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I want to talk to
you about the stock market, because the stock market has been rising in
France and in the United States. I am obliged to reflect upon this, because,
as I have mentioned to you, I have agreed to prepare an afterword to a new
edition of several works of Proudhon concerning stock-market speculation. It
is important to understand what is happening at the moment. Does it mean that
the economy is improving? To that end we need to look back at the events of
the past two years.
In the summer of
2007 we witnessed the drying up of inter-bank credit, by which is meant that
the banks stopped lending to one another. I remind you that the reason for
this is that there was a depreciation, which began to become quite
spectacular from February of 2007, in the value of securities consisting of
large collections of individual mortgage debts, because many people were no
longer able to keep up their monthly repayments. Consequently, the value of
these securities plunged. In the summer an air of general suspicion arose
from the fact that banks did not want to reveal whether they possessed these
products, which could no longer fetch a price, because there was now no
market for them. Everyone in the world of finance suspected everyone else of
possessing these products and thus of possibly being insolvent. An
unwillingness to lend developed, as no one could be depended on now to be
credit-worthy.
I shall remind
you of the first measure that was thought of to deal with this problem: the
creation of what were known as ‘bad-value banks’ or ‘bad
banks’. The possibility was envisaged of putting toxic derivatives into
a form of quarantine so that the banks could get them off their balance
sheets. So ratios of solvency were worked out, to see whether they were above
or below the threshold of solvency. What happened, as has recently become
known, is that the British, who were in much the same position as the
Americans, came to the conclusion that it was impossible, as it would be too
expensive.
The second idea,
which was adopted in previous crises, is known as ‘privatization of
profits with socialization of losses’. This solution, which had always
worked very well before, means that the private sector gets whatever profits
there may be when things are going well and then, when things go badly, the
state, i.e. the taxpayer, forks out to cover the losses. The novelty in the crisis
in which we find ourselves now is that this classic solution can no longer be
considered, as that too would have cost too much, the level of debt which had
been incurred having exceeded the capacity of states to absorb it.
So it was decided to adopt a direct approach which would be less
expensive and which consisted in giving money to the banks to help them out
of their difficulties. Together with this go what are known as ’stress
tests’. You will have heard of the ’stress tests’ that have
been carried out on banks in the United States and are to be carried out in
Europe too in order to determine which banks may be declared to be solvent.
This is nothing but a big public-relations exercise, in fact, as these
’stress tests’ are actually normally carried out all the time.
They have always been carried out everywhere in point of fact. So this great
pantomime has taken place to persuade people that the banks are now in better
health following the recapitalization exercise and that they are now out of
trouble.
What has not been
taken into consideration is that in the background the economic situation has
been continuing to deteriorate. The deterioration resulted from problems in
the financial sector, which have led to redundancies, and created a state of
affairs in which there are fewer and fewer people who are drawing salaries
which are adequate for the purpose of keeping up their monthly mortgage and
credit-card payments. The situation in the American property market has
continued to deteriorate, not only in the residential sector but also in the
commercial one. Problems are developing concerning credit-card loans and all
the other loans that build up in American households, student loans, health
costs and so on and so forth. So, after having made all of these
’stress-test’ declarations following the recapitalization of the
banks, circumstances have changed for the worse to such an extent that, if
the ’stress-test’ calculations had been carried out all over
again, it would have been found that the banks had again fallen below the
threshold determined by the solvency ratio. So what could be done?
There was, in
fact, only one solution. Because results had been adversely affected by the
depreciated value of toxic securities when they appeared on the surface, all
that was left to be done was to start telling lies about the value of these
products. ‘Mark to Market’, i.e. valuing them at prices which
real transactions would have resulted in - the market price of these products
- would have meant valuing them at prices which would have been too low. If
these prices had been mentioned in the results of the businesses, these
financial institutions would almost all have been seen to be what they were
in reality, insolvent!
There was only
one possible approach to adopt, and this was to modify these figures to make
them seem better than they actually were. The solution which was conceived of
for this is what is known as ‘Mark to Model’, i.e. a system of
model quotes, which means that, instead of using market prices, one conjures
up a scenario in which it appears that all is well in all the markets and
then one sells these products on just as they were sold on before. This does
not solve all the problems, of course, because, if in the background people
are still not managing to meet their monthly repayment obligations, the
prices of these products will still go down. But the idea is that this will
all sort itself out in more favourable economic
circumstances so that the prices will be a lot better.
Was it
permissible to do any of this? No, it was not, because rule 157 of the FASB
(the Financial Accounting Standards Board), the US institution concerned with
accounting rules, prohibited it. So what did they do? The American
Bankers’ Association put in place something that they called the Fair
Value Coalition. This organization was allocated $27 million, which was used
to pay members of the US Congress concerned with the Finance Commission to
get these politicians to invite the FASB people to appear before them to be
told that they would have to change this rule, and this is what happened, in
March.
Is all of this
public knowledge? Yes, it is! It was all discussed on the front page of The
Wall Street Journal. On the front page of The Wall Street Journal there was
even an article which even went so far as to specify the exact sums of money
which were paid by the American banks to these members of Congress who are on
this finance committee to get them to take this decision. One should add that
this sort of thing is not against the law in the United States. These are
considered to be contributions which the business community makes to the
electoral campaigns of these politicians. So what do these politicians say
when they are reproached for having sold out to Wall Street? They issue press
statements to say that they have indeed received these sums of money but that
this has not influenced their decisions! Mr. Kanjorski, the congressman who
was at the forefront of the battle and who was the most forceful member of
the committee at its meetings, insulting, as he did, practically all the
representatives of the FASB, received over a period of two years the sum of
$704,000. I repeat that this is not secret information. It was on the front
page of The Wall Street Journal!
So that proposal
went through. What has it made possible? The banks have gone back up over the
solvency ratio. Why? Because they fixed the prices of these toxic assets not
at any old price but in accordance with calculations made on the basis of a
model which was established to put everything back so as to permit these
products to be sold “at a more reasonable price”, as the American
Bankers’ Association put it. So, when they tell us now that the stock
markets are doing well, it is indeed true that that is so. But in what
context are they doing well? In the context in which the figures are not
truly what they are represented to be!
Did they have any
choice in all of this? No, they had no choice, because, if they had continued
to calculate things as they were doing before, and, given that the money
available to governments for the purpose of assisting the banks is limited,
there was only one way to prevent the banks from being shown to be insolvent,
and that was to adopt the procedure which they opted for, which was to
falsify the figures!
What is the
problem with all of this? Everyone would have seen that the banks were
insolvent. They could hardly let all the banks go bust. Something had to be
done. They could have nationalized all these banks and wiped the slate clean.
They preferred that pressure be put on the FASB to change the rules, and
since then everything has been done in a fog of deception and distortion of
reality. On this basis stock markets are doing well. But what is the danger
in all of this? The danger is as follows. When it is said that it is
important that the banks get back to circulating money between one another so
that there is a supply of credit, etc. and that it is imperative that there
be confidence in the system, what is meant by confidence? That simply means
that a bank needs to know if the other banks that it is dealing with are
solvent or not. But now they no longer know, because they have all been told
that they may put on their balance sheets whatever figures they care to put
there.
So, even though
things are bad at the moment, stock markets can still do well, because
everyone knows that that is the established state of affairs at the moment.
But when a recovery begins, confidence will be needed. However, transparency
has been sacrificed. Transparency is needed, though,
so that people can know exactly what it is they are dealing with, etc. There
is more to it than that, as we know. As Proudhon observed, there is a lot of
insider knowledge that makes things work. We also know that volumes are
created at present by means of program trading which operates essentially for
the purpose of moving money about from here to there and back again to take
advantage of the fact that people can benefit from merely creating liquidity,
even if that liquidity is being eaten up as part of the same operations, and
so on and so forth. But, when things start moving again, if they ever do,
everyone will need to know what is what and whom to have confidence in for what
purposes. Unfortunately, however, the strategy which has been adopted makes
this impossible. Transparency has been suppressed, because falsification was
necessary, and that was necessary because the only alternative to it was
nationalization, which was not wanted.
So what is going
to happen when a recovery takes place? Only one solution is possible. They
will change direction. Another $27 million will be found to re-instate the
‘Mark to Market’ arrangement. Why? Because, when a new financial
bubble develops, market prices are more optimistic and everything seems to be
going well again. So that things do not continue in this way we must demand
that this system be brought to an end.
In America, even
though many people have buried their heads in the sand there, and in Europe
it is being observed that this state of affairs has got out of hand. Even
people whom one might have thought of as having a vested interest in what is
happening at present in the United States, as well as people such as myself, are saying that a proper recovery is not possible
given the present condition of the system. If it is not modified, there will
be no transparency, and consequently a proper recovery will not take place.
This system cannot proceed as it is. It is broken. We need to find something
else.
Paul Jorion
Paul Jorion.com
Also
by Paul Jorion
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