The current financial crisis began in the 1990s with the dubious practice of monetizing mortgages by the mechanism of securitized bonds. Essentially, the banks bundled together the income from the mortgages that they held into mortgage bonds and then sold them on the bond market to raise more money to make more loans. Initially the best mortgages made AAA rated bonds that were a reasonably safe investment and so a number of central banks around the world were prepared to invest large sums with the promise of solid returns. Over time the greed of the banks drove them to securitize poorer and poorer mortgages, mostly 100%- 110%, no doc or re-financed mortgages which held their value only so long as the properties that they were loaned against continued to grow in dollar value and so allowed the banks to re-finance the poor loans on the back of the greater equity that the mortgagees held in their properties. And, in order to keep on re-financing these operations, the banks sold most of these semi-worthless bonds to large investment companies such as the superannuation funds, and of course to the central bank of the land. The Reserve Bank of Australia (RBA) held $42b in Australian Dollar Securities much of which must have been based on securitized mortgage bonds that had been issued by the four major banks. In addition, the RBA was holding $35b in similar securities from foreign markets and $51b in foreign currency that was itself backed by more securitized mortgage bonds abroad, mainly in the USA, Germany, France and Japan (RBA figures http:www.rba.gov.au). In contrast, in 2009 the RBA was holding just $104m in traditional treasury bonds and only $11b in similar bonds from abroad, mostly US Treasury Bonds. So in total the RBA was holding nearly $130b in securities, the value of which was determined not by the Australian Government but by Wall Street and ASX Bond Markets. As the RBA is totally backed by the government if these securities tanked the bill would be picked up by the public purse in the form of fiat money inflation and higher taxes. In effect, the banks could make whatever shaky investments, bearing any amount of risk, and at the very least they were sure to get their money back or even make a profit! The Liberal Government of the 1990s had filled their coffers by selling off the nation’s utilities and other public assets creating thereby a false budget surplus for a few years which they invested heavily in securitized bonds through the RBA. But by the beginning of the new century Australia started to run out of things to sell so the securitized mortgage bond game looked appealing to the MPs who saw it as a way to fund their various politically motivated projects. This, no doubt, was the reason that the Liberal Party fat cats always seemed so sure that they could fund all of their “incentives”. The government could use the RBA to buy billions in securities from the four big banks then borrow the money that was generated from the banks in order to monetize their schemes. In turn, the banks could turn those government loans into more AAA bonds, sell them to the RBA and do the whole thing again for another publicly funded scheme. Of course if the international bond markets tanked the money that the debt backed would be worthless. The Liberals rationalized the risk by saying that there was no chance that people would suddenly default on their mortgages in great enough numbers to crash the value of the bonds- but that is exactly what happened. Across the USA the value of houses, that backed the mortgages that backed the securitized bonds that backed the currency, suddenly began to plummet. America’s securitized bonds became worthless almost overnight. Australia’s own securitized bonds would follow if something wasn’t done, and done quickly. The newly elected Labor Party Government, faced with a crisis, came up with a plan to spend! The government dressed it up as an “Economic Stimulus Package” (ESP) the MPs spent over $30b on schools and infrastructure. In addition they just gave out another $10b in cash! Ten million people got a one-off government payment of around $900! The government propaganda machine went feverously into overdrive to tell us that this was the plan to save the nation. And it seemed to work. As the US and Europe nosedived into economic recession Australia remained alone amongst developed economies in its stability. The markets took a hit but we limped on, just winged instead of mortally wounded- or did we? In order to raise the stimulus money, or at least a large proportion of it, the government had to borrow- from the RBA. The RBA raised the money by selling bonds, backed by the Australian Treasury of course. These bonds mature mostly in 3-5 years meaning that the RBA has to redeem them from about 2012 onwards. As promising as the economy has looked its strength has truly been based on the continued growth of house prices that kept the currency afloat. Overseas house prices had crashed to collapse the bond markets while in Australia they had continued to increase, artificially inflated by state government restrictions on the number of new house lots being offered and by the high number of immigrants putting short term pressure on real estate markets. Also, the initial influx of fiat money into the Australian economy did create some buoyancy but as the newly created currency mixed with the old money the resultant inflation drove commodities prices sharply upwards and as the world economy didn’t turn around but continued to slide the benefits of the ESP began to wear off and along with it Australia’s economy began its descent into the recession that we were trying to avoid. Only now it’s $42b worse than it was. So what did we actually achieve by handing out our $42b? Where did the money go and who benefited? After all, it is the average punter out here in over-taxed land that is going to pay the money back. What did the ESP actually stimulate? To answer these questions we need to look at the whole process on a more individual level- what did the punters do with their $900? When the Federal Government announced the ESP (amidst a blaring fanfare of how clever they were being) they told us (the Australian public/the punters) that our $900 gift was to stimulate the retail sector, gov-speak for “go out and blow it on consumer junk”. As we have seen, the Government were fretting that mortgage defaults would increase and tank their securities causing the banks to crash, and they were scurrying to avoid that at all costs. At that point they could have just waited and given a handout directly to the banks (as the US Government did) but that is a politically unpopular thing to do (the punters aren’t fond of the banks), so they came up with a cunning scheme. Kevin Rudd and Julia Gillard got us, the punters, to give the money to the banks for them. Sure a slice of it went into poker machines but that kept the gambling lobbyists happy too- a bonus! What most people seem to have done with their $900 cash bonus was to pay off their debt to the bank. The mortgage got paid, the credit cards got a chunk, and hardly any got handed over to retailers, at least not directly. The rest of the ESP was used to pay contractors to build new school buildings, roads, public housing and the like but lately there have been a lot of criticisms of just how that money had been spent and who it had been spent with. In the end the Labor Government’s Keynesian plan to re-invigorate our economy on the back of public spending has cost $30b and given us very little in return. Of course the big building companies that got all of the work without the need for a protracted tendering process were very happy but local communities were left scratching their heads over the basketball stadium that had been built over their local schoolyard. By this process the Rudd/Gillard government borrowed $42b and then distributed it to the banks and big business and they used almost half of the population to do it! As fiat money is of greatest value to those who are the first to handle it the punters enjoyed its short-term high spending power. The banks suffered little as they handled the cash next and they could use the faltering economy and inflation to justify putting up fees and interest rates to make up any shortfall in their profit margins anyway. The plan would have been devilishly clever if the world economy had recovered and the ESP plan had come off as Kevin Rudd was inclined to believe it would in late 2009. We had spent our way out of trouble and now all we had to do was wait for the rest of the world to fix their economies (usually with similar ESPs) and it would be back to business as usual. But of course the world’s economy hasn’t turned around. In addition the housing bubble seems to have burst, or it is at least no longer growing. Soon the government’s creditors will be wanting their money back. Will the government have it? At this point it seems that they won’t and that the taxpayer and consumer will pick up the tab.
image The Wall Street Journal