyond their means. Like Washington, our bankruptcy-bound automaker had presided over a business model running almost entirely on debt.

They call it 'borrowing,' but in reality Wall Street was basically GM's way of printing its own money. It is no coincidence that, just as Wall Street collapsed, GM executives promptly knocked on Washington's door. They were begging the Treasury to print some money for their company because, for the first time, Wall Street (and GMAC) didn't have any left to bail them out.

To Washington, this was something wholly new, but to GM it was just business as usual. What difference does it make that GM is bailed out by Washington or Wall Street? Perhaps one: GM is now dealing with a lender with real teeth and some semblance of conscience. After all, we are talking about prospective taxpayer money here.

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The truth is that GM was crushed beneath an old weight. It was a slow death because up until 2008, plentiful Wall Street loans kept GM humming indefinitely. Armed with credit eternal, GM made and sold enough cars to make its minimum loan payments. All the while GM's debt kept ballooning and its global competitiveness continued to falter.

But that was fine with GM, apparently, so long as it could borrow enough money to pay its bills.

Little did Wall Street know it was lending to a subprime borrower in GM. Perhaps GM itself did not know. Actually, maybe regulators, bankers and rating agencies just ignored some facts (from 2004) and made the loans out anyway. This kind of self-assured negligence in Washington and Wall Street is precisely what precipitated the subprime mortgage market crash and vaporized a whole lot of phantom wealth.

Sadly, GM's bankruptcy will vaporize more than just wealth, namely tens of thousands of jobs.

This is not just about GM. What brought down the ill-fated automaker also brought much of the American economy to its knees. See job losses in 2008. As it turns out, credit flowed from Wall Street to credit-unworthy or -addicted borrowers across the economic spectrum. The question now is who will be the latest on the chopping block.

Don't just take it from me, but from the man who saw it all coming: Nouriel Roubini, affectionately known as Dr. Doom, who had the strength of will to see through mainstream pre-2008 economics. Everything he is about to say in the following warning is worth looking out for:

This crisis is not merely the result of the U.S. housing bubble’s bursting or the collapse of the United States’ subprime mortgage sector. The credit excesses that created this disaster were global. There were many bubbles, and they extended beyond housing in many countries to commercial real estate mortgages and loans, to credit cards, auto loans, and student loans. There were bubbles for the securitized products that converted these loans and mortgages into complex, toxic, and destructive financial instruments. And there were still more bubbles for local government borrowing, leveraged buyouts, hedge funds, commercial and industrial loans, corporate bonds, commodities, and credit-default swaps—a dangerous unregulated market wherein up to $60 trillion of nominal protection was sold against an outstanding stock of corporate bonds of just $6 trillion.

(read the whole thing here)

This is a joke on us. Have we emerged from the American Century not only as the sole superpower, but also a subprime nation in disguise? When the American economy looks itself in the mirror, does it see GM? How about that family with the foreclosed home? Just don't ask Dr. Doom.

One thing is for sure: we reap what we sow. Wall Street made us rich beyond imagination; too rich, as it turns out. By the 21st century, we had too much wealth chasing too few worthy investment opportunities. So Wall Street, with Washington's nod, proceeded to loan out to the unworthy, the subprime, the GMs of the world, and any family who happens to wants a house.

(Hell, even to illegal immigrants; I mean come on, why not! The party was just getting started!)

After all, Wall Street had no choice. The only alternative was to forfeit the wealth flowing into our markets from all around the world and say, "thanks but no thanks, heehee, we are too rich already." But of course, no self-respecting capitalist nation could ever do such a wrong thing. Certainly not Wall Street, the key driver and underwriter of the indomitable American economy.

This is precisely why our best and brightest minds worked on Wall Street, and why the sum of Wall Street bonuses can dwarf entire nations. This is also why AIG "deserves" its retention bonuses (as I have argued) and Wall Street managed to bag the sixth largest all-time bonus payout in 2008, as I have previously reported.

(F*%&-ing EH, where were the pitch forks for the Wall Street bonuses??!?! AIG was NOTHING compared to what the real banks got. I'm REALLY pissed about that. It was appalling, what populist Washington did to AIG. Democracy at its worse, I'm sorry to conclude.)

It may be hard to imagine today, but there was a time when Wall Street was a legitimate force respected worldwide (even if grudgingly). Of course, this was before Wall Street had to squeeze corners and coax the subprime to keep growing, and growing, and growing, which is what capitalism is all about: relentless growth for profit and shareholders, often at a cost that is not immediately apparent.

Capitalists, as such, cannot escape the temptation of alchemy, that elusive art of spinning straw into gold. The best kind of money is, of course, the kind that you don't have to do anything to make. Just ask Wall Street.

Admit it, you wish you had a friend named Rumpelstiltskin, just like the American economy and GM had a friend named Wall Street.

Whether we like it or not, the post-industrial American economy, as it were, is done for. "Change" is coming and it has nothing to do with Obama's initiative, whose job is merely to administer change. It is "change" we might have to believe in.

The biggest irony is that this crisis was made in our own subprime image. Like GM, Washington saw this coming with eyes wide shut. Have our free markets grown to a weight that can rival that of any centrally planned economy?

Now that, my friends, is a scary thought.

Forget about AIG bonuses or Obama palling around with Jay Leno or his stupid teleprompter. That the very notion of American capitalism is under siege at home and abroad should receive our full attention.

I for one never imagined I would write as I am about these topics. Hell I can't even vote yet!!

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Part 1 - AIG Bonuses Are Immoral, But That Is a Good Thing

Anger can be therapeutic, so can drama. Therapy, however, does not always diagnose accurately. Especially when the therapist is a politician, we should all know better. The mad drama surrounding the AIG bonuses is such that one is hard pressed to separate reality from truth.

I juxtapose truth and reality because, in reality, there is every reason to demonize AIG and Wall Street. After all, the financial sector did bring down our economy. In truth, however, these are bankers and executives who were merely doing their jobs. To punish them is to punish guilt by association, while the real culprits of the financial crisis lie safely elsewhere.

Do not forget that there was nothing illegal about the practices that brought our economy to its knees. For the sake of keeping our eyes on the ball (forthcoming in Part 2), I will defend AIG insofar as reality permits and truth allows.

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In Truth
Bonuses are standard practice on Wall Street, be they performance- or retention-based. Even when financial firms suffer big losses, big bonuses are still doled out to executives in the name of retaining their services and clientele. However reasonable they may be, retention bonuses alone seem unconscionably huge to the common man.

But the truth is, these exorbitant sums accurately reflect the importance of finance to the post-industrial American economy. Simply put, Wall Street salaries and bonuses are set in proportion to its real economic worth, not by losses in a single fiscal year. $165 million does not sound unreasonable in today's context.

I have argued in another post that, even today, our economy needs Wall Street more than Wall Street needs us. Certainly the massive and grudging bailouts of Wall Street and AIG affirms this point. Without Wall Street, the most desirable aspects of the American lifestyle that each one of us covets (admit it) would not be possible.

Until our reliance on Wall Street changes--and it will--AIG deserves its bonuses as much as they ever did, plain and simple.

The truth is, why should it make a difference whether their bonuses are comprised of tax money from their fellow citizens or deposits from far off Asian savers? Their bonuses are deserved because Wall Street gave us our lifestyle, albeit one that eventually drove us into the ground. But what's that got to do with them? Nothing. After all, they're just mere bankers and executives merely doing their jobs.

In Reality
Despite all truth, rewarding executives--no matter how deserving or innocent--whose company is on life support is seen by most people as outrageous at best and criminal at worst. The specific indictments are superfluous to name here. No matter how you look at it, AIG executives who helped themselves to the taxpayer's dime while the economy burns are morally indefensible.

But in reality, does Wall Street or AIG operate on an ethic of morality? If they did, then:

• AIG would preemptively volunteer to forfeit their contracted bonuses;
• AIG would graciously allow us to tax back their bonuses;
• AIG would not have doled out bonuses at all;
• AIG would not reward failure, not on the taxpayer's dime;
• AIG would never have run a quasi-hedge fund that gambled our money away on bad bets;
• Wall Street might not have destroyed itself and our economy along with it.
  

It is as if we expect our bankers and executives to do the moral thing, and getting really mad that they are not. The trouble is, there was never anything moral about this business in the first place. And we know it.

Wall Street plays the market, an institution that knows no moral bounds. Business ethics ring hollow because a free market economy is held to work on efficiency and not morality. More often than not, voluntary "moral" actions contradict market rules and drive the moralizing entrepreneur out of the game.

Can you recall any large shoe-making companies that refused to offshore its manufacturing to Chinese sweatshops? Probably not, since those companies would have disappeared long ago for their morals. Market competition is such that executives cannot submit to their moral discomfort, if such even exists.

As I have asserted elsewhere, this is an economic reality that Americans must own up to: moral detachment, and the productive exploitation of greed, is what drives a capitalist economy to its optimal output.

Immorality, as it were, is a good thing.

The Conclusion
In truth, bonuses are price tagged by the market, not individual intent. In reality, immorality is often rewarded by the market, not rebuked.

As such, moral truths and expectations have no basis in the capitalist reality which Americans subscribe to. To scream about the immorality of AIG bonuses, let alone expecting executives to forfeit them, basically amounts to a moral repudiation of free market principles.

Are Americans really prepared to take this stance? I'm not; not yet, anyway, until all is ruinous. We are not quite there yet, though our economy "stands on the edge of a knife. Stray but a little and it will fail, to the ruin of all. Yet hope remains while all in the Company is true." (from Tolkien)

When things are good, we love Wall Street. When things sour, we do not stay true to the very institutions that brought us riches with the world's envy. Instead we turn against them as if they were filth to begin with.

There is something profoundly misguided about populist anger at the immorality of AIG bonuses, to which an even stronger objection might be raised, namely that the populist anger is itself immoral.

If the AIG bonuses debacle, and the financial crisis at large, can help Americans reflect on our moral contradictions, the cost might well be worth it.

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Bonus Time! The Party on Wall Street Isn't Over JUST Yet

Despite having run the economy into the ground, bankers still know exactly how important they are. Ironically, the TARP bailout has all but reinforced their self-importance instead of slapping them on the wrist. Why? Wall Street understands that we need them more than they need us.

It's 3:30am, the party isn't over yet. They know they can get their huge bonuses today for precisely the same reason they've always deserved disgustingly huge bonuses.

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Ever since manufacturing left our shores for China with its smokey factories, almost two-thirds of our national GDP has come from the service sector. While Wall Street does not comprise the majority of the service sector, they do provide the lifeblood for the majority of its activities: credit for consumption. Our retail industry is the envy of the world not because of how many Fortune 500 retail companies we have, but because Americans on the whole can seemingly buy anything they want whenever they want without worrying about saving a penny. If you find yourself stranded overseas but want the latest toy from Apple, or the latest and greatest from Nintendo? Just import it from the indomitable USA; we'll always have it before anyone else.

Only the magic loom of Wall Street could have made this post-industrial feat possible. Whether it's in the form of 12 month 0% APR credit cards, hedging to give us the world's greatest wealth concentrated in the form of the NYSE casino, or leveraging sub-prime mortgages to give us straw in the form of gold, it's always been Wall Street that enriched all of us. Not to mention our big retail outlets probably couldn't have made payroll consistently without Wall Street's magic either.

Their good bonuses are our good fortunes in turn, as it were.

Although we are now in economic free fall, this long-held tenet in the American political economy has not changed. Not yet. But before it does change (and it will), Wall Street is going to hoard every last bit of bonus money they can because they can. It makes no difference to them whether their bonuses are comprised of tax money from their fellow citizens or deposits from far off Asian savers, and why should it? They deserve their bonuses because they gave us our lifestyle, albeit one that eventually drove us into the ground. But what's that got to do with them? Nothing. After all, they're just mere bankers merely doing their job.

Of course Wall Street knew they would be bailed out. Banks like Wells Fargo or Bank of America probably acquired absolutely toxic waste dumps like Wachovia or Merrill Lynch just so they can strengthen their case as a TARP recipient. Congress knew that; they're not stupid, and that's why they're smart enough to know they have to bail out the banks to protect the American Dream. Or what's left of it, anyway, and if only for a little longer.

The party isn't over yet but it's about 3:45am and ticking, and all poor Obama can do is play the angry father role to appease the common man. While Wall Street won't have the biggest bonuses this year, it's good enough for sixth place overall. Not bad for last call. But for me, in spite of all the doom and gloom of 4am, kicking out a bunch of disgustingly rich bankers onto the merciless streets of unemployment would hardly be the worse thing imaginable today.

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Part 1: Our Anemic Economy, the Question of How Versus Why

In his inspired article the anonymous columnist Spengler at Asia Times Online looks at why the state of our economy is as it is. His commentary is refreshing because he examines the question of 'why', not the mainstream question of 'how'. For instance, most people today understand that our economy ran on a hollow and deep sub-prime housing bubble, and that's -how- our lifeblood of capitalism had been draining out (well before it went primetime in 2008). But -why- did this happen? Without understanding that, we're bound to repeat the same mistakes.

Spengler offers this answer: it's because people run the markets, but in turn the markets ran the people. That's why everything happened, plain and simple. Before the explanation, let's beef up the context some.

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• How: the sub-prime real estate bubble;
• Why couldn't they see there was no there there? (i.e., investing so much into something that can innovate very little beyond the balance sheet nor create new products. By contrast the tech bubble yielded much good, that's how you're reading this post.)
• How: complacent regulation and monetary policy, whereby they spun gold from straw;
• Why do that, when it's obvious that gold one day reverts to mere straw?
• How: a sophisticated financial playbook that can pad balance sheets;
• Why do that, when you're just scrupulously transferring your problems to another part of the ecosystem?
• How: an entire generation of borrowing for mass consumption, a spree with the world's savings to spend;
• Why do that, when you probably knew that credit was leveraged by fatally sub-prime assets?
• How: Wall Street, Alan Greenspan, Ronald Reagan, Margaret Thatcher, GWB (for the masses haha), Bill Clinton, bankers;
• Why guys, why?

Notice that each 'how' explanation begs the question why, and that you can endlessly revolve around these mainstream explanations and still gain little insight into why it all happened.

Mr. Spengler is a pro at doing just that. Among the most big-picture conservative commentators I've read on this subject, his conceits are exquisite enough to warrant attention. Spengler would say that up to this point, we've been looking for the reason -why- in all but the most obvious place, which is in the mirror. For him and like-minded peers, the reason why our economy gets anemic lies in the basics, in how people behave and interact with the market.

If you ever thought that well, maybe everyone was just greedy, then you're on the right track. Chances are you probably have (duh), but it's a bit more complicated than that. Actually we all know and accept that greed is part of the capitalist game, and in fact can inspire great productivity. And so with eyes wide shut, we institute greed as our market incentive structure with the singular purpose of spurring better and higher profits. Through all our ups and downs, it's worked so well so long so many times.

And here's the catch: the market can't natively tell right from wrong. In fact, if the wrong-thing-to-do results in the fattest profit margin, the market will go ahead and call that a winner. Markets only know how to punish incompetence and inefficiency; their only job is to organize and mobilize resources as efficiently as possible according to the rules of the road. So by design, markets are morally neutral and can't control if good guys or bad apples set those rules of the road, and nor should they if you want to make real money and/or stay in business (think Chinese sweatshops).

You see where this argument is going. As Spengler succinctly puts it, "if moral rot has taken hold of a society, the market mechanism will take it to hell faster and more efficiently than any of the alternatives." In other words, even a market economy that's fundamentally sound (a la McCain) can become a race to the bottom very quickly. It happens because people run the markets, but then in turn the markets run the people.

Let's say you are the boss of a top-tier investment bank who exhibits impeccable moral integrity. And let's go out on a limb and say that you responsibly foresaw the disaster of 2008. That is to say, let's give you the benefit of the doubt and say you surmised that some Wall Street geniuses figured out how to supercharge their balance sheets. Those geniuses were then able to claim profit margins far fatter than they could in an alternate universe called Reality. Because you knew this was the wrong thing to do, you willingly chose not to supercharge your own balance sheets because it was the right thing to do. You knew that things would turn out to be a race to the bottom, because you knew that gold spun from straw is still straw. You just didn't know how much time that scenario would take to unfold.

But before you can see your prediction play out, you will be punished by the market because that's what markets do: punish inefficiency and incompetence as measured by profit. Pretty soon, you, your staff, and your shareholders would be out of decent payouts because your margins couldn't hang with the big boys. Soon thereafter, pressure will mount for you to get in the game or hit the road. You are forced to realize that your duty to compete in the market comes before your moral discomfort. Telling yourself that you're not breaking any laws anyway, you supercharge your balance sheets like everyone else and just hope that things will work themselves out in the market as they always have. In the meantime, all your subjects seem to be happy and your job is secure. What else can you do anyway?

And just like that, the race to the bottom has a new entrant and thereby propagates itself to live another business cycle. And the market is happy it did its job.

That's how when people run the market, the market ends up running them. To Spengler, this systemic interaction between people and the market is -why- things came to a head in 2008. And so he joins the chorus of conservative voices today that blames our anemic economy on the moral rot of individuals, rather than concede anything is wrong with their economic fundamentals per se. Some would say that this is just a politically expedient explanation, but the conservatives do have a point (especially at the pen of Spengler). In the year of Bernie Madoff, moral rot in the market is probably something that conservatives and liberals can agree on. Their eternal conflict is in how we go about fixing it: do we fix the people, or do we tweak the system? (I say both)

Spengler elegantly lays out his prescription in said column, and I find myself in full agreement. Nonetheless, in Part 2 of this series I'd like to pick a bone with his prescription, namely that it cannot possibly work. Stayed tuned! It's coming whether you like it or not.

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