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Wednesday, May 25, 2011

Foreign Derivative Swaps

This is my first reform effort for the financial industry. I think it's thought provoking. The Americans for Financial Reform (dot org)posted a letter to the same committee stating a similar argument. I'll try to remember to link to it soon. The final concept here is that
finance has not contributed to prosperity, it has diverted our attention. It should be much smaller. The book The Great Financial Crisis is a good source of info that I should review (and I'm writing to myself, as usual). Written around May 12, 2011

To the U.S. Treasury,

Re: Regulations on international “swaps” and the exemptions rule.

This is my suggestion.

You are about to exempt international “swaps” from regulations in the Dodd-Frank Commodity Exchange Act. I object.

I surmise from my reading that the financial system is much too large, and the U.S. Treasury should do its utmost to reduce its size. I gathered the following facts from the book Epic Recession by Jack Rasmus, a professor at St. Mary’s College in northern California. He was commenting on the growth of debt in the U.S. since 1978, and he drew from Federal Reserve’s Flow of Funds Report, Q1 2009.
Total U.S. Debt, 1978 to 2008:
Government debt up 8.0 times (all are ‘78 to ‘08),
Total Consumer Debt (including mortgages) up 10.3 times,
Non-Financial Corp. debt up 9.4 times,
Financial Corp debt up 47.0 times. Financial corporate debt jumped from $412 billion in 1978 to $19.5 Trillion in 2008 — Federal Reserve Flow of Funds.
As Marshall Auerback wrote at New Deal 2.0 in May 14, 2011, “The whole boom of the last 25 years was predicated on financial deregulation, massive fraud, and a huge build up of private debt as a consequence of inadequate fiscal policy to generate full employment and rising incomes.”

I commented, “The huge increase in financial corporate debt had no matching component in real world investment. There were relatively few projects to fund, as the figures prove. But there were corporate mergers and buyouts, and CDO securitization and credit default swaps and financial engineering. Real financial intermediation which is the true function of finance and credit was replaced by financial engineering, and often that resembled gambling more than investing. How else can you explain the numbers that increased financial corporation debt by a factor of 47? Financial corporations’ profit as a portion of all corporate profit also grew, Our financial system has yet to resolve the “frozen negative assets” (a phrase ‘coined’ by H. Paulsen and B. Bernanke) that they hold, and housing prices are expected to decline another 15%. The losses must be faced and absorbed privately, not transferred to the public. Then we need an economy modeled on growth that serves the majority of citizens. “Mark to fantasy” has replaced Mark to Market. “Extend and pretend” is the new banking norm. Banks own over 60% of U.S. home equity since the recession stripped value from mortgage holders. But the book value which the banks show does not reflect the true, reduced value of these housing assets. As Auerback claims, the banks are still bankrupt.”

Another book that makes a similar argument is The Great Financial Crisis by Foster and Magdoff, two socialists. On page 20 they display a graph that shows from 1959 to 2007 two measures, “Debt as percentage of GDP” and “Total goods production as percentage of GDP”. From an index of where both items begin at 100 in 1959 the Debt figure rises to 250, the Total Goods figure falls to 65. “The search by capital for profitable outlets for its surplus despite the stagnation of investment opportunities within production, coupled with the belief that asset prices as a whole went only one way -- up --, generated a secular financial explosion.” But, they conclude with Karl Marx, “The real barrier of capitalist production is capital itself.”

Using the findings of another report we see much the same trend.
Thomas Palley (Financialization: What It Is, Why It Matters, PERI, U.Mass/Amherst, 2007) shows that financial corporation profits as a percentage of all corporate profits grew from 20% to 43% between 1973 to 2005 (Palley, page 37). Financial corporation debt as a percentage of GDP grew, 1973 to 2007, from 9.7% to 31.5%, increasing by a factor of 2.4 times (Palley, page 38) . Non-financial corporate debt decreased from 90.3% of GDP to 68.5% (Palley). Mortgage debt, 1973 to 2005 increased from 48.7% of GDP to 97.5% (Palley).

Palley's findings show a rapid growth of financial corporation debt (by a factor of 2.4), but not as rapid as the findings reported by Rasmus or by Magdoff and Yates (showing an increase by a factor of 6) in The ABCs of the Economic Crisis, page 77. The Magdoff and Yates figures align with the Rasmus figures. Perhaps Palley's definition of a financial corporation was more restricted, not including the 'shadow' banking corporations. (See also Palley's 2009 paper, America's Exhausted Growth Paradigm: Macroeconomic Causes of the Great Recession, for more analysis along this line.)

So, why ?, I ask myself, is the Treasury exempting “swaps” from regulation?

My suggestion comes from another book, The Keynes Solution by Paul Davidson. He proposes an International Monetary Clearing Union (IMCU). “All international payments, whether for imports or financial funds crossing national borders, would go through this clearing union.” (page 136) You can read the rest of the chapter for yourself. But I’ll shortly quote his three objectives:
1. Prevent a lack of global effective market demand for the products of industry from occurring due to liquidity problems whenever any nation holds excessive idle reserves by saving too much of its internationally earned income. . . .
2. Provide an automatic mechanism for placing a major burden of correcting international trade imbalances on the nation running persistent export surpluses.
3. Provide each nation with the ability to monitor and, if desired, to control movements out of the nation of:
a. Financial funds ... moved .. to avoid paying taxes on such funds.
b. Earnings from illegal activities leaving the nation.
c. Funds that cross borders to finance terrorist operations.

I want to remind you of a few uncomfortable facts: since Nov. 2009 one in four children in the U.S. get their food by way of food stamps, and now it is about 29% of all children, one in seven of all citizens, over 44 million. 24.1% of all households have “zero or negative” wealth or savings, probably almost one in three have less than $5,000. Our nation produces a GDP/capita of over $47,000. We have tremendous inequality. The top one percent now own 225 times more than the median household, an all time high. The median household has just lost over $40,000 (or 40%) in savings. (These figures come from Sylvia Allegretto’s report State of Working America, Wealth, published by Economic Policy Institute, March 2011.)

Inequality is widening, opportunities are shrinking, precarious security is infecting more and more. Various forces could tip the balance in catastrophic ways, which would really be tragic (food prices, gas prices, housing prices, more unemployment, disruptions). The people at the Treasury should have a bigger outlook than what I presently see. They seem to be protecting the private holders of financial assets, the status quo, the wealthiest people on the face of the earth who themselves created a monumental mess. The arrogance of the mighty creates suffering for those who did least to create the problem.

In addition to Foster and Magdoff, and Paul Davidson, and Sylvia Allegretto, I recommend you read the facts at, see the side-bar links to income and wealth inequality. I also have a blog,, in Feb. 2011 I posted a 6 point program. Raise wages, increase minimum wage, increase EITC, create public jobs, impose tariffs and quotas, emplace a values added tax on multi-national corporation’s imports. I just collected ideas from scholars and writers, it’s not my own creation. I will add a 7th proposal, drawing from Rep. Jan Schakowsky’s deficit reduction plan, eliminate the interest payment deduction enjoyed by financial corporations, a savings of $77 billion a year. Raise capital gains tax to normal marginal tax levels, and if sold before 12 months raise that rate to 70%.

Lawrence Mitchell wrote The Speculation Economy, a financial history centered around the 1900s when the stock market began to overshadow productive industry. Perhaps it is time to reel-in speculation. The world lost between 2007-2009 about $35 trillion (17% of all value) because incentives were poisonous, incentives that U.S. government officials nurtured. It’s time to think deeply.

I hope this gives you a glimpse of a new world of prosperity, justice, endeavor, and growing enjoyment of life. We should all be working less, doing art, visiting friends, but not worrying that the foundation is about to crack and sink into the Ocean of Chaos. The German worker works 9 weeks less per year, the Gini level in Germany is 25, not the 41 in the U.S. Time to humanize the system.

Yours, Ben Leet, I live in San Leandro, CA, May 12, 2011
I am a retired public school teacher, not an economist.

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