I’ve spent a large part of the last few months reading about America, trolling through various online archives and, while absorbing buckets of information, have been spewing buckets of rage-soaked bile around the house.

Why am I angry? What have I learnt? Can I pass any of it on? I’m going to try, because, while this is all about the US, there are some very serious lessons in it for us, and we need to understand what’s happened. Because what has happened in the US is a coup, no less. Their political system, already so corrupted that laws are no longer made in Congress but are created in back rooms by stacked committees, has finally evolved to become a creature perfectly suited to the environment its new owners created.

I don’t particularly care about the American people as a whole. Unfortunately they, and their rapidly-crumbling Empire, are enormously important to the rest of the world, and it behoves us to sit up and take notice of What Went Wrong.

There’s an unspeakably brilliant piece by Niall Ferguson in Vanity Fair, comparing the fall of the Roman Empire (and others) to the decline of the US, and I urge you to read it. However, the purpose of this piece is to try to explain how the Global Financial Crisis all happened, in easily-digested terms.

THE WORLD OF FINANCE

Finance is no longer as simple as putting your savings in the bank to earn a bit of interest, borrowing from the bank for a car or a house at higher interest, and the bank making a profit on the difference. Planet Finance is now “worth” approximately eight times the value of everything on Planet Earth. This is all thanks to debt becoming a commodity to be traded and an asset to be borrowed against.

When the debt market collapsed, the world was hit with what was called the Credit Crunch. Remember when it hit Australia, the Reserve Bank lowered the baseline interest rate, and Malcolm Turnbull et al were running around screaming like Rita Hayworth “Why, Oh WHY, won’t the bastard banks pass on the full rate cut?? Won’t somebody think of the children/farmers/working families????” They were full of shit. They knew why, but, like politicians everywhere, they were looking for a quick headline and a way to score some popularity points by bashing the banks, who we all love to hate anyway.

It’s simple: the banks do not get all of their money from the Reserve Bank at the headline rate (and Turnbull, who used to own a bank, knows this very well). Sure, they borrow a fair bit from the Reserve, but they are also borrowing from you and me, and institutional investors, and, most importantly, from each other. They find themselves, every day, either short or long of hundreds of millions in “cash” (not paper monies, but the equivalent).

So, the ANZ, needing to keep its cashflow (for want of a better word) liquid, will approach the CBA, and in Carlisle St/Chapel St (Windsor end) parlance they’ll have the following conversation:

ANZ: “Dude, we just need, like, $200 mil ‘til next week, just to cover the rent and Shanae’s new tattoo, but we’ve got a big Centrelink payment comin’ through the week after that, you know we’re good for it, brother, and the fuckin’ Reserve says we’re over our limit this month and they’re short of the readies anyway.”

CBA: “Fuckin’ arseholes did that to me last week, too, man. I can cover you, what have you got in, like, collateral?”

ANZ: “Here, man, look at these Pawn slips from Cash Converters, there’s a guitar, an’ a stereo, and Shanae’s phone and shit…”

CBA: “Cool, brother. I’ll spot ya, but it’s at two points above the Reserve.”

ANZ: “Fuck, man, that’s steep.”

CBA: “Yeah, well, can you get it from the fuckin’ Reserve? Nuh. Two points, or you can go beggin to Wang down the road, and you know he’ll hit ya for four..”

ANZ: “Ah, fuckit, allright. I’ll take it. Two points. You know next time you come round here short of a coin I’ll hit you for your fuckin two points before ya can say fuckin Andrew Bolt’s a legend.”

CBA: “Yeah, I know you will. Catch ya.”

So, the CBA fronts ANZ the cash for a week or so, and the next week the exact reverse happens. They lend to each other at a slightly higher rate than they can get from the Reserve, because they are there to make money (yes, that’s the whole point of privatising services, they exist to make profits) and that’s why banks are rarely able to pass on an entire rate cut. Simple, huh?

Now, you’re thinking, why did all the credit dry up, almost overnight, when the “crunch” hit?

It was all to do with those Cash Converters pawn slips they were holding against each other’s debt, and it’s an interesting how it highlights the reasons the crunch didn’t hit here in Australia as badly as it did elsewhere.

Here in this wide brown land, despite the best efforts of some highly-skilled lobbyists, there is still some halfway decent regulation and accounting law. If you want to call something an asset (against which you can borrow), you have to show that it actually is an asset. So, in the example above, the CBA can wander down to Cash Converters and actually see the guitar and the stereo and the mobile phone, and if ANZ defaults, well the CBA’s got himself some bitchin’ stuff he can sell down the pub, and his debt is covered.

In the US, however, lobbyists work on a completely different level. Comparing them with the Australian system is like throwing the Jonas Brothers on stage in front of a Slipknot crowd. Add to that the Reagan and Clinton eras of deregulating everything they could get their hands on, Dubya throwing poo and Ayn Rand around the room, Alan Greenspan having wacky fun with the Federal Reserve for 10 years and by 2009 you would have had more luck asking Michael Jackson’s chimpanzee to explain the theory of relativity to South American pygmies than asking American banks to explain what their assets were worth.

After the huge stock market crash of 1929 and the resulting Great Depression, the Glass-Steagall Act was enacted in America to ensure that people betting on the investment markets couldn’t take down the entire economy again when they hit a major losing streak. One of the biggies in the Glass-Steagall Act was the separation of Low-Risk and High Risk banks. Low-risk was the suburban bank who looked after your savings and loaned you money for a house; their only source of income was mortgages and the like, so they needed to know that you had a job and the house existed, and you had a good savings record and so on. High-risk was for company start-ups, bond issues and derivatives and high roller poker games; people with a lot of money who wanted to make more and could afford the risk. No bank could operate in both markets, which protected the housing market (Main St) from the vagaries of the investment market (Wall St).

Justified by Clinton’s well meaning but completely impractical “home for every American” plan, the Glass-Steagall Act was repealed in 1999, meaning that small banks had to throw themselves into the world of derivatives and risk if they didn’t want to get swallowed up by the investment banks. So they did, and with less regulation in a massively expanding consumer economy small banks went nuts on lending to less and less suitable borrowers, in order to keep the train rolling.

Small banks also discovered that they could make more profits (and reduce the risk of lending $500k to illiterate Joe who sweeps the floor at the Moe’s Bar) from their dodgy mortgages by selling them on to the investment banks. Investment banks discovered that they could make huge profits by buying up a whole swags of these dodgy debts, chopping them up, throwing a new packing label on them and then re-selling them as a completely different product.

So, thanks to a compliant Congress, the guitar and the stereo and the phone and Illiterate Joe’s $500k shack were pawned about nineteen times around the world, then sliced and diced into little pieces and put into parcels with bits of costume jewellery, busted-arse share-house IKEA couches, and IOUs from that guy who stands outside Coles bumming cigarettes from you when he’s not shouting at the tram stop. Each parcel was wrapped up in a nice shiny bag and sold another twelve or fourteen times. The parcels are called Collateralised Debt Obligations (CDO), and are basically a way of turning debt into an asset that can be bought, sold, and borrowed against. What they really are, however, is a bet: a bet that a certain proportion of their contents will remain worth something.

Some folk in Congress and the financial world, still smarting from the dotcom crash, started to wonder what the hell these CDOs were, and think that perhaps they should be regulated, because nobody seemed to know where they were all coming from and, from an accounting point of view, they just didn’t make sense. More and more billions of them were being traded every day, and it seemed that perhaps share prices and profit margins were being inflated (again) by chimeras. Before anything sensible could be done about it though, the Wall St lobbyists sprang into action, and another law was passed that made CDOs impossible to regulate, either as commodities or what they actually were: gambling.

Assets are subject to ratings; I assume you’ve heard of Standard & Poors rating agency, for example. Their ratings supposedly show the risk in a product. So if I hold a B-rated asset (I own a share of a tattoo parlour opened by an ex-con), I’m going to pay a higher interest rate if I borrow against it than, say, if I held the mortgage on Crown Casino.

CDOs were almost all rated as AAA. That meant, in theory, they were completely safe. The reality, however, is laughable. They were rated AAA on the basis that there was 1% of a mint-condition 1968 Gibson Les Paul in the CDO, and it made up 10% of the entire CDO; there’s no way a guitar like that would ever crash in value, so 10% of the CDO was rock-solid. Therefore, using actuarial tables that only the truly deluded could read, the entire package, including the IOU from tram-stop-guy, was rated AAA. Then tram-stop-guy fell asleep under a tree and got set alight by a bunch of teenagers, the Ikea couch had to be thrown out because it was full of rats, no repayments were made for a few weeks, and suddenly 90% of the CDO was worth NOTHING and no-one could find the Cash Converters slip for the 10% of 1% of an asset that was actually worth something.

Trillions of dollars’ worth of CDOs were being bought and sold like hot potatoes by banks, hedge funds, local councils, and personal investors all over the world. Some of the CDOs were made up entirely of rock-solid mortgages, Eric Bana’s VISA bill and my coffee supplier’s truck loan. Most, on the other hand, were made up of tiny tiny little chunks of the above, mixed with a whole lot of IOU slips from tram-stop-guy and rat-infested Ikea couches. But because of the shiny (but opaque) packaging nobody knew which was which, so nobody could trust anybody else’s balance sheet, so nobody could lend anyone anything and no one could borrow anything to make up the shortfall in their rent, so everybody got evicted.

Of course, the market for all these things didn’t just go through the floor, it went fucking subterranean, so companies holding them lost billions of dollars in value within days. Not only were the US banks left holding worthless Cash Converters slips of their own, they were also covering huge loans for companies whose collateral was shares in other banks that owned millions of worthless Cash Converters slips.

The company that did the most damage in the CDO market was AIG Financial Products. That’s the outfit that got a huge bailout, then shortly afterward paid millions in bonuses to its traders. They dealt in Credit Default Swaps, effectively a form of insurance on CDOs, and are far too complicated to go into here, however suffice it to say that they were a bet on a bet, where the house wins big but no-one knows who the punters are.

So everybody was losing money at a rate of knots, and it was time for someone to step in and do something. Alan Greenspan’s replacement at the Fed Reserve, Ben Bernanke, has a slightly skewed take on Milton Friedman and interventionism; his solution to the credit crunch haemorrhaging? Let some people bleed to death, while we keep a few favoured ones alive and then, when the dust settles, we can all go back to doing exactly what we’ve always done.

Bernanke’s version of triage was grotesque; he appropriated about $700 billion dollars from the US government, and handed it out to Wall St ad hoc. Thus, Lehmann Brothers (Goldman Sachs biggest competitor) disappeared, but Goldman Sachs survived and, in fact, prospered. Oh yeah, and when AIG was on the brink of collapse, owing money all over the block, the first creditor to be paid out when they got their share of Greenspan’s bailout was Goldman Sachs (this, of course, has nothing to do with the proliferation of Goldman Sachs alumni at every finance related government office in America).

This method of injecting liquidity into the system was like giving a four-litre blood transfusion to a soldier with his leg blown off, but not applying a bandage to the leg. The bailout money keeps flowing, in the form of the Fed stepping into the securities market on a weekly basis, but these repurchases are no longer out in the open, like the first bailout was, they’ve been renamed “Term Auction Facilities”, and “Money Market Investor Funding Facility” and other equally nonsensical euphemisms. None of them have to be made public, and all of them were supposed to be temporary.

But they’re not. They keep getting renewed, and the Fed has pumped trillions, yes trillions of dollars into the market, as direct investment or loans, and no one who isn’t a part of the game is able to find out who’s getting the money, or how much, or what they’re doing with it.

Effectively, Citigroup and Goldman Sachs and the other institutions that are “too big to fail” are on a constant feed from the Federal Reserve. They’re rebuilding their war chests at everyone else’s expense, after they gambled and lost everyone else’s money in the first place. When they eventually recover and start making profits do you think they won’t go back to their multi-million dollar bonuses?

Do you think they won’t take advantage of this new, secret system of having the taxpayer bail them out when they lose, while hanging on to any profits they do make? The people on the government side who are supposedly in charge of all this all come from the very industry they’re there to regulate, and they’ll go back there after a few years.

Wall Street is now, effectively, the government. For the banks, by the banks, of the banks.

The lesson that we need to all keep in mind here is that Australia dodged the bullet that left the American financial system crippled and bleeding. Not because of Rudd and his vote buying stimulus package, but because our banks and financial institutions had comparatively strict regulations about assets and debts so even when things got tight, they were still worth something, could still borrow something and weren’t holding onto a trillion dollars worth of nothing mortgaged three times over.

Sometimes, regulation can be A Good Thing. Let’s not forget that.

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