Michael Hudson Why the Bail Out of Freddie Mac and Fannie Mae: is Bad Economic Policy

We are not in a cycle but the end of an era. The old world of debt pyramiding to a fraudulent degree cannot be restored, despite the repeal Glass-Steagall Act in 1999 that unleashed financial conflicts of interest when the Clinton Administration backed Treasury Secretary Robert Rubin and financial lobbyist Greenspan in claiming that financial markets would be self-regulating and law-abiding. The real estate bubble was made possible by the unique degree to which America's population emerged from World War II relatively debt free. Each recovery has taken off from a higher debt level. This something like trying to drive a car with the brakes pressed tighter and tighter to the floor each time there is a stoplight (recession). We have now reached the debt limit, and the economy is stuck. The class war is back in business, with a vengeance. Instead of it being the familiar old class war between industrial employers and their work force, this one reverts to the old pre-industrial class war of creditors versus debtors. Its guiding principle is "Big Fish Eat Little Fish," mainly by the debt dynamic that crowds out the promised economy of free choice.

This is being portrayed as a post-industrial economy, but it is a much older story. No economy in history ever has been able to pay off its debts. That is the essence of the "magic of compound interest." Debts grow inexorably, making creditors rich but impoverishing the economy in the process, thereby destroying its ability to pay. Recognizing this financial dynamic most societies have chosen the logical response. From Sumer in the third millennium BC and Babylonia the second millennium through Greece and Rome in the first millennium BC, and then from feudal Europe to the Inter-Ally war debts and reparations tangle that wrecked international finance after World War I, the response has been to bring debts back within the ability to pay.

This can be done only by wiping out debts that cannot be paid. The alternative is debt peonage. Throughout most of history, countries have found again and again that bankruptcy - wiping out the debts - is the way to free economies. The idea is to free them from a situation where the economic surplus is diverted away from new tangible investment to pay bankers. The classical idea of free markets is to avoid privatizing monopolies, such as the unique privilege of commercial bankers to create bank-credit and charge interest on it.

Current proposals would replace bad debts that are not publicly insured (except by an "implicit" guarantee that relevant legislators have bought into) with new debts, and new suckers are to be left holding the bag. Bahrainis and Saudis in particular are being courted.

But most of all, there is a public campaign being waged by the FIRE sector (Finance, Insurance and Real Estate) to convince the American public that, in the infamous words of Margaret Thatcher, TINA, "there is no alternative." (See for instance the Wall Street Journal's excellent coverage of the FNMA/mortgage crisis on July 11, 2002, p. A12.) When one hears this, it means that political censorship is being mobilized to flood the popular media with the intellectual equivalent of sterile fruit flies being released to stop the spread of a threat. All one hears is a barrage of claims that the government must preserve the financial fictions of FNMA and Freddie Mac in order to "save the market."

But what is "the market" that is to be "saved"? To Wall Street and its Congressional advocates, it is the mass of bad debts growing at compound "magic" rates of interest, beyond the ability of debtors to pay. If the debtors cannot pay, then the Government - "taxpayers" are to pick up the check to Wall Street. Meanwhile, more tax breaks are to be given to leave the finance, insurance and real estate sectors with enough money to "earn back" their losses, by extracting yet more rent and interest from the industrial economy's consumers and wage-earners.