Why The Wall Street Casino Lives On

David Stockman, Budget Director under President Reagan and partner at private-equity firm Blackstone Group, lashes out at the Fed-induced LBO of Extended Stay America that amounted to a scam, made Blackstone Group billions, and saddled taxpayers with the detritus. This is the third installment of the Extended Stay debacle, the bitter end. It’s from Chapter 26 of his bestseller, THE GREAT DEFORMATION: THE CORRUPTION OF CAPITALISM IN AMERICA.

On a personal note: This section is perhaps the most brilliant explanation ever as to why the Fed bailouts of Wall Street since the financial crisis were an asinine idea that benefited the “0.0001%” with destructive consequences for everyone else, including the taxpayer, and the main-street economy. 

Drastically overpriced debt is eventually smacked with painful losses on the free market, but not on a Wall Street served by compliant central bankers. When the Bernanke Fed bailed out Bear Stearns in March 2008, for example, it was sitting on tens of billions of impaired or worthless assets.

Among this financial sludge was $1.1 billion of the undistributed Extended Stay paper. Accordingly, the taxpayers of America through their central bank became the owners of busted bonds which, on the margin, had funded nearly half of Blackstone’s legendary profit on the sale to Lightstone.

In this saga of low-rent hotel rooms the evils of bubble finance are starkly revealed. It demonstrates vividly how the mega-LBO frenzy of the second Greenspan bubble escalated income and wealth to the top 1 percent, or in this case the top 0.0001 percent. But even more importantly it documents why Washington’s frantic bailouts after September 15, 2008, were so misguided and counterproductive.

The time was long overdue for a classic liquidation of the massive credit bubble which had built up since the 1980s. A generation of speculators who rode it to the peak needed to be unhorsed once and for all. And it could have been easily achieved: Bernanke only needed to ignore the Cramer rant which echoed throughout the canyons of Wall Street in August 2007 and, instead, order the Fed’s open market desk to sit firmly on its hands.

So doing, the Fed would have engaged in the right sort of “accommodation.” It would have facilitated Wall Street’s desperate need for a financial housecleaning, just as J. P. Morgan did with such sublime effect in October 1907.

By staying out of the Treasury market the Fed would have permitted short-term interest rates to soar, thereby laying low the financial meth labs all along Wall Street. Their toxic inventories would have been dumped into the market at fire sale prices; they would have had no choice because trading desks would have been faced with crushing double-digit funding rates in the repo and wholesale money markets—rates which would have been rising by the hour and threatening to soar to terrifying levels. That is how panics ended in historic times, and that’s why speculation did not become deeply embedded and institutionalized as it has in the age of bubble finance.

The result would have been a bonfire of speculative paper that would not have been forgotten for a generation. Every single investment bank, including Goldman, Morgan Stanley, and the embedded hedge funds at JPMorgan, Citibank, and Bank of America would have been rendered instantly insolvent and dismembered under court and FDIC protection. Speculators would have denounced the Greenspan Put for decades to come. No banking institution reckless enough to make $100,000 bridge loans against $35,000 hotel rooms would have reemerged from the conflagration.

Just as importantly, the bonfires would have largely burned out in the canyons of Wall Street. The nonfinancial businesses of Main Street would have been largely unscathed for four principal reasons.

First, after having already massively inflated its debt, from $4 trillion to $11 trillion during the fifteen years ending in 2008, the business sector needed to liquidate borrowings, not go into hock even further. A period of high interest rates and scarce new debt availability would have been economically therapeutic.

Secondly, at that moment in time viable and solvent businesses did not need cheap debt to finance productive assets. Huge sectors of the US economy centered on commercial real estate, retailing, hospitality, and other forms of discretionary consumer spending were already vastly overbuilt. A period of high-cost debt, therefore, would have dramatically reduced the rampant malinvestments of the Greenspan bubbles and forced businesses to fund only high-return projects out of internal cash flow or expensive long-term debt.

Thirdly, high interest rates would have shut down the multitrillion flow of new debt to financial engineering. As previously shown, buybacks, buyouts, and takeovers contribute little to real business productivity and growth of national wealth, and mostly serve to scalp economic rents from Main Street and channel them to the top 1 percent.

Finally, thousands of drastically overleveraged business like Extended Stay America would have been forced into bankruptcy but they would have nevertheless continued to function under court protection. More importantly, they did not need Wall Street to reorganize their finances. Several trillions of business debt that had been incurred to fund LBOs, stock buybacks, and corporate takeovers could have been repudiated by debtors in bankruptcy court and replaced by simplified, equity-based capital structures.

Businesses thus freed from the yoke of Wall Street–originated debt would have emerged from Chapter 11 and have been controlled by the knowledgeable businessmen and skilled employees who had operated them all along. The American economy would thereby have embarked on the road to definancialization. Real economic productivity, investment, innovation, and growth based on honest free enterprise might have again become possible.

Instead, after the Lehman event, the madcap money printing of the Bernanke Fed and the bailout frenzy of the Paulson Treasury Department stopped the Wall Street cleansing in its tracks. The only thing that changed was that the remnants of the “departed”—Bear Stearns, Merrill Lynch, Lehman, Wachovia—were recycled back into the even greater girth of the  “reprieved”—Goldman, Morgan Stanley, JPMorgan, Bank of America, Barclays, Citigroup, and Wells Fargo.

The system which finally failed in September 2008 was actually reincarnated in even more destructive aspect. The Bernanke Put was far more insidious than the Greenspan Put because it refused to permit even a 10 percent correction in the stock averages before pumping a new round of juice into Wall Street.

Likewise, the carry trade became an even more one-sided gift to speculators: risk assets could now be funded in the wholesale money markets for virtually nothing, while hedge fund operators were solemnly promised by the monetary central planners that their cost of carry would be frozen at nearly zero for years on end.

Check out his book at your favorite bookstore or at Amazon…. THE GREAT DEFORMATION: THE CORRUPTION OF CAPITALISM IN AMERICA.

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