But Congress did not approve the Treasury’s $250 billion of
“preferred” stock investments in Wall Street banks. The happy
recipients, their stockholders and officers evidently worried precisely
that this “investment” would end up taking losses. That is why the
Treasury stands in back of bona fide creditors. That is why “preferred”
stock was preferred by existing stockholders to loans and guarantees
(which have priority in case of bankruptcy), not to mention the
conditions that Congress thought it had laid down calling for these
institutions to renegotiate mortgages to bring them in line with the
debtor’s ability to pay.

The Fed has refused to let Congress know any details – any details
at all – about its cash-for-trash swaps with these institutions. This
is what concerns Congress, and what has prompted reporters at Bloomberg
to bring a lawsuit in order to discover and publicize the details. It
is not hard to see why this curiosity exists. The only reasonable
explanation as to why investment banks, American International Group
(A.I.G.) and commercial banks apparently headed by Citibank (whose
shares plunged yet another 26 per cent on Thursday) have turned over a
trillion dollars worth of illiquid mortgage securities, junk bonds and
who knows what other junk to the Fed is to avoid taking a loss on these
bad loans and investments. As Mr. Paulson explained matters, “the
Federal Reserve has statutory authority to lend against a pool of
mortgage loans on a fully secured basis. The Fed was able to assist the
JPMorgan purchase because they believed that there was a reasonable
prospect of avoiding losses.”

(ARTICLE CONTINUES BELOW)

What time frame are we talking about here? Evidently one in which
Mr. Paulson will have left the administration, sticking his successor
with the losses and, presumably, the blame.

Everything seems to have been unexpected to Mr. Paulson – as if
ignorance is a defense. “When I came to Washington in 2006,” he
reminisced, “markets were benign.” We were still in Alan Greenspan’s
idea that inflating asset prices on credit constitutes “wealth
creation.” At that time I myself was only one of many who warned that
the real estate market had come to rest on a foundation of junk
mortgage lending. Every banker with whom I spoke at the time knew this.
But most were still seeking to make hay while the making was good, and
it was still quite good – for the banks, that is. Matters were not
benign for the increasingly debt-ridden U.S. economy, but at least they
were rosy for Wall Street. Bank executives were paying themselves
enormous salaries and even larger stock options. Meanwhile, the smarter
money managers were beginning to shift their funds out of the U.S.
economy in a wave of capital flight of a magnitude not seen since
Russia in the mid-1990s.

Acting as if all this could not have been foreseen, Mr. Paulson
assured his mistake-friendly audience, “There was no playbook for
responding to a once or twice in a hundred year event.” A kind of
random historical earthquake seems to have been at work, a financial
San Andreas fault. Mr. Paulson then trivialized this, however, with the
euphemism “housing correction.”

The key is, what is to be corrected? Is it not the financial market itself?

Mr. Paulson then set about dissembling the character of the U.S. and
global financial system. “Our financial system,” he claimed, “is built
on the hard work of our citizens; it is built on the savings of our
citizens.”

This is where he seeks to spread the disinformation about the
explosion of debt that now burdens the U.S. economy, which is the
result of autonomous credit-creation by the commercial banking system
and has nothing to do with the savings habits of “our citizens”. The
basic financial principle of modern banking is that “loans create
deposits.” The bank loan comes first – then the deposit or “saving.”

Here’s how it works. A bank’s marketing department seeks to drum up
customers for debt. A borrower will go into a bank and sign a
promissory note, and the bank then creates a checking account in the
amount that is stipulated. The note calls for a specific rate of
interest to be paid – a rate much higher than that which the bank can
borrow from the Federal Reserve or in the money market in general. One
benchmark global rate to bankers is the London Interbank Borrowing
Overnight Rate (LIBOR), and the other is the Federal Reserve’s discount
rate to banks. (Japanese banks also provided loans to large financial
institutions at under 1% per year, spurring the international “carry
trade,” borrowing cheap in yen and then converting the funds into other
currencies and lending at a higher rate.)

None of this involves saving. It involves credit creation in which
banks have a legal monopoly, with funding monetized by the U.S,
Japanese and other major foreign central banks. This free credit
creation is at the root of the problem, not the natural growth of
savings.

What have banks done with this credit-creating privilege? Nearly all
their loans have been to enable buyers to purchase assets (real estate,
stocks and bonds or entire companies) already in place, or to enable
hedge funds to play the mathematical games that have come to
characterize today’s casino capitalism. Mr. Paulson depicts the
resulting financial system as being essential for the good functioning
of “Main Street.” But surely he must know some lawyer who might explain
to him that only very, very wealthy speculators are allowed to play the
hedge fund game of financial derivatives that lies at the heart of
today’s financial breakdown and negative equity for banks that have
made bad gambles. The legal reality is that in order to invest in hedge
funds and similar casino capitalism gambles (or in Broadway plays and
other high-risk ventures, for that matter), prospective financiers must
sign releases attesting to the fact that they can afford to lose their
money.

“If the financial system were allowed to collapse,” Mr. Paulson
warned, “it is the American people who would pay the price. This has
never been just about the banks; it has always been about continued
prosperity and opportunity for all Americans.” Not really. Wall Street
is hardly so altruistic. It has increasingly made its money off
Americans by engaging in increasingly predatory, extractive lending to
the economy. That is what has caused the U.S. debt burden to soar so
far ahead of the ability of debtors to pay. It also is what is now
diverting spending away from consumption and (for companies) new
capital investment to pay creditors.

Not content with misrepresenting how the U.S. economy works, Mr.
Paulson then drew a picture of the global economy that also is a
travesty. “The world was awash in money looking for higher return,” he
explained, “and much of this money was invested in U.S. assets.”

Not exactly. The world economy has been awash in the U.S. payments
deficit, which has swollen the reserves of central banks in the
creditor nations from Asia to Western Europe. These central banks have
recycled $4 trillion of their dollar inflows to the United States under
dollar hegemony. Rather than seeking a “higher return,” central banks
have found themselves obliged to invest in low-yielding U.S. Treasury
securities, or somewhat higher Fannie Mae and Freddie Mac securities.
These returns are much lower than U.S. investors have sought in buying
up foreign companies and their stocks, whose price appreciation far
exceeded the rate that foreign economies were able to recoup on their
dollar recycling to the United States.

Mr. Paulson wants above all to deter foreign economies from breaking
away from this dysfunctional system. “The second important priority,”
he explained to his Reagan Library audience, “must be continued reform
of the International Financial Institutions like the World Bank and the
IMF to allow for greater participation of developing nations.” The aim
here is to make the financial sector’s lobbying control over the
world’s financial system global. “A final reform priority must be
consistent liberalization of policies on trade and investment, with an
emphasis on avoiding new protectionist measures and achieving a
breakthrough in the Doha round of global trade talk.”

“New protectionist measures”! Even as U.S. auto companies are
advocating special subsidies for the U.S. auto industry in Detroit and
pursuing beggar-my-neighbor financial policies (let foreign banks and
economies absorb the financial loss from playing in the Wall Street
casino), foreign countries are not to develop a financial system more
highly regulated, an agriculture more aimed at feeding their own
people. They are not to block capital outflows from the United States
based on “free” credit creation to buy out the commanding heights of
their economies as the IMF imposes austerity plans and forced
privatization sell-offs on Third World and post-Soviet countries, while
cutting taxes at home in the face of an escalating U.S. trade deficit
and rising foreign military spending.

Mr. Paulson’s speech looks like a major salvo in the Bush
Administration’s attempt to make both the Wall Street bailout and the
U.S. predatory finance irreversible, while the government replaces
public debt (Treasury bonds) for Wall Street’s bad gambles. His errors
are calculated to misinform, as are most lobbying efforts by the
banking and financial sector. One can only hope that Congress will
question his testimony that has repeatedly followed this line with more
acumen than prompted its earlier acceptance of the Treasury’s bailout
act. It’s time to clean up this act.

PS: As I watched Citibank’s stock (C ) take yet another plunge of 10
per cent in the firsthour of Thursday morning, my wife showed me
something that a Citibank advertiser was handing out to students at New
York University yesterday afternoon: A flyer begging them to put their
money in at 3.10 per cent per year. (Vanguard’s Treasury-money market
fund offers under 1 per cent at present.) I told Grace that our net
worth was higher than Citibank’s, but I’m not able to draw down a $10
million a year salary like their jokers do.

The Citibank handout (when have you ever heard of street hawkers for
banks says, “You’ll have the safety of FDIC insurance and your CD’s
term is just 6 months. So you can keep your money secure at a great
rate. …Citi never sleeps.”

Citi’s stock has fallen 84 per cent this year, and the company is on the rocks. I’d be sleepless too, if I were them!