Midwinter, 2008 Nobel Laureate Joseph E. Stiglitz wrote of the Davos Economic Forum: "Even the plea of one of central banker that 'no one could have predicted the problems' moved few in the audience-perhaps because several people sitting there had, like me, explicitly warned about the impending problem in previous years. The only thing we got wrong was how bad banks’ lending practices were, how non-transparent banks really were, and how inadequate their risk management systems were. ...This is the third U.S. crisis in the past 20 years, after the Savings & Loan crisis of 1989and the Enron/WorldCom crisis in 2002. Deregulation has not worked. Unfettered markets may produce big bonuses for CEO’s, but they do not lead, as if by an invisible hand, to societal well-being. Until we achieve a better balance between markets and government, the world will continue to pay a high price" A month later, a forgotten author, quoted on www.fallstreet.com, "That noise you hear isn’t sleigh bells ringing-it’s the sound of pumps working day and night… what markets take away, the feds have a hard time replacing…"

When did the current financial crisis begin? Probably in August 2007 when the credit markets crawled towards a stop. Since then the U.S. Federal Reserve, in cooperation with the central banks of Great Britain, Switzerland, and Euro land tried in various ways to get them to work once more. The problem has been variously diagnosed. Certainly the packaging of mortgage loans from the United States and the selling of them worldwide turned out to be a bad idea. Suddenly no one trusted other banking institutions to have a solid assets as the value of U.S. houses began to decline, particularly the poorer mortgages.

The idea is to replace the liquidity that the markets are destroying, and prevent the free market from working and causing a recession/deflation of unknown magnitude. The central banks in Europe and the United States are supplying boodles of cash and credit, but this only seems to delay the day of reckoning. The banks are unable to find solid customers for their loans. Whether this problem will be resolved by the Central Banks stimulating inflation or allowing deflation remained unclear. Inflation has a terrible history dating back to the destruction of early Chinese Empires. More recently the Japanese central bank allowed deflation with the collapse of the Japanese stock market almost 20 years ago. Real estate too had been overly priced: the putative value of Tokyo real estate was more than the value of the entire U.S. economy.

As February continued Chairman Bernanke said he expected no recession and was prepared to act to prevent it from happening. Ha! Then in Europe the German government had to intervene as German state-owned banks were on the verge of collapse.

Der Spiegel reported, "The German government has had to bail out state-owned banks with taxpayers' money after their managements recklessly gambled away billions on subprime investments. But if a state-owned bank were to go under, the consequences could be disastrous for the whole economy."

The Zeitgeist continued to develop, probably with an article by Eric Janstzen a veteran of the dot.com bubble who wrote "Priming the Market for the Next Crash" in Harpers Magazine February 2008, explaining how bubbles were really the new capitalism. At the same time he was pointing out how terribly destructive this phenomena had been in actual historical capitalism. Usually there was only one per hundred years. They were so bad that the governments learned their lesson and repeatedly did a reasonable set of regulations that made them impossible given the economic system at the time. We seem to be moving towards having one every decade. What to worry about however, seemingly ends as Mr. Janstzen goes back at his old job as a shil for the circus. The new bubble would be alternate energy production. A veteran of two recent bubbles, his definition is worth remembering. "Asset-price hyperinflation"-the huge spike in asset prices that results from a perverse self-reinforcing belief system, a fog that clouds the judgment of all but the most aware participants in the market... a market aberration manufactured by government, finance, and industry, a shared speculative hallucination and then a crash, followed by depression."

"The FIRE (Finance, Insurance, Real Estate) sector’s power grew unchecked as the old manufacturing economy declined. The root of the 1920's bubble, it was believed, had been the conflicts of interest among banks and securities firms, but in the 1990's, under the leadership of Alan Greenspan at the Federal Reserve, banking and securities markets were deregulated. In 1999, the Glass-Steagall Act of 1933, which regulated banks and markets, was repealed, while a servile federal interest-rate policy helped move things along. As FIRE rose in power, so did a new generation of politicians, bankers, economists, and journalists willing to invent creative justifications for the system, as well as for the projects-ranging from the housing bubble to the Iraq war-that it financed. The high-water mark of such truckling might be the publication of the Cato Institute report "America’s Record Trade Deficit: A Symbol of Strength." Freedom had become slavery; persistent deficits had become economic power."

"The Fed is trying to stabilize the financial markets, the real economy, and the price level with a single interest rate," says Louis Crandall, a former Fed official who's now chief economist at Jersey City, New Jersey-based Wrightson ICAP LLP. "That's not easy to do."

The basic contradiction from the point of view developed here is that by the1930's most of the world had learned that totally free markets always lead to market failure. In that sense capitalism ended. Presumably remarking on this realization Henry C. K. Liu makes the ironic remark, "Free markets need regulation to remain free." One can find this in his long running series on www.atimes.com.

The boom and bust of capitalism was too dangerous. The Great Depression had produced unemployment rates in the United States and Germany among other countries of around 25 percent and more. The credit crisis meant that factories were vacant and the unemployed were hungry. Capitalism had no way to resolve this timely.

The Soviet Union had demonstrated by then that governments could run industrial economies. When Hitler failed to revive the German economy using orthodox capitalist methods, he turned to a government controlled economy, placing Nazi party members in every factory and turning German industrial production towards war. He lowered real wages 25 percent and put the 25 percent unemployed to work. Faced with the possibility of civil disorder in the United States and the collapse of our economic system, FDR came up with a government interventionist solution that kept us functioning at a reduced economic level. But our economy did not really improve until massive war production, organized and financed by the government stimulated its great growth in the 1940's. FDR through a heavy taxation and government investment made income and wealth more egalitarian in the United States. This continued until 1974. Since World War II the capitalist sectors have been underwritten by governments that provide economic stimulation through research grants and arms programs. Other kinds of government spending and planning are very controversial and raise questions of economic democracy that are hard to resolve politically. During this epoch other countries industrialized, principally Japan and China using a combination of government industrial policy and alliance with U.S. banks and corporate CEOs. Successive U.S. governments subsidized this development looking for allies and clones as part of its struggle with the Soviet Union. State-controlled "command economies" like those of the Soviet Union and its allies were less efficient for a variety of reasons, including a lack of industrial capital, its need to compete militarily from a smaller industrial base, and a lack of informational feedback characteristic of an open society. The Soviets Union's allies turned to Western banks to try to industrialize: Poland being a prime example. Ironically, the indebtedness of some of the Soviet Union’s allies to Western banks became part of the reason for the collapse of the Soviet Union.

Now we are faced with a developing situation similar to the 1930's. The pseudo-capitalist system continued to require increasing amounts of stimulation to make the economy work. Kennedy had the moon race, Nixon had the war against cancer and educational as well as government capital investment continued to grow as a part of the economy. The government invention, the Internet, provided a new opportunity for Capitalist speculation, and it boomed and collapsed posing a serious danger to the system. Fearful of the results, Alan Greenspan, a child of a depression divided household - his divorced businessman father was an atypical pro FDR bookwiter and supporter, and out of the household - didn’t want another economic collapse and Greenspan allowed the development of another "bubble" to shore up the system. This meant further misallocation of capital, a problem in either capitalism or pseudo-capitalism because it meant that the productive base of the economy was not developing as it should.

Mr. Liu does a nice job also in reminding us of the role that J. P. Morgan had in rescuing the United States from the Great Panic of 1907. Once again J.P. Morgan is the mechanism, but it no longer has the country dancing to Morgan’s tune in the taking over of Morgan’s competitor, Bear Stearns. This time, the Fed uses the Morgan Bank as its conduit, paying it handsomely as its bureaucratic subsidiary. Probably Morgan will make 12 billion on their "public spirited action."

But it is government money that guarantees it: Morgan couldn’t do it itself. Last time around, a hundred years ago, it was part of the cabal with Rockefeller interests, which drove down Heinze stock in Union Copper from U.S. $60 to $10. Then a rumor was circulated that the Heinze banks were folding. J. P. Morgan joined the Rockefellers announcing that the thought Knickerbocker Trust Co-part of the Heinze party-would fail, thus panicking depositors to withdraw their money from Knickerbocker. It closed in a few days. Fear spread to other allied Heinze banks and then the crash of 1907 was on.

Millions of depositors were sold out penniless, their savings wiped out by bank failures, and homeowners rendered homeless by bank foreclosure of their mortgages becoming destitute and hungry. The 1907 depression was much more severe for the average family than the one in 1930 argues Henry C. K. Liu in the Asia Times.

While J. P. Morgan seemed to have saved the economy, his bank first toyed with it, broke it, and then was lionized for saving the economy! Woodrow Wilson lauded Morgan for his public spirited action, I presume not having the long hindsight of Mr. Liu. The House of Morgan was the power deciding which banks should survive and which ones should fail, and by extension, deciding which sector of the economy should prosper and which should shrink. Now the Federal Reserve, created when the U.S. Congress decided that it was better to have a national bank than leave it up to Morgan to establish national banking rules. It tries to exercise a similar power, and it is much stronger in economic resources, represents the government, but only has the power to control the economy thru regulating and controlling money supply and interest rates. This favors financial manipulation, not the creative power of capitalism: which had been private savings allied with daring new technologies. Current private capitalists are too timid generally to have produced much of the new productive endeavors in this period. It is the government, or its sponsored enterprises and research houses which does so, generally at least paying for the research also that made the new enterprise possible. Thus the great bank of yesteryear is now only the Fed’s conduit: its well paid errand boy.

Those who criticize the Fed, often because it has presided over the cheapening of the dollar, forget that the institution is a major player in the tremendously succesful job of raising the standard of living of the American people. The U.S. is far richer for most people than it was under Morgan’s domination. Very recently the very richest 0.5 percent became as relatively wealthy as they were in 1916 as economic inequality grew under Republican administrations. However, the super rich are now employees, bureaucrats, professionals, and not capitalists, by and large. A new class, to use old language.

The central bank is both a market regulator and a market participant. It sets the rules of the money market game. It says it is helping the market to remain free by distorting the very same rules through the use of its monopolistic market power as a market participant. But of course it is more than that, so it is not merely a market participant. It is an economic planner of a pretend-capitalist system. Economic planning using smoke and mirrors. No wonder it can not speak very clearly.

The Fed is a believer of free markets who at the same time does not trust free markets. In turn the brokerage houses and other bold market participants have set up a parallel to the regulated banking system with $500 trillion worth of instruments that had no formal reserves, but using instruments-CDOs, SIVs believed able to spread the risk. No one looked too closely.

Now the danger is that the spread risk will sink the whole financial system. In the spirit of an Orwellian world, previous to the collapse, Standard & Poors, the rating agency, put some of the insurers of this system on credit watch. When it became clear they would not pass, S&P simply said they were putting them back as OK in the beginning of March 2008. No clear explanation, but almost everyone who knew the markets knew that they were simply unwilling to say that the world’s "freely traded" credit markets were probably bankrupt, and therefore be the one to smash it. Ambrose Evans-Pritchard a frequent writer in London’s Daily Telegraph, eloquently describes the current situation, after the panicked Federal Reserve kept dropping interest rates, which he had sort of predicted in earlier articles. Not to speak of offering-brokerage houses as well as banks-several hundred billion dollars of U.S. bonds in return for whatever collateral the banks wanted to give. A few months ago the Fed did this for banks with good collateral but for 24 hours. Wall streeters joked about what they would offer as collateral: Paul Kasriel of Northern Trust suggested used cigar bands.

Unfortunately, Evans Pritchards current conclusions have a fatal and misleading flaw. On 19 March 2008 he says, "Put a clothes peg on your nose. The moral stench of bail-outs for the über-rich will be sickening. None of us wants to pay a farthing to rescue the bankers and assorted debt pimps who got us into this financial mess, and in doing so exposed our societies to such harm."

But he defends the bailout of Bear Sterns for if not, the system would fail, and the U.S. would fall into a depression. Capitalism still really exists and can work he seems to think, like most economic commentators and, now Bernanke who has studied the great depression will save us all from those rotters. If we are true to our feelings of anger, and let the crooked institutions collapse, we will turn the 1930's recession into a depression, and get the Nazi’s etc. Good observer that he is, he misses the main point.

He makes a lot of good observations that other commentators avoid. Like him some recognize that this is probably the start of inflation. Incorrectly and falsely he says it is a "massive taxpayers' rescue of the banking system," which stinks. But it is not a rescue of the banking system but of a brokerage system that has no reserves and has been effectively operating outside the banking system, and lying about its assets. For a central bank to buy up bad securities willy-nilly is not a rescue of the financial system, but of bad bankers, and was prohibited by Walter Bagehot, the grandfather of Central Banking. It eventually bankrupts the state and merges bad holdings with good holdings. At risk is sinking the whole ship as it takes on too much. In this way institutions which have benefited from skirting the law and providing false information to enrich their CEOs largely, as well as their attendants, hope to continue until another day. Inflation will continue to impoverish savers, and the bailout adds even more public debt to a collapsing national system. Of course, the orthodox economists bemoan the lack of savers, but in a tricky economic system like this one, only the speculators and scammers seem to make money. Why then save? Evans Pritchard knows that there has been a property crash. Serious commentators talk of a fall in housing prices of another 20 to 50 percent. Fifty percent was the drop in Asian markets particularly Japan and Hong Kong in the early 1990's.

Alan Abelson of Barrons on 23 March 2008, quoted the CEO of Freddie Mac as saying another year will bring real estate values down another 10%. Freddie Mac and Fannie Mae of course are the government sponsored entities which, were created to finance low income housing; the sort that capitalist bankers didn't used to like to lend on. Despite being weakened by a recent history of internal CEO corruption the Fed has now reversed itself, lowered their capital requirements, and told them it's fine to lend up to three quarters of $1 million for houses. In this way they trump Congress’ power to control the system. The Fed was once created to prevent bank failures; now it finds the need to prevent brokerage failures outside the banking system, and fears of stock market crashes claiming the world would end if Bear Sterns went bankrupt. More likely the world of most people will continue to decline as long as the likes of Bear Sterns are propped up instead of jailed when their fraudulent and irresponsible lending schemes fail. Instead of providing reasonably planned, affordable housing, the housing bubble provided vacation homes, luxury homes beyond realistic ability for most to afford to live in, but which became the principal speculative means for middle class and richer Americans to get even richer on paper. The nations financial resources were spent on this greedy endeavor, while productive investments that would help individuals have jobs that could pay for houses were avoided.

At core, Evans Pritchard’s argument is that the brokerage houses must be bailed out to save the rich, but the mortgage holders shouldn’t be bailed out primarily: "Even bodies standing at the top of the credit system are no longer deemed safe. As Barclays Capital put it, this was a `tsunami event’. Or in the words of City veteran David Buik at Cantor Fitzgerald: 'No one in living memory has ever seen a banking crisis like this. I am older than God, and the outlook has never looked as bleak." ... Property booms will soon be deflating across the Anglo-Saxon world and the eurozone's Club Med belt. Japan is already on the brink of recession. Debt levels are higher now in most rich countries than they were in 1929. The levels of financial leverage are greater. As the Bank for International Settlements wrote last year, we are more vulnerable to a 1930's dénouement than people realize-should the authorities botch the response.  

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