The issue here is one of investment banks acting as insurance companies without the necessary backup.

Liquidity has the characteristic of allowing much more boats (all kinds of companies) to float than without it.

Once the liquidity tide started to ebb, then companies began to falter too, defaulting on their debts, triggering credit default swap calls on the redemptions of these insured debts.

These were supposed to be covered by investment banks, AIG, and such, the sellers of these CDS, but, they don’t have the money to comply with their obligations –akin to Lloyd’s stating that they could not comply on an insurance call.

As a consequence, the seller of CDS, the company that borrowed and the bank that so freely lent, are all in big trouble.

In essence, bankers disguised CDS as financial instrument, which otherwise would’ve been considered an insurance policy on debts, to avoid the latter’s stricter regulations.

“According to Moody’s Investors Service, some $62 trillion of debt was protected by CDS contracts at the end of 2007. That number exploded from $10.2 trillion in June 2005 and represents the face value of the underlying debt. The face value would have to be paid to CDS buyers if all the underlying debt were to slip into default.”

My point is that there is at least that much fireworks under the shack that’s already on fire… If water doesn’t get here quick, this will be one hell of a new year’s.

And, yes… In that same basement you’ll find some other very flammable stuff, like subprimes, credit card debt… and the like.

So, it promises to be quite an unforgettable spectacle to experience, unless, you get too close, of course.

A couple of things that would have made this uesful piece even better:

1. There is never enough bank capital in a systemic crisis (i.e. enough to make gvt assistance redundant), becasue of th ambiguous nature of -especially US- gvt responsibility for the financial system. I say specially US bacause of the extreme level of ambiguity (it is not even certain that decidedly non-bank, and totally devoid of prudential regultion- entities like money mrket funds, are non-insured) and because of the global nature of USD based finance.
2. For some reason there has ben much attention for the politics of a specific solution (i.e. one that leaves the dominance of US firms in global finance intact (a mercantilist implicit seondary goal) without focsusing on the problem. Systemic crises feed on themselves, but as appears from widely accepted literature on the great crash of 1929 (for instance Friedman’s Monetary History of the US, systemic crises appear lrger than they really are and solving them may be simply more expensive than leaving them alone (not that I would propose this on the basis of the very little I can observe)
3. One would like to see a range of solutions, combined with a reasonable assessment of the consequences. This plan appears poorly costed and risks being still too little, as well as a feding frenzy for speculators and assorted white collar crooks..

Suppose you are a going concern that makes and sells cars at a profit. Positive cash flow and surplus working capital from retained earnings give you plenty of dough to buy steel, design new products, etc. I don’t think you’ve ever been in business, have you? Biggest users of CP are running on empty (”Just In Time” transposed from the shop floor to the treasury function). Sigh. GE has been stripped of working capital at this point, trying to flip every penny of “excess cash flow.”

The Fourth Branch of Government

The US government (and many others) is divided up into three branches: executive, legislative and judicial. This was a bit of an innovation when it was created since previously the concept of government as separate from power groups was not as clear.
A traditional society had some version of a royal ruler who was assisted by courtiers and appointed ministers. Judges and the rest of the legal system was devoted to settling disputes between people, not matters of state. In addition there was frequently a strong religious sector with its own source of funds and hierarchy.

As time went on and the excesses of royalty become burdensome to the large landowners various types of legislative bodies were introduced, their ability to promote policies at variance to the will of the ruler was not assured.

The innovation in the US was to do away with royalty and to replace this executive function with an elected official. The judiciary was (eventually) given responsibility, not only for settling domestic issues, but oversight over the constitutionality of laws passed by the legislature. Laws required the agreement of the executive and legislative branches to be enacted (with rare exceptions).

The small permanent military presence that was the norm for most of the US history no longer exists. The military sector is now a continuing presence in the power structure. We in the west are used to thinking of other states as having the military as a quasi-independent force in society. For example Burma is run by the military. In China the military owns various industries outright. In Pakistan Musharraf retained his military position after he seized power in a coup. In Lebanon the military is being called in to stop fighting between armed factions since the “government” can’t do the job.

I claim that the military is now the fourth branch of government in the US. The idea that it is part of the executive branch and is headed by civilians is just a technicality. It commands half the discretionary federal budget. It has a permanent hierarchy which remains in place regardless of which party is in power. It has members of the legislature who are its supporters and ensure that funded is maintained. It has the ability to determine which information about its operations are released to the public and even to congress and the judiciary. It has continuing relations with military contractors who supply lobbyists that work on promoting projects that will benefit both the military and the contractors, as well as sending military spending to the districts of cooperative legislators. It has a propaganda arm which supplies (mis)information to the press and the general public. It has over a dozen spy agencies which can manufacture intelligence information that suits the long term goals of the military.

There was no provision in the design of the government for a fourth power center and as a consequence the “checks and balances” that apply to the three branches of government don’t operate on the military. It’s like a cancer and appears to be unstoppable. It has already sucked much of the money away from social services and infrastructure maintenance and is now going after political dissidents using the cover of domestic security.

As I’ve said before, the ability of spy agencies to uncover plots by unknown actors is extremely limited. That’s why things like the London transit bombings can occur even with heightened surveillance. Agencies can’t find small groups of first-time actors who are careful not to be obvious in their planning. What spy agencies can do is to track political groups which are not trying to be invisible. In fact most of them make a point of trying to get the public’s attention, since their purpose to change the political dialog. When these groups start to be heard or are on the verge of getting their message out it is easy to round them up or prevent them from being heard.

We see this time and again as political rallies are broken up, especially when they coincide with events that will be covered in depth by the media. This happened at both the Democratic and Republican conventions during the last presidential cycle and in many less publicized cases since then. In a new twist people can be forced to turn over records of innocent activity (such as library or phone records) and even the fact that a subpoena was issued cannot be disclosed. This is the ultimate in an abridgment of civil liberties.

It just shows to what extent the military sector will go to keep its operation free of interference or oversight. Generally when the military gets this strong it either takes over the government explicitly (as in Pakistan or Burma) or permits a powerless government to exist as a “democratic” cover as in Lebanon.

One could argue that we have not reached this stage in the US, the president and his advisers forced a war with Iraq, not the military, but we really don’t know. What would have happened if the military had really opposed the idea of invading Iraq? After all most of the top brass thought that the toppling of the regime would be quick and easy. This would also improve their image and give them further justification for future expansion. The few critics of the plan were removed from the chain of command or were in other branches such as the state department and were marginalized. So did the president order the war or was he allowed to do so?

If the existence of this fourth branch of government becomes widely understood what changes can be expected? There is little incentive for the existing military/industrial/congressional nexus that is profiting from the spending to push for change. The public is still in a state of heightened anxiety over an invisible threat which seems to exist without end and the worry about a decline in the standard of living as resources become scarce makes support of a muscular foreign policy popular even as people deny this is their preference.

As the limits on political activity increase the ability of the small group that wants to see change to get their message out will diminish further and only the road of militarism will be discussed. We have seen this path before, it occurred in Germany every few decades through much of the late 19th and early 20th Century. It occurred with many of the colonial powers in an earlier age. In every case the lot of the common man became worse as essential services were sacrificed to the god of war.

The US is already suffering from weakened social services, especially in health care, education and employment support. Recently we have seen key civil engineering infrastructure start to crumble and the government unable or unwilling to protect citizens from natural disasters. When the USSR became a hollow shell with an over-sized military it collapsed from within. Is this to be the fate of the US?

By rdf
http://robertdfeinman.com/society/#problem

knot RP — the absence of real wage growth (and the rise in real debts in that context) is at the root of this problem.

*****

If this is true, Brad, why isn’t Washington focused on real and permanent tax reduction for working families with that 700Bn?

All it would take is a decision to stand down on military spending, and the like, and shift the expenditures to this end – that is an increase in income for working folk of at least $4000 a year, or about $75 a week.