Rigged

WASHINGTON RESISTS EUROPE’S FINANCIAL REFORMS

In March Treasury Secretary Timothy Geithner delivered a pointed warning to European finance ministers against tough new regulations for hedge funds and private equity funds. Gordon Brown, the British prime minister, strongly echoed Geithner. The complaints are both framed in free-trade terminology—as if the Continent were trying to exclude inexpensive, high-quality British and American steel.

Bear in mind that the financial terrorists who blew up the global economy little more than a year ago were mostly American and British financial institutions. European banks helped out too, but they joined the party late, and often got stuck with most of the losses. Since the eventual taxpayer tab may run to $10 trillion or more, a tough regulatory response should hardly surprise.

What’s disheartening is the blatancy of Geithner and Brown’s shilling for favored constituents. Most hedge funds and private equity funds are American or British, so their governments leap to do their bidding. What if President Felipe Calderón complained of America’s hostile attitude toward Mexican drug cartels?

It’s worth reminding ourselves what the financial crisis was about. In 2001, then–Federal Reserve Chairman Alan Greenspan joined President George W. Bush in a campaign for federal tax cuts, disproportionately tilted toward the very wealthy. Then in the wake of the 2001–02 recession, Greenspan drove interest rates down to their lowest levels ever, and kept them there, to make it easier for banks to lend.

Both those measures put huge new pots of free cash in the hands of the very rich. Real investment—in things like new machinery or new roads—stayed pretty flat, however. Instead the money flowed into financial instruments, and especially into hedge funds and private equity funds, which claimed to earn much higher returns than those available to hoi polloi.

Private equity funds used to make money by buying underperforming companies or other distressed assets and actually fixing them. It was hard work and often financially risky. But with all the free cash floating around in the 2000s, you could dispense with the grungy “fixing” part. It was easier to just pile up debt and take the money home.

Consider a once-thriving European cell-phone company, TIM Hellas, that was snapped up in 2005 by two private equity funds, one British, one American. The buyout price was €1.7 billion. The funds put up €450 million of their own money, and borrowed the rest on Hellas’s books. So on day one, Hellas had gone from cash-rich to debt-poor, and its healthy profits had turned to losses. The next year, the company floated another €1.9 billion in debt, €1.5 billion of which was paid directly to the fund partners. For their efforts in self-enrichment, moreover, the funds charge the company yet another €2 million in annual fees. In other words, Hellas has been looted, and is now in danger of folding. Although the funds call themselves “investors,” they are really malignant parasites, feeding on hosts until they die.

There is no single category of hedge funds, but many were deeply implicated in buying and distributing the complex financial instruments like CDOs (don’t ask) that let banks spray toxic subprime mortgages, or auto loans, or consumer debt throughout the land, then collect the poison in pretty boxes and gift-wrap it with AAA ratings. Unsuspecting “sophisticated” investors, like Danish school boards and Mississippi pension funds, happily snapped up the pretty boxes. And the savings so diligently gathered for worker pensions or school textbooks were siphoned away into the pockets of distant bank and hedge-fund executives.

In other words, the financial system in the last decade was a machine for redistributing wealth upward. It worked well, too: in both England and America, from 2002 through 2006, nearly three-quarters of all income growth went to the top 1 percent of earners.

Working folks were blinded by the easy availability of money for big houses, big cars, and electronic toys from China. But like the employees of Hellas, they’ve discovered that the rich took all the cash, leaving only mountains of debt behind. And now they’re losing their jobs besides.

When the Obama administration came into office, the rallying cry about the financial meltdown was “Never again!” On their face, the European proposals seem targeted at exactly the destructive, highly leveraged deal-making that was such an important cog in the 2000s klepto-machine. Indeed, the fact that bankers hate it so much suggests that the Europeans are on to something promising. So it’s sad and shocking to see the highest officers of the land meekly take their places in the bankers’ chorus.

Published in the 2010-04-23 issue: 

Charles R. Morris’s most recent book is The Rabble of Dead Money, a history of the Great Depression (PublicAffairs).

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