America Foreclosed:
The 500 Trillion Dollar Debt Bubble Pops

By Peter E. Chojnowski, Ph.D.

            Edward Jordan is a 78 year old retired postal worker living in California. Living now on a pension, he had been financially responsible all his life and was a few short years away from completely paying off the mortgage on his home. This financial responsibility was demonstrated by his 800 credit rating, which placed him among the 13% best credit risks in the nation.
            Then one day a financial broker knocked on his door and told him that he was paying too much for his monthly mortgage. With his credit rating, she could guarantee him a rate of 1%. Mr. Jordan was intrigued by the idea and sought out advice from another broker who confirmed this and got a new mortgage for him with Countrywide. Total fees for the new mortgage were $20,000. Mr. Jordan’s American financial nightmare had only begun.
            After the deal was signed, Jordan found that his interest rate, sold to him as being only a single percentage point based on his credit history, would quickly escalate to as high as 9.95%. When he complained to Countrywide, their “loss-mitigation” unit offered him an interest only alternative, but…..at a higher rate and…with a steadily escalating principal. Monthly payments would eventually rise to several times Jordan’s income. He is now afraid that he will lose his home. Mr. Jordan was robbed by Countrywide. The files of the legal services in the area where Jordan lives are bulging with cases like this.[1] Welcome to America 2008.
            Before considering the way in which the United States got to such a point --- the collapse of the House of Usury -- let us consider the ancient wisdom. St. Basil the Great, when speaking about usury or the taking of interest on a non-productive loan, makes a play on the Greek word for “interest” tokos, which, also, means “childbirth”. With a tone that cannot be called anything but sardonic, St. Basil states that the taking of interest on what ought, by its very nature, to be a gratuitous offering to a needy brother, is fittingly given the name tokos, both because of the “fecundity of the evil” and since it produces “anguish and travail” in the souls of those who find that they must give birth to extra money to repay their debt to the usurer. Aptly describing the one indebted to the usurer as in a position of slavery, he states “there is interest upon interest, the wicked offspring of wicked parents.”[2]

A)    Are We in for a “Very Great American Depression”?

            On the morning that I write (June 18, 2008), the research team for The Royal Bank of Scotland advised clients to brace for a full-fledged crash in global stock and credit markets over the next 3 months.[3] To cite the report, “the S&P index of Wall Street equities is likely to fall by more than 300 points [this would mean a drop of ¼ of the value on the exchange] to around 1,050 by September as ‘all the chickens come home to roost’ from the excesses of the global boom, with contagion spreading across Europe and emerging markets. Such a slide on world bourses would amount to one of the worst bear markets over the last century.” The report continues, “The Fed is in panic mode. The massive credibility chasms down which the Fed and maybe even the ECB will plummet when they fail to hike rates in the face of higher inflation will combine to give us a big sell-off in risky assets.”[4]
            If this warning, coming from financial analysts in a major world bank, were singular, it would be disturbing, but this warning is echoing Morgan Stanley which is speaking of a “catastrophic event”[5] and LEAP/Europe 2020 which is speaking of a “Very Great American Depression.”
            In March 2007, Charles Morris, a lawyer and financial writer whose software company developed programs for building and analyzing the securitized asset pools that play such a critical role in this current financial crisis, went to Peter Osnos at Public Affairs and told him that he expected the “mother of all crashes” by mid-2008. This prediction and the information that was behind that prediction, led to the publication of Morris’ most recent book, published in the spring of 2008, entitled The Trillion Dollar Meltdown.[6] This prediction --- one that Morris acknowledges to be extremely conservative --- was uncannily confirmed by John Paulson, founder of the hedge fund Paulson & Co., in an address to the GAIM International Hedge Fund Conference in Monaco on June 18^th, 2008, when he stated that global writedowns and losses from the credit crisis may reach $1.3 Trillion…We’re only about a third of the way through the writedowns.”[7]

B)    Rich Man Poor Man 2008 and the Second Gilded Age

            What most financial analysts agree upon is that it is because of the default of the American homeowner and consumer that the world faces a global “systemic crisis” (i.e., a crisis which throws into question the very foundations of the world order post-WWII). If the United States is at the epicenter of the seismic activity, it is the average American who has both initiated the crisis and stands to suffer the most from it. The average American is caught by the undertow of two very specific trends. First, there is the shifting of global economic activity away from the United States. For this first time since 1913, the United States has lost its status as the world’s largest financial center. Not only is the role of the United States decreasing in the field of international trade and wealth production (e.g., 60% of Russian foreign trade was with the European Union, 20% of Saudi Arabian trade was with Europe, while only 16% was with the United States, etc.), but according to Ian Harnett (managing director of ASR and former UBS-Warburg’s Head of European Strategy) the European stock markets, including Russia, by the end of March 2007, totaled €1.18 trillion as against the value of €1.176 in United States’ markets. In the past few years, European markets grew by 160% while US markets grew by only 70%. It must be remembered here, that the decline in the value of the dollar contributed to this trend.[8] According to LEAP/Europe 2020, what has also contributed to this trend is the progressive impoverishment of the American consumer and collapsing competitiveness related to the collapsing quality of education.[9]
            Such is the United States as a nation; what is, also, reaching a critical state is the income disparity between the highest percentiles of income wealth and the 90% of the rest of the American populace.  Not only are the 90% defaulting on their home loans, their equity lines of credit, and their double-digit interest credit cards, they are increasingly receiving a smaller and smaller percentage of the nation’s wealth. A recent study conducted by Thomas Piketty and Emanuel Saez, shows the revenue disparity ratio is now comparable to what it was on the eve of the Great Depression. According to this work, the revenue ratio between the richest .01% and the poorest 90% was about 170/180 from 1950 to 1980. This had left to 880/180 in 2005. This figure is progressively getting worse.[10]
            The figures marshaled by Charles Morris in his The Trillion Dollar Meltdown, indicates clearly who is getting relatively richer and who is getting relatively poorer. In a chapter entitled, “Winners and Losers,” Morris delineates what he refers to a “tidal shift” in American society --- a widening disparity of wealth and income not seen since the Gilded Age.[11] This dramatic shift of taxable income towards the wealthiest people has meant that the top 10% of the population’s share of all taxable income went from 34% to 46% an increase of about a third from the years 1980 to 2005.[12]
            As Morris emphasizes, it is the changing wealth distribution within the top 10% of Americans which is truly indicative of the shift of wealth over the past generation. The “unlucky folks” in the 90^th to 95% percentile actually lost a little ground while those in the 95^th to 99^th percentile gained only a little. Overall, the income share in the 90^th to 99^th percentile was basically flat. Almost all the top 1/10^th share gains went to the top 1%. Their slice of the American pie went from 9% to 19%. The top 1% also own 62% of all private business income, 51% of all stocks, and 70% of all bonds, including those in IRAs and 401(k)s.
            Even within the top 1%, the distribution of gains was radically skewed. Nearly 60% of it went to the top .1% of 1%. Overall, the top .1`% of 1% more than tripled their shares to about 9%, while the top .01% of 1%, or fewer than 15,000 taxpayers quadrupled their share of the national income to 3.6%. Among those 15,000 the average tax return reported $26 million dollars, in 2005, while the total amount “earned” by the 15,000 was $384 billion. The Second Gilded Age – and the summer of our discontent – has arrived.

C)    Bretton Woods, Keynesian Left Liberalism and the Carter Malaise: 1945-1980

            If this is the “end of the Western world as we’ve known it since 1945,” if this involves “the collapse in all its dimensions (economic, monetary, financial, diplomatic, intellectual, and strategic) of the central pillars of the 20^th century incarnated by the United States, we have to ask ourselves “How did we get here?” Why is it that, “The pillar now lies on quick sand --- the global architecture will then collapse piece by piece”?[13]
            In The Trillion Dollar Meltdown, Charles Morris charts this history of rise and fall, by first identifying the factor that allowed the United States to become the pillar of the post-World War II world, the Bretton Woods agreement. Bretton Woods made the US Dollar the global economic common denominator by making it the reserve currency of the world. Also, if nations wanted to buy and sell, they would have to do it in US greenbacks. These firm props for the dollar and fiscal responsibility it engendered, the US agreed to redeem the dollar at the rate of $35 for an ounce of gold,[14] created the conditions for the affluence of the 50s and early 60s. During these years, for a large segment of the population the “American Dream” of a house and a decent school for the children came true. The unprecedented prosperity in America during the 50s, even caused John Kenneth Galbraith to write a book entitled The Affluent Society (1958) in which he announced that the problem of production had been solved, the consumer’s wants were on the verge of being sated, and that it was time to focus on “expelling pain, tension, sorrow, and the ubiquitous curse of ignorance.”[15]
            The problem was that the children of the 50s became the teenagers of the 60s. The stable and prosperous American society of the 50s had decided to make up for the low-birth rates of the Depression 30s and World War 40s. The statistics are clear. 18 to 24 year olds were 4.3% of the population in 1960 and 5.6% of the population in 1970. On the face of it, this looks like a minor change. It was not. The total numbers of youth jumped from 7.6 million to 11.4 million and, in the Liberal ambiance of the time, this was utterly disruptive. Juvenile delinquency jumped to the top of the social agenda. Struggling to cope, police forces became more selective about the behaviors that elicited an intervention, a process which Daniel Patrick Moynihan called “defining deviance down.”[16]  
            The explosion of the college-aged population --- and the fact that a higher proportion of young people were spending 4 years in college --- set the stage for the campus war protests of the late 60s and early 70s. The “60s” came to an end in 1971, when the war protests were over because the draft was over. When Richard Nixon took office in 1969, Lyndon Johnson having decided not to run in 1968 due to the intensity of the war protests, he inherited an economy that was already careening towards serious trouble. According to Morris, Nixon’s fixation on winning reelection in 1972 caused him to make a bad economic situation immeasurably worse.[17]
            For purposes of understanding the great economic debacle of 2008, Nixon’s rescinding of the US government’s commitment to redeem dollars for gold is by far the most important decision made during the second week-end in August 1971 when Nixon helicoptered his entire economic team to Camp David to hold, what was called, “the most important economic meeting since the New Deal.” Along with taking the US off the gold standard and establishing a “fiat” currency --- a currency backed by nothing other than the word of the government --- Nixon announced tax cuts, imposed wage and price controls throughout the economy, including the critical oil sector. With price controls in place and no tie between the dollar and the supply of gold, Richard Nixon and his Fed Chief Arthur Burns could spike up the money supply without worrying about price inflation. As a result, the money supply numbers jumped by more than 10% in 1971, the biggest increase ever. Getting what he wanted, economic growth had reached a healthy 5% by the time of his landslide over George McGovern in 1972.[18]
            The flooding of the system with “floating” dollars was a direct contributor to the OPEC oil price hikes which helped to trigger the Great Inflation of the 70s. During the 70s, the Keynesian Left Liberalism, brought to Washington in 1961 by John Kennedy, was clearly the governing ideology. High intelligence employed in activist government would use the levers of the State to achieve specific results in the economy. The “floating” of the dollar --- not tying it to the availability or price of any concrete metal or commodity --- also, allowed the government to manipulate the money supply for the political ends of the political party that happened to be controlling the US administration. The value of the dollar spiraled downward, as did American prestige.[19]

D)    Volker, Milton Friedman, and Free-Market Folly: the 80s

            Paul Volker, the “candidate of Wall Street,” was appointed by Jimmy Carter as Fed Chairman to do one thing, fight the inflation that would reach 13.5% in 1980. During this time, the price of oil was going up 6% a month (sic) and gold had jumped 28% in a single month. The United States was facing a Weimar-type hyperinflation. Remember “stagflation,” recession accompanied by runaway inflation, had never before happened in the United States. Inflation was sending a signal that the economy was out of control.[20]
            According to Morris, it was Volker’s stubborn insistence on keeping interest rates high, at 19%, which caused inflation to break in 1982. Economic growth, minus inflation, would soar to 7.2% by the election of 1984. The dollar also soared in value. The grim demonstration of what America would endure to protect its currency transformed the world’s impression of its economic management. The US’s commitment to price stability was assumed as a matter of fact.[21]
            The 80s are to be known as the decade of economic deregulation. This deregulation was motivated by the economic theory of Milton Friedman and the Libertarian Chicago School of Economics. As Morris states on the very first page of his book, Chicago School Economics morphed from being a method of analysis to becoming a Theory of Everything. The core concept was that the Free-Market, if allowed to work without obstruction, will consistently produce optimum outcomes. Having adopted this ideological orientation, one of Ronald Reagan’s first acts as president, in 1981, was to complete the deregulation of oil prices. The deregulation of the financial markets would soon follow.[22]

E)     Milton Friedman, the CMO and the Inflation of the Housing Bubble

            With the election of Ronald Reagan in 1980, Keynesian Left-Liberalism was replaced by Milton Friedman’s Libertarian “Monetarism” or Right-Liberalism. Officially, Monetarism is a theory about money. If the supply of money rises faster than real economic activity, prices will rise. Government policy need concern itself only with the money stock. According to this theory, if the Fed expanded the money stock at approximately the rate of economic growth, prices would also stay roughly constant.[23] What the Monetarist theorists had, apparently, not factored into the equation, was the fact that, under these monetary restrictions, “profit-seeking banks would created new financial techniques to avoid the restrictions.”[24] This is exactly what happened.
            If Friedman’s Libertarian Laissez-Faire ideology or “Right Liberalism” was a dominant spirit in the financial and political circles of the 80s, 90s, and early 21st century, Charles Morris claims that the engine generating the speculative bubbles of these last few decades was something very prosaic. According to Morris, the surge in speculative financial investing was initiated and fed by a 1973 law requiring companies to set aside money to fund their pension promises to workers. Pension fund assets quickly ballooned to $1 Trillion and pension fund managers clamored for more leeway in the strict pension fund investing rules. When the regulations were finally eased in 1979, it was pension fund, foundation, and endowments that were the source of most of the venture money.[25]
            Another cause for the phenomenal increase in financial speculation is the complicated mathematically-structured investment instruments that emerged in the 80s and 90s from a problem which emerged in the secondary mortgage market (i.e., the market in which mortgages are sold to investors by the banks which originate the loans). The problem for those who were investing in mortgage-backed securities was that whenever interest rates fall, homeowners rush to refinance, and if rates are rising, they hold on to their mortgages forever. Unexpected shifts in maturities can devastate investor returns.[26]
            Most of these problems were solved by the Collateralized Mortgage Obligation (CMO), invented in 1983 by Larry Fink and a First Boston team on behalf of Freddie Mac. The origin of the CMO, now threatening to undermine the current global financial system, was in the New Deal’s attempt to establish Savings and Loan banks (S&Ls) as the linchpin of its strategy for broadening opportunities for home ownership. To keep S&Ls in lendable funds, the government established quasi-federal agencies (e.g., Fannie Mae and Freddie Mac) that would liquefy local lending markets by buying up mortgages from S&Ls and other qualified lenders. In order to maintain their own liquidity, these agencies would maintain their own cash flow by selling mortgage-backed securities or “mortgage pass-throughs.” These securities are created by transferring a group of mortgages to a trust, which in turn issues certificates representing a slice of all the principal and interest that it receives. For example, a trust comprising $100 million in mortgages paying an average interest rate of 6% would sell a certificate entitling the investor to, say, 1% of the trust’s proceeds. The investor would therefore receive 1% of $6 million each year, until all the mortgages are paid down.[27]
            With the aid of mathematics Ph.D.s and high speed computers, Larry Fink and associates were able to make these mortgage-backed bonds more attractive by “slicing” or tranching them horizontally into three segments, with different bonds for each segment. The money that came in from all the mortgages – no matter on which tranche (i.e., mortgages with borrowers with excellent credit histories, borrowers of less than excellent credit histories, and, finally, in the lowest tranche, risky mortgages offered to less than credit worthy borrowers) would be filtered through the CMO from the top down. The top-tiered bonds, which represented, say 70% of mortgages, had first claim on all cash flows. Since it is inconceivable that 30% of normal mortgages portfolio will default, top-tier bonds get triple-A, super-safe ratings and paid a lower interest rate, say 4%; safer and, yet, a smaller yield.
            The second tranche would included, typically, 20% of the mortgages that would be sold at a somewhat higher percentage rate, say 8%, while the third tranche, covering the last 10% of the mortgages was the first to absorb all loses --- since there would be a certain low percentage of mortgages which were defaulted on. Since these bonds were risky --- you might not get paid if you held them – they would have a higher interest rate, say 10-12%. This would be equivalent to speculative or “junk” bond yields; the CMO, therefore, offered risk and yield choices to satisfy any investor’s appetite.[28]
            The first CMOs were very profitable. All the big Wall Street firms began scarfing up mortgages and putting them out as CMOs. The CMO fundamentally changed the entire mortgage business. Formerly, mortgage lenders were a “one-stop shop.” They interviewed applicants, approved the credits, held the mortgages, collected the monthly payments, and managed default workouts and foreclosures. CMO made mortgages the stuff of financial speculators and separated the home “owner” and borrower from those who “owned” the mortgage.
            The new mortgage industry was like this: mortgage banks with little capital attracted and screened mortgage applicants. Other thinly capitalized mortgage banks bid for the loans and held them until they had enough to support a CMO. Investment banks, using complicated mathematical models, designed and marketed the CMO bonds. Serving specialists managed collections and defaults. By the 90s, the complexity of these financial instruments spiraled out of control. CMO “shops” spewed out phantasmagorical 125-tranche instruments that no one could possibly understand. The stability of these financial houses of cards depends upon families and individuals keeping up payments and not defaulting. What if they do in record numbers? Very big, very complex, very opaque structures built on extremely rickety foundations are a recipe for collapse.
            As was inevitable, in light of the above, there was decomposition in mortgage banking. A new generation of mortgage banks, instead of holding them for the term of the loan, sells off mortgages in weeks or months; as the point of loan origination, brokers are usually compensated strictly for the fees they generate, and they often work with a customer entirely by email or phone. Countrywide reports show that their staff programmatically steers customers towards financial products with the highest fees.[29] When money is free because of low rates and fractional reserve banking, when lending is costless and riskless the typical lender will keep on lending until there is no one else to lend to. By the 1^st decade of the 21^st century, we had entered --- or we were told by Alan Greenspan that we had entered --- a glorious new era of finance. Greenspan announced “a new paradigm of active credit management.”[30] Profit seeking banks would now give home equity loans to strapped homeowners and high-rate credit cards for insolvent consumers. The brokers would simply log in the loans, collect his or her fees, and sell them off to yield-hungry investors. The broker’s fees were real money. The loans might be paid off.[31] Stephen Roach, chairman of Morgan Stanley Asia, has called the Fed’s actions during this period of unlimited credit expansion, “unconscionable.” In 2004, when we were reaching the height of this credit spike, the Economist magazine stated, “the global financial system…has become a giant money press as America’s easy money policy has spilled beyond its borders….This gush of global liquidity has not pushed up inflation, instead, it has flowed into share prices and houses around the world, inflating a series of asset-price bubbles.”[32]
            In order to pay for the costs that are associated with buying and paying for a home, many consumers have, in recent years, resorted to home-equity loans and credit cards. With the coming of the credit crunch many of those home equity loans have been reduce or withdrawn. Here it is important to remember that if, say, your home equity line of credit --- for whatever reason your lender may decide --- is reduced from say, $20,000 to $10,000 and you just happen to have spent $10,000 dollars of the line already, it will be reported to the credit agencies that you have “maxed out” your credit account, causing your credit score to suddenly tumble. Moreover, in light of the drying up of the home equity market, more and more people are maxing out their credit cards, often using them to make payments on their mortgages. With interest rates for good credit risks approaching 20% and interest for the less qualified as high as 40%, it is not surprising that Fortune magazine has reported credit card payment delinquencies to be up about 50%.[33]

F)     2008: America’s Very Great Debt Depression

            It is very difficult to adequately portray the ocean of debt upon which the United States floats. The fundamental point to remember here is that the stability of an economic order floating upon debt is that there is someone who is going to pay on those debts. If a debt is not going to be paid on, the one holding the loan is holding worthless paper. Moreover, even if investors lose confidence that debts will be paid, the securities based upon debt will be rendered worthless. How can a system hold which is based upon the “value” of “packaged” debt, when that debt is, or is at least potentially, valueless? Can we ever get back to an economy based upon the value of real things? Is debt real or do we just take it to be real? What happens when a debt structure implodes? Will it hurt?
    The answer to the above question is clearly, “Yes, it will hurt and it will threaten to collapse the system.” The financial powers that be know this. That is why they have tried to put off the day of reckoning by injecting hundreds of billions of dollars of liquidity into the banking system and by regularly cutting interest rates in order to keep the lending and borrowing rolling, in spite of the fact that this just exaggerates the problem. By “printing money” to provide liquidity, the Federal Reserve has devalued the dollar to the point that it has fatally undermined the US greenback’s status as the world’s reserve and trading currency. It has, also, fired up the furnace of inflation. For how long will the Chinese, Russians, and Arabs hold dollars, US bonds, and assets that are increasingly worthless? By allowing foreigners to buy US debt, have we made them the new masters’ of the fate of the average American?
            What is the outlook for the next couple of years? To quote Charles Morris, who is intentionally moderate in his conclusions, “Over the next 2 years (2008 and 2009), $350 billion in sub-prime and other risky residentially mortgages will reset, many at punishing rates. Defaults will rise sharply. A large number of people, perhaps as many as 2 million could lose their homes [Leap/Europe 2020 estimates 10 million]. House prices will continue to fall. Consensus estimates at 10% but pessimists are expecting at least 30% and pessimists have yet to be wrong in this cycle. Many consumers will be stuck with “upside-down” mortgages (i.e., greater than the market value of their homes)….Consumer spending must fall. The consumer spending which jumped from 67% of GDP to 72% in early 2007 was due to the withdrawal of $9 Trillion in home equity and is no longer sustainable, especially with rising oil prices….The stage is set for a true shock and awe surge of asset write-downs through most of 2008….Add to this even mildly bad outcomes in the credit insurance markets, and the global financial system will be in catastrophe.”
            To quote, Morris, during the 1998 potential global financial meltdown due to the Asian currency crisis and the Russian defaults, Fed officials gathered 20 New York bankers in a conference room, and they agreed to put up $3.6 billion to resolve the crisis. In 2008, there is no one to call a meeting, there is no conference room big enough to hold the parties, and no one knows who should be on the invitation list.[34] 

SEE ALSO:

• An Interview with Dr. Chojnwoski on Economic Meltdown - Oct 11, 2008

• Dr. Chojnowski's September 2008 CFN article: "The Fall of Phantom Assest":

• Conference on "The New World Order and the Economic Collapose"

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