The 21st Century Greater Depression

I became interested in the question of how an organization whose business plan is theft can go bankrupt during the Enron debacle. I was well aware that many companies are forced into bankruptcy so that the executives can loot the pension plan and that this has been an accepted business practice for many decades; out of fashion now that there are no pension plans to loot. However, the thefts were made possible by junk bonds that destroyed companies that otherwise were going concerns providing real products and services that had a genuine customer base.  In other words, the executives looted the company as well as the pension plan. Grand theft indeed but Enron seemed different simply because its only evident product was illegally rigging the price of electricity to make a fortune buying low and selling high in that rigged market. In other words arbitrage in the energy market.

Enron was a bucket shop and bucket shops get shut down but they don’t go bankrupt. How can a successful thief have no money?

As with most mysteries once you stop looking for erudite explanations the answer is obvious.

The bankruptcy is meant to cover up the evidence of the real crimes.  That is the purpose of bankruptcy. In the case of Enron it just didn’t work.

Within modern history all financial panics, now called depressions, have been characterized by two attributes. The first is a sudden, severe loss of liquidity; there is insufficient money to maintain the level of commercial activity. This is a condition that is usually engineered by the Central Bank or a consortium of commercial banks when no Central Bank is in existence. Since Central Banks are owned and operated for the benefit of their subscriber banks the distinction between Central Bank and consortium is purely linguistic. In any event money is removed from circulation and the country (or world) enters a depression characterized by mass unemployment. The proffered solution is always the same: austerity. This is a word that simply signifies a policy of reducing the rate of return on human investment, (i.e. labor) to increase the rate of return on capital investment, (i.e. money).  This only makes the situation worse but after all that is the whole point of it. The purpose of the depression is not only to transfer wealth from the poor to the rich but also to provide a smoke screen to the second attribute of financial panics. It must be made to appear that depressions are the result of a mysterious business cycle over which no one has any foresight or control.

The real cause of depressions is massive theft.  Pundits claim that depressions are caused by a lack of confidence, the solution being to put the ‘con’ back into confidence. Less respected observers simply note that the suckers have wised up.

How this theft takes place is best illustrated by the movie “The Producers”.  Two Broadway producers realize that they have a great talent for backing losers. Since all of their endeavors are widely publicized failures they decide to oversubscribe their next venture by 300% and pocket 100% each after the show fails. Once the show is a failure there is nothing to account for and no questions are asked.  The two key properties of this swindle are widely acknowledged complete failure leading to no questions asked; the facts speak for themselves.

The first time that this swindle was used in modern history was in the fledgling railroad industry. The US Government gave the railroads ownership to public land adjacent to any railway that they built. The land was to be sold to finance the building of the railroads and people would buy the land because of its access to the railroad which meant that their farm produce could be transported to markets rapidly and cheaply. The government gave the land to the railroads and they promptly sold the land and pocketed the money taking it out of circulation. This led to a depression which gave the railroads the excuse for not building the promised railways. It was all due to the business cycle and no one was to blame. The Harrimans and Vanderbilts just barely managed to survive the crash.

It was not until the country neared the turn of the century that Jay Gould managed to engineer a panic by oversubscribing a public company. Gould controlled the Erie Lackawanna Railroad which Vanderbilt wanted to acquire.  The more shares that Vanderbilt bought, the more shares that Gould printed. The upshot was the depression of 1897.

1929 brought an opportunity for investment bankers to oversubscribe any number of dubious enterprises with stocks bought on margin. As people bought more and more stock on margin, more and more money was withdrawn from circulation. The swindle was that most of these enterprises never had any chance of success and knowing this the bankers oversold the authorized number of shares to be issued and pocketed the proceeds from the fraudulently conveyed stocks which were recorded but no certificates were issued. When the depression hit it was all blamed on the business cycle. Since the failed businesses no longer existed how many shares were issued was a moot point not to be subject to further inquiry.

At the turn of the 20th century the whole thing was repeated in Penny Stocks issued on ‘high tech’ companies that had no business plan, no history, no products, no anything except a prospectus and a basement or garage from which the business would operate. Although margin sales were not available on Penny Stocks people lost fortunes on the mostly imaginary enterprises in which they invested. This time the Fed did not engineer a depression and most of the bucket shops folded and many of their operators went to jail.

The current great depression has been engineered by the Federal Reserve, the U.S. Treasury, the International Monetary Fund and Goldman Sachs. Since the Fed, Treasury and IMF are really run by Goldman Sachs it is best to think of them as a single entity. The current Great Depression has been created to cover up the massive theft in the derivatives market.

The market for derivatives grew out of the market for municipal bonds.  It was recognized that all bonds could be separated into two components. The first component was the face value or the amount of money to be paid upon surrender of the bond upon maturity. The second component was the income stream created by the bond as determined by the interest at which the bond was issued. Many years ago these were represented by the coupons that the owners clipped (stripped) from the bonds and submitted for payment.

Brokers learned that they could purchase municipal bonds and make a separate market for each component of the bond. Some people wanted only income and would buy STRIPS, that is the income stream from the bonds. Others wanted only the future delivery of a specified sum and bought TIGARS, that is the amount paid upon maturity of the bond. To accommodate the needs of different buyers various munis with different interest rates and different face values were bundled together and their combined interest streams and principal amounts were sold to different buyers. These were the first derivatives. Title and ownership were conveyed.

It is frequently believed that derivatives are a natural outgrowth of the options market. This is not true and is part of the effort to obfuscate the actual situation.  Options are contracts to buy (or sell) a specific commodity or financial instrument, usually stocks, on or before a specified date at a specified price. The contract establishes the legal rights of the parties to the contract. Whether the contract will or will not be executed is determined by the market value of the commodity or stock prior to the expiration of the contract. However, the contracts are negotiable and can be sold at any time prior to expiration and the value of the contract at the time of sale is determined by the market value of the underlying commodity or stock.

The distinction between a derivative and an option is that an option is not secured by any collateral, has a short life with the option expiring in the very near future, typically 90 days or less and is usually entered into with the expectation that it will not be exercised. Further neither title nor ownership to the commodity or stock is conveyed until the person holding the option exercises it.

A derivative is secured by collateral, has a life span of many years and often decades and is purchased with the expectation that the funds will be delivered. Title to, and ownership of, a negotiable security is conveyed upon purchase of the derivative.

In the case of mortgage-backed derivatives the collateral is the mortgages held on the properties and the derivative is the stream of earnings generated by these mortgages. This is what the purchaser of the derivative buys, the future earnings from the interest payments on the mortgages.

Note that Goldman Sachs (or other banks) keep the title to the mortgaged property and sell only the interest payments on the loans. These interest payments are bundled into tranches with loans having similar characteristics and are marketed based upon the credit worthiness of the Frankenbond created by this process.  Tranches with a low probability of repayment are sold at a steep discount creating a high rate of return.  It is these tranches that can be over sold to many different purchasers with absolute certainty that the Frankenbond derivative will default. Since the Frankenbond derivative has no principal component but only the future stream of earnings any default leaves nothing to dispute. The underlying mortgages are no longer paying interest so the Frankenbond is in default with no collateral because only the future interest payments were conveyed.

Of special interest it must be noted that only the people who created the derivative can determine if it is or is not in default. There appears to be no mechanism by which the purchaser can make this determination.

The CIA World Factbook for 2013 places the Gross World Product at $74.31 trillion.  According to the Bank for International Settlements, the total notional value of derivatives contracts around the world has ballooned to an astounding 710 trillion dollars ($710,000,000,000,000).  Other estimates put the grand total well over a quadrillion dollars. The ‘bets’ placed on the economy of the world are roughly 10 times the value of all of the goods and services produced in the world in one year. It has been estimated that the total value of all land, property and goods on the planet is 3 times world GDP or $223 trillion.

In accounting assets must equal liabilities. If they don’t, it is evidence of some type of theft or fraud.

The argument is often made that the notational value of the bets cancel out each other. Since all bets are either winners or losers if all bets were settled today, the winners would receive and the losers would pay out between 1 and 1.5 times the current market value of the entire planet. It is obvious that these bets can never be paid.  It is also obvious that many derivatives are either not secured by any underlying collateral or are secured by the same collateral used many times over. Imagine a scheme where 100 mortgages for $100k each are issued against a single house valued at $100k and you grasp the essence of cross collateralized financial instruments. It was the same scheme used in the stock market and consumer finance that brought about the Great Depression of 1929 and 1930s.

The Great Depression of the 21st century was brought about by the bailouts of large financial institutions. These bailouts removed enough money from circulation so that there is now insufficient money to maintain a level of commercial activity sufficient to create full employment while clearing the market of accumulated inventory. The purpose of the depression is to cover up the great swindle in the derivatives market. The facts speak for themselves.

Paul Majchrowicz served in the US Army from 1966 to 1968. He graduated from the State University of NY at Buffalo in 1972 with a BA in Philosophy and worked in the insurance industry until he retired in 2000. Read other articles by Paul.