A Gathering of Donkeys at the “Genteel Surroundings of the Great Hall of Kings College”

Last week, the inaugural meeting of the Institute for New Economic Thinking was held in Cambridge University.

Gillian Tett attended the meeting and covered it for the readers of the Financial Times:

In the genteel surroundings of the Great Hall of Kings College, Cambridge, dozens of the world’s leading economists conducted an earnest conference on the future for economics, partly funded by Soros’ $50m largesse. One of the central conclusions of the day was that economists and market traders alike needed to devote far more time to human psychology, rather than just the raw economic numbers beloved by so many policy wonks.

So, the aim of the seminar, with George Soros as its sugar daddy, was to promote the “behavioral economics” that has been making the rounds in the past decade – the word “new” in the title of the gathering notwithstanding.

The meeting produced some original and high quality thoughts.

Jeremy Siegel of Wharton compared the years prior to 2007 with the years prior to 1929 and noticed a similarity: In both cases the “risk premium” went down. This, he concluded, only makes sense if investors “convince themselves that the economy is stable”.

George Akerlof, a behavioral economist, said: “In good times, people trust. But in bad times, confidence disappears and that cannot be restored.”

Adair Turner of FSA said: “We need to recognise that humans are partly rational and partly instinctive.” Half angel, half devil, he might have added.

George Soros summarized them all: “Economic phenomena have thinking participants, natural phenomena do not ... [but] participants’ thinking does not accurately represent reality.”

Hmmmm. Participants’ thinking does not accurately represent reality.

I don’t suppose Soros meant that people involved with markets are mad; that would be embarrassing. He must have meant, rather, that the reality “in itself” is something different from what we comprehend; we cannot know the reality, he wanted to say. This is more than saying that the reality is unknown. It is saying that reality is unknowable. America's own European sophisticate skipped over 200 years of the development of philosophical thought in the West to reach the beliefs of the medieval monks, which he suggests should be the starting point of a new way of thinking about economics and finance.

***

A while back I wrote about the Walking Man and pointed out that Giacometti is depicting a man at the instant of stopping in reaction to something he has seen.

The key to understanding the work is the Walking Man's face, which is void of any expression . At the instant that we see him, he has not yet had time to analyze, contemplate, recognize or otherwise form an opinion about the object before him. These stages of mental engagement will come later – an instant, an hour, or a year later. Our Walking Man, as we see him, is not a Thinking Man. He has not stopped because he remembered or realized or thought of something. He has stopped because he saw something in the outside world.

What will come next?

If he recognizes the object – a river, an animal, a group of men running towards him – he would do so from experience, either his own or that of his fellow men.

If he does not recognize the object, he would have to “investigate”; thinking alone will not do.

Through observation and thinking, the Walking Man would learn only the immediate, outward properties of the object. But no amount of staring at the object and thinking about it will reveal anything about its essence. He has to get closer to the object and examine it.

The connotations of “investigate” and “examine” are clear: our Walking Man will have to take action . He could, for example, run an experiment: change the natural state of the object and force it to react to new conditions and relations, in consequence of which it will reveal new properties. There are other methods of cognizance available to our man. The point is that the conscious, purposeful interaction with the outside world is the beginning and condition of the knowledge.

Knowledge is the reflection of the outside world in human consciousness. But such reflection is not passive or mechanical, a mere “mirroring”. It is “active” because it is interplay of the outside world and the man’s faculty of reasoning, interplay between the material world and subjective thought which arises from the purposeful and practical transformation of the real world by men.

But how could our Walking Man be sure that his subjective thought process accurately reflects the essence of the object, the thing “as is”, or “as God sees it”? After all, his thinking takes place through abstract, a priori notions such as cause and effect and time and space that do not seem to depend on experience. If his thinking depends on these subjective constructs, what assurance is there that he will be able to understand the true essence of the black cube, that Thing-In-Itself?

Thinking is subjective. And it does take place through a prior notions. But these notions, far from being independent of experience, are the controlling forms of experience as reflected in the human mind. They are the framework through which humans perceive the world.

It is precisely the interaction of the material world and subjective mind that is knowledge, or the search for Truth. There are not two sets of knowledge, one, “true” nature of the world, the Thing-In-Itself and the other, its reflection in human mind, the Thing-For-Us. Knowledge, rather, is the dialectical unity of these opposites. Truth is the process of interaction between the material world and the subjective mind. It is the truth of this relation, the Identity of Thinking and Being.

Truth, then, is absolutely relative because it is a process of becoming. It constantly evolves towards a higher stage, as we discover more interconnectedness. At the same time, it is relatively absolute in the sense that, with respect to a given set of conditions, it describes persistent and stable relations. The Newtonian mechanics is absolutely true within the confines of Newtonian mechanics. So are the relations of quantum mechanics within its confines. But neither is, considered abstractly, absolutely absolute.

At each stage, within the given bounds, we verify the absolute truth of the relation objectively: by our ability to reproduce, exploit and recreate the objects under definite conditions. When we know all the qualities of a thing and the synthetic unity of its parts, we know its “essence”; there is nothing more left to know except that the object is outside us.

***

Everything I wrote above is a part of the Western philosophical canon.

(Eastern, too, as I will show in Vol. 5. For now, here is Rumi, with an impossible brevity, in 14 words in Farsi, and an impossible beauty and poetry that cannot be translated: You hold the pen in your hand and the entire universe is a view in front of you. Some attributes of that view you create [by drawing]; some you take in [by being there]. Let the Western philosophers struggle to explain the interaction of mind and matter and the transformation of the material world by man!)

Yet, setting aside the enticement of the “research” dollars offered by Soros, none of the donkeys gathered in the Great Hall of Kings College knew anything about it. This is clear from the agenda of the conference and the utterances of its participants: In good times, investors “convince” themselves that the economy is stable. In bad times, they convince themselves otherwise. Just like that.

We say nothing by saying that man is the cause of what takes place in the world. That statement is self-evident enough. It is akin to saying that the “cause” of airplane crashes is gravity.

Man is the ultimate economic agent, it is true. But he does not act in a vacuum. He reacts to the objective conditions in the outside world.

I began this blog with a 10-part series on the current crisis. In Part 1, I wrote:

The events leading to this seizure have been covered in detail from many perspectives but always within the same prescribed framework: the crisis as the culmination of a series of unfortunate events set in motion by (choose your emphasis) greedy traders, irresponsible lenders, foolish borrowers, sleeping-at-the-switch rating agencies and feeble regulators.

The focus on the human element makes for good storytelling and has an evangelically uplifting bent that is appealing: If only the bad guys were to be replaced with good guys – something definitely in the realm of possible – the wrongs will be set right. The fault, dear Brutus, is not in our stars, but in ourselves!

Such takes on the crisis are not inaccurate; they are irrelevant. The subject matter of finance is not people; it is capital in circulation. It is silly to point out that “ultimately”, things happen in markets because people take actions; capital as a thing cannot trade or structure deals. People, however, do not act in a vacuum. They act on the basis of what they see and perceive in the market, which is another way of saying that their actions are shaped by the dynamics of capital – the form and pattern of its movement in the market. This movement takes place according to the objective laws that rise and operate independent of the actions of individual agents. To the extent that these individual actions also affect the markets, such effect is secondary.

This theme is present in many of the posts on this blog, most recently here and here.

I will have more to say on the subject on Vols 4 and 5.

A Sad Justice

“What really for me marks a conservative judge is one who doesn’t decide more than he has to in order to do his own job. Our job is to decide cases and resolve controversies. It’s not to write broad rules that may answer society’s questions at large.”

Thus spake Justice John Paul Stevens of the U.S. Supreme Court on the eve of his retirement from the bench.

What a fool. What a waste. What an ass.

A few pages later, under the heading “School Law Clinics Face a Backlash”, the same New York Times reported how, after these clinics “go after powerful interests, lawmakers get involved”:

Law school students nationwide are facing growing attacks in the courts and legislature as legal clinics at the school increasingly take on powerful interests that few other nonprofit groups have the resources to challenge.

On Friday, lawmakers [in Maryland] debated a measure to cut money for the University of Maryland's law clinic if it does not provide details to the legislature about its clients, finances and cases.

The measure, which is likely to be sent to the governor this week, comes in response to a suit filed in March by students accusing one of the state’s largest employers, Perdue, of environmental violations.

Yet, the man who sat on the bench of the Supreme Court for 35 years, deciding matters of life and death – of individuals, communities, societies, customs and habits – sees his role as that of a clerk and a referee, of merely “resolving controversies” and not “writing broad rules that may answer society’s questions at large”.

Another simpleton who scorns “social engineering”.

I am the clerk. I am the scribe, not understanding what I hear, not knowing what I write.

What explains this mentality – this limiting quality, really?

The answer is the absence of self-criticism, that not “watching oneself”. “To the extent that I look back at earlier situations,” the judge told the Times, “I really don’t think I’ve changed all that much.”

John Berger, in his masterful novel on the exposition of art, A Painter of Our Time, writes:

[A]genius ... watches himself. That is the largest part of his technique, and it is what separates him from others. We all forget continually. The genius, because he watches himself, remembers. He naively remembers his dreams, he ruthlessly remembers his real experiences, and gradually, very gradually, he learns to remember the exact nature of his mistakes and successes as a man applying paint to a flat surface. And so he recognizes what others have felt but never known. Technique and genius are nothing more nor less than that recognitions.

The point here is not to criticize an old clerk; merely to emphasize the importance of being continually self-critical. Such vigilance gradually brings about a broader comprehension of events; we see how they all are connected.

That stage of comprehension is the material basis of a theory that is no longer an intellectual pursuit or a parlor game but a weapon.

When the Fed People Act Responsibly

Dialectics is the investigation of the relation between the whole and the part. In the past couple of times that I wrote about the illegality of the Fed’s actions, I put them in the context of a larger development of social decay.

But there are also the parts. Like the individual lines in a painting or sentences in a story, they shape our comprehension of the big picture.

On Thursday, under pressure from Congress, the Federal Reserve Bank of New York released more information about its holdings. I am quoting a few passages from a related Wall Street Journal article, followed by my comments in blue.

• The Federal Reserve Bank of New York lifted a veil of secrecy on the troubled mortgage assets it purchased as part of the 2008 rescue of Bear Stearns Cos. and American International Group Inc.

That’s very good. We’re all for transparency. What did the newly released data show?

• The data show the government is now in the same situation as many U.S. banks: dealing with a portfolio of loans and property that have lost their value, and which borrowers are struggling to pay off.

No surprise there. Unloading junk unto the Federal Reserve is like throwing garbage in the ocean. The garbage might not be in front of your eyes, but it is there in the environment and will be returned to you in due time.

• For months, the regional Fed bank has been under pressure from lawmakers to make public details of the assets in three special-purpose companies that were created to take on roughly $80 billion in troubled mortgage positions previously held by Bear Stearns and AIG ... As of the end of 2009, the New York Fed was owed about $62 billion by three Maiden Lane vehicles.

The New York Fed has invested $80 billion in troubled “positions”; the paper cannot bring itself to call them securities. Now if you invest $80 billion in fixed income securities, you should be “owed” $80 billion. But the New York Fed is owed “about” $62 billion. The missing $18 billion must have been straight write down, money down the rat hole, as explained next.

• One loan controlled by the government is $12.75 million in financing Bear Stearns provided to the owner of the 167-room Radisson Hotel in Jacksonville, Fla. The hotel is owned by a venture controlled by Philadelphia real-estate investment company AMC Delancy Group Inc. Kenneth Balin, AMC chairman and chief executive, said he believed Bear provided the loan with plans to include it in a debt pool known as a securitization. But that never happened, leaving Bear, and now the government, with the note.

Bear Stearns provided the loan with plans to include it in a debt pool known as securitization.

In case you don’t follow the technical jargon, Bear Stearns lent $12.75 million to AMC Delancy group without, no doubt, much of any review or analysis. Why? Because it was planning to bundle the loan with other equally shaky loans, say one for $12.25 million and another for $25 million, and sell the pool, now a “callateralized debt obligation or CDO” for more than its par value of $50 million, to say, $55 million. That is what Countrywide also did. And Citi. And Washington Mutual. You get the idea. That is what drove the “boom” that preceded the crash.

Alas, all the good things must come to an end. Bear went under before it could sell the junk to the public.

• Mr. Balin said that loan was used to refinance debt borrowed in 2004, when it bought and renovated the hotel property.

This is the confirmation, if any was needed, that the current “note” is a junk bond that replaced another junk bond. The interesting thing is that the Journal does not say when the refinancing took place. My guess would be sometime in 2006.

• Mr. Baling said that, so far, he gives top marks to those overseeing the loan on behalf of the U.S. taxpayer. “The people that are handling this note are behaving responsibly,” Mr. Balin said.

Here, the Journal abdicates its responsibility of honestly reporting the event by not telling us the Mr. Balin winked. In fact, it adds a wink of its own by bringing in the U.S. taxpayers.

Nasser, but you were not there. How do you know that he winked?

The man must have winked because he is mocking us.

He has a $12.75 million loan that he cannot repay. But the original lender is gone and the loan has somehow ended up on the books of the Federal Reserve Bank of New York, which “oversees” it. And what a marvelously accurate word that is, the “oversee”, the ultimate mot juste.

You see, the New York Fed cannot foreclose the loan, else it would be in possession of a Florida hotel. No one would buy the loan because it is junk. So, what other option is there if Mr. Balin is not paying, which he is not? The answer is, Nothing. The bank has to oversee the loan, the way a loyal agent would oversee an estate, until such time that Florida real estate market recovers. Then Mr. Balin would approach the Fed with an offer that the bank cannot refuse. He will buy his note at some deep discount and the New York Fed would announce another step towards the anxiously awaited goal of reducing its balance sheet.

• Noting guest-satisfaction surveys, Mr. Baling added: “It’s a beautiful hotel”

I told you, the man is mocking us.

One critical item that I do not understand is how this note ended up on the balance sheet of the New York Fed. I thought that Bear Stearns was taken over by JPMorganChase, so this security should have been on the bank’s balance sheet.

But that is not entirely accurate. Come to think of it, I actually do understand.

Surmising Bernanke’s Personality

I was a taken aback when I read in the Wall Street Journal that the Federal Reserve Board had a “director of fine arts program”. It was like learning that the Islamic Republic of Iran had a chief sommelier. You don't quite know what to make of it.

Apparently, both the office and the title are real. A certain Ms. Goley who was in charge of the program for over 30 years had written to the Journal to offer a window into Bernanke’s character from his taste in art. She concluded that the chairman is “creative, innovative and flexible”.

Ms. Goley thinks that these are unconditionally positive adjectives.

But if I have said it once, I have said it a hundred times that nothing exists out of context. Think of corporations using “creative accounting” or politicians who are “ethically flexible”. As for “innovative”, it might be an admirable trait for an architect or a teacher, but what does it mean when applied to a central banker?

When applied in the context of what transpired in the past three years and Bernanke’s role in the events, Ms. Goley’s adjectives describe a man who plays ball, someone who can be counted upon to find ways to accommodate those who must be accommodated.

Now, I don’t know Bernanke personally. But I figured out all these personality traits on my own. See, for example, here, here and, most recently, here.

These people are functionaries. They are not particularly complex characters. You can read them like an open book from the evidence of a single newspaper article.

The Meaning of “System” in Systemic Risk – Part 2: Breakdown of the Law

In the Letter to Mr. Baxter, I touched upon the legality of the Fed's bailout of AIG. The bill currently stands at $182 billion.

Because AIG is a financial institution and the Fed, in the popular understanding of its function, “deals” with money and financial institutions, the matter, when noticed at all, has been given a short shrift. Baxter – recall he is the general counsel to the New York Fed – was not pushed on the subject in his testimony before a House Committee investigation of the crisis. And he used a lawyerly sleight of hand around the word “authorize” to skirt the issue:

On September 16, 2008, the Board of Governors authorized the New York Fed to lend up to $85 billion to AIG through a secured revolving credit facility.

And then again:

In November 2008, the Board of Governors authorized the New York Fed to take a second step to alleviate these pressures.

These statements are technically accurate, but they do not address the central point, which is: the Federal Reserve Board did not have the authority to authorize the New York Fed to bail out AIG.

This point is critical. The Board of Governors of the Federal Reserve is a creature of statute. It can engage only in activities for which it is specifically authorized and nothing else.

The Board, as one example, does not have the authority to have someone executed.

The Board, as another example, does not have the authority to grant Bernanke the right to ignore traffic laws.

Likewise, it does not have the authority to authorize the New York Fed to pay the outstanding balance on my mortgage.

And it does not have the authority to authorize the New York Fed to pay $180 billion to AIG and its various counterparties.

Yet, that is precisely what it did. The justification, as per Counselor Baxter, was preventing a catastrophic systemic collapse:

The policy decision to authorize a loan to AIG was a difficult one ... Nonetheless, the potentially far-reaching consequences of an AIG bankruptcy compelled policymakers to take affirmative action ... Last month, Chairman Bernanke observed that the Federal Reserve did not lend support to AIG for the Fed’s own benefit, “because it obviously has hurt the Federal Reserve in the public’s view. We did it because we felt that there was no other way to avoid what [many] have called the risk of a catastrophic collapse of the financial system.”

You recognize the argument. It is Jack Bauer’s: had to torture the man, else Los Angeles would have been destroyed. (Just ask Antonin Scalia!)

The Fed, likewise, had to do it to save the system. There was no self-interest. Only selfless service, in consequence of which if Bernanke and the Fed are criticized, so be it. That is the fate of the true patriots. Just ask Jack Ryan!

This is the perverted reincarnation of the “general good” idea that the French Materialism in the West – and long before them, Sufis in the East – thought was the driver and the guiding principle of morality.

In its debased reincarnation, the greater good is now the least harm. It is no longer the question of bringing the greatest good to the greatest number of people but minimizing the damage from the catastrophic effects of some crisis. Crisis is the starting point and the driver of the narrative. Like bad weather in the opening scene of a play, it is given and must be accepted as such. And it sets the stage for what is to follow.

But the crises we are discussing are man-made. They are different from floods and hurricanes because they develop from, and within, the social system. By “develop" I mean that crises come about as a result of the logical progression of the events within a “live” system; the social body produces them the way the biological body produces cancer. They are the materialization of internal growth gone bad, the consequence of the body having turned against itself.

Countering crises, then, requires interfering with – disrupting, destroying and weakening – the regular functioning of the system. Because a civil society functions within the law and is sustained by it, it follows that countering social crises necessitates breaking the laws that hold the system in place. In this way, through crises, the focal point of the coming together of all internal contradictions of a system, we arrive at the final contradiction where the attempt to save the system from immediate collapse weakens its foundation and undermines its long term survivability. It is the old “destroying the village to save it” that has come back to haunt and taunt the inventor, not that a functionary like Baxter would know or even suspect that.

In speaking of the breakdown of laws, it is clear that I am not talking about common lawbreaking by ordinary citizens or the usurping of dictatorial powers by this or that strongmen. What I am discussing here is the dislocation of the legal system in its entirety, the wholesale unraveling of the Anglo-Saxon jurisprudence.

The chief characteristic of this phenomenon is that it is institutional and system-wide and yet, not organized. If it were organized, in the sense of being consciously directed from a political command center, it would be a revolution. But it takes place through sporadic events with no obvious connection to one another. Torturing a suspect to learn of the location of a “ticking bomb”, dismissing the Magna Carta as “quaint”, dispensing $180 billion without having the authority to do it – such are the instances of manifestations of a breakdown.

(Lawbreaking is an anti-social act, which is why the functionaries who are attracted to process are stigmatized. The public correctly recognizes them for the doers of the dirty work that they are. Even Hollywood and TV programs which must sell these new elements to the public must relegate them to a different, "anti-hero" category, separate from the traditional heroes.)

On the surface, these matters seem to be removed from finance. They are more in the realm of politics, social science and national security. But facts are not isolated to events.

In Decline of the West, Spangler writes: “What concerns us is not what the historical facts which appear at this or that time are, per se, but what they signify, what they point to, by appearing.”

I suggest we need to go even further. The important point is not what historical facts point to by appearing but why they appear in the first place. If that question is answered, the question of where the facts point to will be self-evident.

The culprit in the breakdown of the law is finance capital. Because it can no longer function – i.e., generate profit – within the historically established legal framework, it moves to dismantle the “whole intellectual edifice” in the attempt to create a "living space" for itself.

I am not overstating the case.

Observe this ruling by the three-judge panel of the United States Court of Appeals for the District of Columbia Circuit that found, according to the New York Times, the presidential war power to detain those suspected of terrorism [without trial] is not limited even by international law of war. Judge Janice Rogers Brown wrote: “War is a challenge to law, and the law must adjust.”

The law must adjust.

If that statement strikes you as nothing particularly out of the ordinary, you, too, have been softened by the assault of finance capital.

By way of comparison, look at this ruling of the Supreme Court in the 1866 in the Ex Part Milligan case, where a civilian detained during the Civil War had been denied a civilian trial. The justices of the Supreme Court described the rules applying to men in the military and went on to add:

All other persons, citizens of states where the courts are open, if charged with crime, are guaranteed the inestimable privilege of trial by jury. This privilege is a vital principle, underlying the whole administration of criminal justice; it is not held by sufferance, and cannot be frittered away on any plea of state or political necessity. When peace prevails, and the authority of the government is undisputed, there is no difficulty of preserving the safeguards of liberty; for the ordinary modes of trial are never neglected, and no one wishes it otherwise; but if society is disturbed by civil commotion-if the passions of men are aroused and the restraints of law weakened, if not disregarded- these safeguards need, and should receive, the watchful care of those trusted with the guardianship of the Constitution and laws. In no other way can we transmit to posterity unimpaired the blessings of liberty, consecrated by the sacrifices of the Revolution.

Comparing the two rules, one is compelled to ask: What changed in the past 150 years to give rise to these diametrically opposite views of the U.S. Constitution by professional judges?

The answer is that the position of civil society in the timeline of history changed. One ruling belongs to the era of construction and ascent, when immediately after the Civil War, the U.S. was poised to become a great industrial power.

The other belongs to the era of destruction and descent, where the established business models and economic theories and even the moral and ethical standards are no longer functional. So, the “system” in systemic risk is the civil society itself. Even those without a theoretical clue can somehow sense it. So, for its review of Paulson’s book, The Wall Street Journal chose the heading Present at the Destruction, the exact wording that I had used for one of the postings on this blog in a different context.

The unraveling of the system is a process. The Supreme Court justices in the Ex Part Milligan case understood this when they wrote about “transmitting to posterity ... the blessings of liberty”.

When the legal foundation of a system begins to decay, the transmission to posterity of the blessing of liberty slows down. This, the vile usurer of the Merchant of Venice understood better than all the Supreme Court justices and moral philosophers who were to follow him:

And by our holy Sabbath have I sworn
To have the due and forfeit of my bond
If you deny it, let the danger light
Upon your charter and your city’s freedom

And later:

If you deny me, fie upon your law!
There is no force in the decrees of Venice.

Look how modern his use of the word “freedom” is. He uses it in the context of enforcing a bond’s covenant. The Anglo-Saxon jurisprudence, I pointed out in Vol. 3 of Speculative Capital, has its foundation in “the commercial consideration of the early stages of capitalism in England. So the system had to be flexible to allow for commercial eventualities”.

When even this flexible system gives way under the onslaught of finance capital, more than the legal and financial system is in jeopardy: it is the social system that encompasses them.

That is the meaning of the systemic risk: the social system being unable to reproduce itself.

Parsing the Categories of Necessary and Accidental By Means of Mortgages

In the past three years, I have looked high and I have looked low, but never – not once – have I seen even a hint of a reference to the conscious, premeditated and deliberate destruction of Fannie Mae and Freddie Mac that set the stage for the ongoing crisis.

Everyone was involved in the conspiracy: The Wall Street Journal, The New York Times, Alan Greenspan and his Fed machinery, Wall Street, chief executives of financial conglomerates. I chronicled the destruction in a two-part series on this blog, here and here and in a subsequent epilogue. If you have not read them, I urge you to do so. In light of what has transpired, they read even better today. And more evidence keeps coming in.

Look at this admission from today’s New York Times. It comes from the paper’s real-estate section:

But many of guidelines that New York City apartment buildings don't meet have been in place for years. Fannie and Freddie guidelines have long held, for example, that no single person or entity can own more than 10 percent of the units in an established condo or co-op building. During the boom, that didn’t matter much. Investors were hungry to buy bundled residential mortgages, and banks could bypass Fannie and Freddie and sell the loans elsewhere. Now, Fannie and Freddie are by far the biggest games in town, so on conforming loans, their rules are gospel.

During the boom years, that didn’t matter much.

“That” is the defenestration of the rules and conditions for mortgage qualification, so that a Mexican strawberry picker in California who did not speak English and had made all of $14,000 the year before, would not get a $700,000 mortgage – which he did, courtesy Countrywide.

But more important is the phrase "during the boom years". How did the boom years come about in the first place?

The answer is: by banks and mortgages companies getting together to deliberately and consciously destroy Fannie Mae and Freddie Mac whose strict, “gospel-like” borrower qualification conditions stood in the way of unqualified borrowers getting a mortgage.

Here is the seed of the conspiracy, as reported by The Wall Street Journal. I do not provide a link because the paper requires subscription, but it is from March 9, 2001, page A2.

A coalition of chief executives from more than a dozen large financial institutions has decided to press for reform of Fannie Mae and Freddie Mac, even as another company joined in accusing Fannie Mae of threatening to take business from critics.

The decision to seek a review of the way the government-sponsored mortgage giants conduct their business was made two months ago at a meeting in Amelia Island, Fla., of the Financial Services Forum… The group, an intentionally low-profile organization of chief executives from the country’s biggest financial companies, backed the successful effort to repeal laws separating the banking and securities industries, and has also endorsed an overhaul of the federal bankruptcy code that now appears imminent.

Tensions have risen in recent years between the mortgage companies and other financial-service concerns amid fears that rapidly growing Fannie and Freddie would diversify and take business away from other companies.

Now, place yourself, if you will, in early 2001 in Amelia Island, Florida. George Bush is at the White House. You are the big shot executive of an important financial institution: a Sandy Weill, a Hank Paulson, a Richard Fuld. You have just arrived by your private jet to Amelia Island. The world is your oyster. Everything is yours for the taking – money, women, favorable press coverage, sycophant journalists.

Your institution needs to generate even better and steadier profits. Borrowing at the commercial paper rate of about 2 percent and buying mortgages that yield 6% is the best game in town. That is 4% profit margin without doing anything and God Bless America.

Your borrowing power has virtually no limits. But you need mortgages to buy with the borrowed money. And Fannie and Freddie rules stand in the way. So, what would you do?

As an individual with free will, you could certainly walk away. You know by training, by instinct, and by logic – however arrested the three might be – that ultimately no good could come out of weakening and then breaking the lending standards. You are a financial executive, for God’s sake. All you have to do, then, is walk away and let Fannie and Freddie be.

But could you, realistically speaking, walk away, just say No? Would you be there, in the first place, if you were the type or person who would/could say No?

Now you see in what sense the developments in the world of finance can be said to have a direction and an “outcome”. It is precisely the free will of individuals, which, through being capable of being shaped, acts as the medium and agent for the manifestation of the laws of economics and finance. Which is why I often repeat that the subject of finance is studying the laws of movement of capital in circulation – and nothing else.

The U.S. Senate Exempts Payday Loans from Regulation

Today’s New York Times reported that “Payday loans get exemptions in Senate bill”. No surprise there. That was/is par for the course. Just a few comments on the subject:

• In a payday loan, you receive an immediate cash loan against your employment paycheck. The rate, according to the Times, is generally around 400%. But if you count late fees and rollover fees, the rate is about 600%.

• Who borrows under these conditions is clear: the absolutely, totally desperate. The Times said that payday lenders charge “exorbitant fees for low income consumers with little financial sophistication.” But that is The Times maligning the poor. I’ll match the financial knowledge of any payday borrower against any Madoff “investor” any day. It is just that the poor are desperate. They have no option, no choice. So they yield.

• The Times made it sound like one senator, Bob Corker of Tennessee, was the culprit behind the exemption. Don’t you believe that spin. Everyone was involved. Dodd of sophisticated Connecticut, the chairman of the Senate Banking Committee, “went along in an effort to reach a bipartisan deal.”

• The name of the lobbying organization on behalf of the payday lenders is the Community Financial Services Association. I like the name, especially the way the word “community” is used. Reminds me of that old Twilight Zone episode when the main book of aliens, titled “To Serve Man”, turned out to be a cookbook

• ”Steven Schelein, a spokesman for the Community Financial Services Association, said the industry should not be dragged into regulatory reform.” Of course not. God forbid.

• ”In 2006, Congress adopted a bill ... to cap at 36 percent ... on loans to active-duty members of the military and their families ... The industry says a cap would be devastating to its profitability”. Note the wording. The cap would be devastating not to the industry, but to its profitability. Also, a 36 percent loan to “active-duty” members of the military is considered fair and reasonable. Imagine the Fed raising the interest rates to 1/2 of that, or a mere 18%. The entire financial system would come to an immediate halt.

Finally, the payday loans are not risky loans to bad credits, where the high interest rate would compensate for the potential high default rate. That is the junk bond business model. The payday borrowers have an iron-clad collateral: their employment paycheck, which they will receive at most in two weeks. So charging these borrowers 600%, now with the blessing of the U.S. Congress, is beyond simple robbery. It is also rape.