Financiers seek to have fondest dreams come true through own secret trade deal

The financial industry has grown ever more powerful in recent decades, so perhaps the world’s governments believe it is only fitting that it has its own secret treaty. Similar to “free trade” agreements that curtail regulation of manufacturers, the Trade In Services Agreement’s Financial Services Annex, if passed, would eliminate the ability of governments to regulate the financial industry.

Incredible as it sounds, the annex, being negotiated in secret among 50 countries with continuing advice from lobbyists, would require signatory governments to allow any corporation that offers a “financial service” — that includes insurance as well as all forms of trading and speculation — to expand operations at will and would prohibit new financial regulations.

The driver of this offensive is the “investor-state dispute mechanism.” Deceptively bland-sounding, the “mechanism” is secret tribunals controlled by corporate lawyers that are commonly used under “free trade” agreements. Corporate executives angered because an environmental or safety rule keeps it from earning the highest possible profit can ask for a hearing at a designated tribunal to adjudicate its “dispute” with a government. Many of the judges who sit on these tribunals are corporate lawyers who otherwise represent corporations, and there is no appeal to their one-sided decisions.

City of London expanding (Photo by Will Fox)

City of London expanding (Photo by Will Fox)

The Financial Services Annex contains language identical to standard language used in “free trade” agreements that obligate “equal treatment” of all corporations. The practical effect of that language would result in the profits of speculators being elevated above all other human considerations, similar to proposed agreements such as the Trans-Pacific Partnership and Transatlantic Trade and Investment Partnership that would elevate corporate profits above all other considerations, should they come into force.

The countries negotiating the Trade In Services Agreement (TISA) Financial Services Annex, which include the United States, Canada, Australia, Japan and the 28 countries of the European Union, refer to themselves as the “Really Good Friends of Services.” If the “services” in question are services to the financial industry, then these governments are indeed really good friends.

If it is done in secret, it is for a reason

That we know anything at all about the Financial Services Annex is because the text has been published by WikiLeaks. Just as agreements like the Trans-Pacific Partnership and Transatlantic Trade and Investment Partnership are being conducted in secret because, as former U.S. Trade Representative Ron Kirk admitted, if people knew what was in the TPP, it would never pass, the annex is kept hidden from view, except for industry lobbyists.

The leaked text of the Financial Services Annex states it should be declassified “five years from entry into force of the TISA agreement or, if no agreement enters into force, five years from the close of the negotiations.” A deal designed to give financiers even more power over the economy is a state secret!

As with the ongoing “free trade” agreement negotiations, one should not hold one’s breath waiting for substantive information on TISA or the annex. The latest round of negotiations were held June 23 to 27 in Geneva, and here is what the U.S. Office of the Trade Representative reported, in full:

“The fourth round of TISA talks was positive and productive, with participants expecting to table offers by the end of this month. Additionally, the draft text of the agreement was further stabilized with the removal of all brackets concerning the ‘negative list’ approach. U.S. negotiators look forward to further work on this important agreement.”

Yep, that’s it. Despite that meaningless ode to bureaucratic blandness, the United States and the European Union are vying to introduce the most draconian language. WikiLeaks, in a press release accompanying its publication of the secret text, said:

“The US and the EU are the main proponents of the agreement, and the authors of most joint changes, which also covers cross-border data flow. … The draft Financial Services Annex sets rules which would assist the expansion of financial multi-nationals — mainly headquartered in New York, London, Paris and Frankfurt — into other nations by preventing regulatory barriers. The leaked draft also shows that the US is particularly keen on boosting cross-border data flow, which would allow uninhibited exchange of personal and financial data. … [T]he Agreement is being crafted to be compatible with [the General Agreement on Trade in Services] so that a critical mass of participants will be able to pressure remaining [World Trade Organization] members to sign on in the future.”

The intention is to make the agreement universal, solidifying the financial industry’s grip on the global economy.

A backdoor for Wall Street to eliminate Social Security?

Articles 1 and 2 of the Financial Services Annex place no limits on what constitutes covered “financial services”:

“This section/Annex applies to measures affecting the supply of financial services. … A financial service is any service of a financial nature offered by a financial service supplier of a Party. Financial services include all insurance and insurance-related services and all banking and other financial services.”

“Party” in the text refers to a signatory government. Among other provisions, the annex would require:

  • Countries to change their laws to conform to the annex’s text (Article 3).
  • Countries to “eliminate … or reduce [the] scope” of state enterprises (Article 5).
  • Prohibit any “buy local” rules for government agencies (Article 6).
  • Prohibit any limitations on foreign financial firms’ activity (articles 7 and 10).
  • Prohibit restrictions on the transfer of any data collected, including across borders (articles 8 and 11).
  • Prohibit any restrictions on the size or expansion of financial companies and a ban on new regulations (Article 15).
  • Require any government that offers financial products through its postal service to lessen the quality of its products so that those are no better than what private corporations offer (Article 22).

Beyond the dry, bureaucratic language in which the annex is written is the crucial matter of how the text will be interpreted. Already, under the North American Free Trade Agreement, a corporate parcel-delivery service sued Canada in an attempt to have the Canadian postal system dismantled. That attempt failed, but as the secret tribunals issue more and more rulings granting more and more “investors’ rights” that become precedents for the next dispute, it is no stretch to believe that a tribunal of three “really good friends” of the financial industry could issue a ruling that a government retirement system such as Social Security is an illegal restraint on private profit.

Wall Street has long desired a privatization of Social Security, and the Financial Services Annex might prove to be the ticket for it to achieve its most sought-after goal and thereby put other countries’ public retirement systems at risk. Articles 5 and 22 hold the potential for a tribunal to rule that a government financial service such as a national retirement system is an unfair state subsidy. Consider Goldman Sachs, where customers are referred to as “muppets” with the intention of “ripping eyeballs out.” The infamous “vampire squid” stands out among its financial-industry peers for its ability to, in the words of Matt Taibbi:

“hoover up vast sums from the middle and lower floors of society with the aid of a crippled and corrupt state that allows it to rewrite the rules in exchange for the relative pennies the bank throws at political patronage.”

The foregoing, of course, is the standard operating principal of the entire financial industry. Is this who you want to control the possibility of your retiring some day?

European privacy laws would also be in the crosshairs. The U.S. has proposed language allowing cross-border movements of personal data without restriction, while the E.U. (which is negotiating on behalf of its 28 member countries) has proposed language allowing data transfers ameliorated only by boilerplate language that exempts personal privacy unless it “circumvents” the annex — a loophole wide enough to drive a truck through.

Existing “free trade” agreements have similar boilerplate language supposedly granting exceptions for human health and safety, but other clauses requiring adherence to “international norms” supersede such exceptions, rendering them meaningless.

Speculators would have unconditional rights to profit

Article 20 contains language sponsored by the U.S. and the E.U. that would require investor disputes to be heard by a panel having “the necessary expertise relevant to the specific financial service” — an invitation for bankers to sit in judgment of such disputes — and Article 13 contains language pushed by the U.S. that is essentially identical to text typically found in “free trade” agreements requiring “equal treatment” of domestic and foreign corporations.

It is that “equal treatment” language that is the battering ram used by corporations to knock down national regulations on health, safety and the environment.

For example, Chapter 11 of the North American Free Trade Agreement codifies the “equal treatment” of business interests in accordance with international law and enables corporations to sue over any regulation or other government act that violates “investor rights,” which means any regulation or act that might prevent the corporation from earning the maximum possible profit. Canada, in two separate cases, had to reverse bans on chemicals known to be dangerous to human health and pay millions of dollars to the chemical manufacturers.

In one of those chemical cases, the tribunal ruled that, when formulating an environmental rule, a government “is obliged to adopt the alternative that is most consistent with open trade.”

These are the types of precedents that will be used to further engorge financial speculators should TISA and its Financial Services Annex become law.

Those living in countries not yet part of these negotiations also have much to fear. Developing countries are mostly shut out of the TISA negotiations. The coalition group Our World Is Not For Sale, which includes more than 200 member organizations, writes:

“The proposed TISA is thus a cynical attempt of the major proponents of so-called ‘free trade’ and aggressive market opening to ensure that corporate wish lists can be fulfilled, without having to make any changes to existing WTO [rules] demanded by poor countries.”

A separate group of 341 civil-society organizations, in an open letter demanding ministers cease TISA negotiations, note that:

“The TISA negotiations largely follow the corporate agenda of using ‘trade’ agreements to bind countries to an agenda of extreme liberalization and deregulation in order to ensure greater corporate profits at the expense of workers, farmers, consumers and the environment. The proposed agreement is the direct result of systematic advocacy by transnational corporations in banking, energy, insurance, telecommunications, transportation, water and other services sectors, working through lobby groups.”

Red carpet for lobbyists, red-baiting for unions

The watchdog group Corporate Europe Observatory reports that the European Commission trade department, which is negotiating on behalf of the E.U.’s 28 countries, has met more than 20 times with the European corporate lobbying group leading the push for TISA, the European Services Forum (ESF), but has met only once with trade unions. In fact, the ESF was set up with the encouragement of the European Commission in the 1990s, leading to a situation “where the public authority lobbies business to lobby itself,” the Observatory said. On the other hand, the Commission has descended to red-baiting unions when they bring up their concerns:

“When the Commission meets concerns about its aggressive services liberalisation agenda, it reacts with ignorance and mockery. A staff member of the European Federation of Public Service Unions, told Corporate Europe Observatory about one of the Commission’s Civil Society Dialogue meetings: ‘When I voiced concerns over the way public services were being dealt with in the EU’s trade policy, one of the officials basically said ‘there is no going back to the Soviet Union.’ ”

Privatization über alles! The European Commission, the bureaucratic arm of the E.U., is free from democratic accountability and if even if it weren’t there would be little or no accountability considering that the four largest blocs within the European Parliament collectively holding 549 of the 751 seats are broadly in favor of “free trade” agreements; the main center-right and center-left blocs hold a majority of the seats between them.

Nor should help be expected from the other side of the Atlantic. Not only does the U.S. consistently push for the most draconian rules regardless of which party is in the White House but its trade representative, Michael Froman, is a former high-ranking executive at Citigroup Inc. who is a protégé of former Treasury Secretary Robert Rubin, an architect of the Clinton administration’s 1990s dismantling of financial regulations, which led to the next decade’s economic collapse.

Multi-national corporations are well organized across borders; financiers and industrialists understand their common interests. If there is any hope to put an end to “free trade” agreements — and then go on the offensive to reverse those already in place — we had better do the same.

High court rules that financiers are more sovereign than Argentina

The victory handed to speculators by the United States Supreme Court over one of the world’s larger countries provides a lesson in where power actually lies. It is not in a government building.

Two June 16 decisions by the U.S. Supreme Court elevates the “right” of hedge-fund speculators to massive windfall profits above all other human considerations. That ruling is consistent with rulings handed down by the secret tribunals used to arbitrate disputes between corporations and national governments that arise under “free trade” agreements that elevate “investors’ rights” above environmental and labor laws.

Between these Supreme Court decisions, most of the attention has focused on the ruling that federal courts in the U.S. can order sovereign countries to hand over information on their assets to speculators. In other words, the U.S. legal system has formally declared it has jurisdiction over other countries. Arrogant as that ruling is, the more dramatic development was the court refusing to hear an appeal of lower-court rulings directing Argentina to pay $1.3 billion to holdout speculators that refused to accept terms agreed to by a large majority of bond holders.

Simply put, the U.S. legal system not only declares U.S. law applies around the world, but that it will be applied to benefit the most aggressively greedy.

The Puerto Madero district of Buenos Aires. (Photo by Juan Ignacio Iglesias)

The Puerto Madero district of Buenos Aires. (Photo by Juan Ignacio Iglesias)

Much of the commentary on this case has attempted to reduce it to a simple morality tale of a debtor being obligated to pay back its creditors. The lead speculator in this affair, hedge-funder Paul Singer, who is trying to be paid the full value of bonds on which he paid pennies on the dollar, has tried to paint it that way.

Reality, of course, is far more complex. So first it is useful to understand the odious nature of Argentina’s debt.

Military junta uses dirty war to impose austerity

Prior to the 1976 military seizure of power, Argentina was an industrialized country with active union and left-wing movements, a sizable middle class and large tracts of arable land. But the Argentine economic elite and the multinational corporations that operated there wanted Argentina turned into a low-wage haven. Only extreme violence would be able to achieve that goal.

Upon seizing power, the military handed over economic policy to a well-connected industrialist, José Alfredo Martínez de Hoz, who ruthlessly implemented a severe neoliberal program of shock therapy, backed by a savage campaign of torture, “disappearances” and killings waged by the military and two allied fascist groups. The CGT union federation was abolished, strikes outlawed, prices raised, wages tightly controlled and social programs cut. As a result, real wages fell by 50 percent within a year. Because of the collapse of internal consumption caused by this austerity, ten percent of Argentina’s workforce was laid off in 1976 alone.

Tariffs were reduced deeply, leaving the country wide open to imports and foreign speculation, causing considerable local industry to shut. High interest rates led to more foreign speculation and an overvalued currency, further hurting national production. Against this backdrop, the dirty war was intensified — initially targeting leftists, the régime quickly began to eliminate students, lawyers, journalists and trade unionists.

This was the régime of which David Rockefeller, whose loans helped finance it, famously said, “I have the impression that Argentina has a regime which understands the private enterprise system.” Further economic contraction occurred, and for the last five years of the military junta, 1978 to 1983, Argentina’s foreign debt increased to US$43 billion from $8 billion, while the share of wages in national income fell to 22 percent from 43 percent.

Civilian control and formal democracy was re-established following the collapse of the junta, but the debt did not go away.

A civilian president, Carlos Menem, imposed an austerity program in the early 1990s in conjunction with selling off state enterprises at below-market prices. This fire sale yielded $23 billion, but the proceeds went to pay foreign debt mostly accumulated by the military dictatorship — after completing these sales, Argentina’s foreign debt had actually grown. The newly privatized companies then imposed massive layoffs and raised consumer prices.

By 1997, about 85 percent of Argentines were unable to meet their basic needs with their income. During this period, Argentina’s debt steadily mounted, leading to a scheme under which the debt would be refinanced. A brief pause in the payment schedule was granted in exchange for higher interest payments — Argentina’s debt increased under the deal, but the investment bank that arranged this restructuring racked up a fee of $100 million, the latest in a series of financial maneuvers that shipped a billion dollars to investment banks in ten years.

It all finally imploded at the end of 2001, when the government froze bank accounts and the country experienced so much unrest that it had five presidents in two weeks. The last of these presidents, Néstor Kirchner, suspended debt payments. Had Argentina resumed scheduled payments in 2005, interest payment alone on the debt would have consumed 35 percent of total government spending. Kirchner announced that Argentina intended to pay only 25 percent of what was owed and any group that refused negotiations would get nothing; in the end, Argentina paid 30 percent to bondholders who agreed to talk.

Vulture capitalist seeks extortionist gains

Approximately 93 percent of bondholders agreed to accept 30 percent of the face value — 30 percent is better than zero. Argentina has repaid these on a steady schedule and Argentine law forbids giving the holdouts a better deal. Some of the bonds held by the original holdouts were bought by NML Capital, a subsidiary of Paul Singer’s Elliot Capital Management, and another hedge fund, Aurelius Capital Management. These were the two whose lawsuits reached the U.S. Supreme Court.

Including interest, the holdouts would walk off with $1.5 billion if paid in full. NML Capital, Argentine President Cristina Fernández said, would see a gain of 1,600 percent for bonds it bought for $48.7 million. “I don’t even think that in organized crime there is a return rate of 1,608 per cent in such a short time,” she said in a national address following the U.S. Supreme Court decisions, in which she said Argentina would not “submit to such extortion.”

Mr. Singer, the type of character for which the term “vulture capitalist” was coined, certainly has been persistent in attempting to collect the full face value of bonds for which he paid a small fraction of that value. In November 2012, he had an Argentine naval ship impounded in Ghana after earlier plotting to seize the presidential plane and artworks that were to have been shown at a Frankfurt book fair.

Among other exploits, he has demanded $400 million from the Republic of the Congo for bonds he bought for less than $10 million and compelled the government of Peru to pay him a 400 percent profit on the debt of two Peruvian banks he bought four years earlier. His specialty is buying debt at a small fraction of the face value and demanding full payment, regardless of the cost to others, and has become a billionaire through doing so.

In the imperialist crosshairs

A series of one-sided rulings in a federal trial court, upheld by the U.S. Court of Appeals for the Second Circuit, favored the hedge funds over Argentina. When the appeals reached the Supreme Court, the bond holders who agreed to accept 30 percent (a “haircut” in financial parlance) backed Argentina, fearing that there would be no money for them should Argentina be forced to pay off the holdouts at full face value. The U.S. government also sided with Argentina, fearing a precedent that could be used to enable it to be sued.

The Foreign Sovereign Immunities Act of 1976 is supposed to bar lawsuits in U.S. courts against non-U.S. governments, but a 7-1 bipartisan majority of the Supreme Court decided that the law is malleable when not convenient. The Argentine bonds were sold with a provision that New York law would be used to settle disputes related to them, which gave U.S. courts the excuse needed to extend U.S. law to Argentina.

Under New York law, investors must be treated equally. That provision could have been interpreted to mean the holdouts would get the same 30 percent payment in installments — which the Argentine government would have agreed to had they been willing to negotiate — but instead it was used as an opportunity to give more rights to speculators.

The practical effect of these rulings is that “investors” — hedge funds with the well-earned sobriquet of “vultures” — have been elevated above a national government. This is perfectly consistent with the decisions handed down by secret tribunals like the World Bank-affiliated International Centre for Settlement of Investment Disputes when “investors” sue governments under “free-trade” agreements such as the North American Free Trade Agreement.

The hedge funds can leverage the U.S. legal system to enforce their will over Argentina in this case because the U.S. financial system is used to make payments to the bondholders who negotiated the 30 percent agreement with the South American country. Argentina could only continue to make those payments, while simultaneously refusing to pay anything to the holdouts, by doing so completely outside the U.S. financial system, which is possible but very difficult due to the system’s global reach. Moreover, those payees within the reach of the U.S. legal system would be susceptible to being sued by the holdouts.

Argentina has consistently said it has does not have the money to pay the holdouts and continue to meet its continuing obligations to the bondholders it has been paying, another reason for those bondholders to side with Argentina against the holdouts. The next payment is due June 30 — on that date, Argentina would be in defiance of the U.S. Supreme Court should it not pay the full face value of the holdouts’ bonds. But if it does so, or simply agrees to pay more than 30 percent, the holdouts would likely demand to re-negotiate to get the same deal.

Immediate conflict doesn’t negate larger interests

What to do? One possibility is to up the ante. That is the recommendation of Argentina’s counsel at the New York corporate law firm Cleary Gottlieb Steen & Hamilton in a memorandum dated May 2, 2014:

“[T]he best option for the Republic could be to permit the Supreme Court to force a default and then immediately restructure all of the external bonds so that the payment mechanism and the other related elements are outside of the reach of American courts. Argentina wants to continue paying its restructured debt. The Courts, nevertheless, have placed it in a terrible position.”

Courts do not act in a vacuum, but ultimately express the interests of the most powerful industrialists and financiers similar to any other component of a government in the capitalist system. It is certainly true that those interests are in conflict in this matter. Such a conflict is not unusual. The victory for one particular set of speculators here, however, serves to tighten the screws of austerity by further codifying the dominance of the most ruthless capitalists within the capitalist legal system.

Should the end result of this case be that all parties agree to a payment level higher than 30 percent, would the speculators on the losing side be crestfallen? Regardless of the outcome, the precedent set here provides additional leverage for speculators in future financial deals. Not even the opinion of the U.S. government, the ultimate protector of corporate interests through its intelligence and military apparatuses and “free trade” agreements, was allowed to interfere with a bid to further tighten corporate power. That is what was at stake here, not the short-term interests of this or that speculator.

For Argentina, or any other subaltern country, to rid itself of odious debt and re-orient itself toward the greater good of its citizenry rather than the profiteering of speculators, will require entirely new structures in a different economic system.

Wall Street plunders Detroit while pensioners take blame

The Detroit bankruptcy has been portrayed as a simple morality tale of city mismanagement, but the crucial role of financial industry chicanery has been conveniently ignored. Municipal debt is a largely unknown but very lucrative field — lucrative, that is, for speculators.

There are so many questions that can be asked about Detroit’s bankruptcy filing. What is Wall Street’s role in municipal debt? How is it that almost $300 million is available for a new ice hockey arena when there is no money for pensions? How is that business taxes can be cut by 80 percent at a time of fiscal crisis? Why did the total of pension liabilities suddenly increase fivefold from earlier this year?

Ambassador BridgeThese are questions that are rarely raised in the corporate media. Asking such questions disarms the narrative of public-employee retirees bleeding taxpayers dry and masks larger systemic issues. It is quite difficult to believe the same folks who brought you the economic crash of 2008, and five years and counting of hard times, are completely innocent of fleecing local governments. Indeed, they are not.

Although it is the stock market that draws the lions’ share of the public’s attention, the bond market is much larger (and, in turn, foreign exchange is a far bigger market than bonds). Municipal bonds, although a relatively small portion of the overall bond universe, are big business — US$3.7 trillion. Yes, you read that correctly — trillions of dollars. That is one big pot of money to tap, and tap it financiers do.

Why pay taxes when you can loan it and earn interest instead?

Absent from discussions about Detroit is why governments have to issue so much debt. The reason is not complicated: Big business, and the wealthy, would much rather loan money at interest to governments rather than pay taxes. It’s not only national governments that are in debt, it’s local and regional governments as well. That is so around the world, demonstrated most vividly by the ongoing European Union crises as one country after another imposes austerity in the face of unsustainable debt.

In North America, Detroit fulfills the same function as Greece does for Europe: A scapegoat. Although it is true that Detroit’s city government is due a share of the blame for poor management, larger economic and social forces, disinvestment and financial industry legerdemain loom much larger. Complex, and poorly understood, derivatives were decisive in Detroit’s fiscal downfall. When local governments had to borrow money (ordinarily to finance large infrastructure projects) in the past, they would issue “plain vanilla” bonds — a set amount of debt paying back a set amount of interest on a specific schedule. A safe, if conservative, investment for buyers of these bonds and  predictable payment terms for the issuer.

Wall Street wanted higher profits from this once staid market, so an ever more dizzying assortment of exotic instruments were conjured, allowing the financial institutions that handle these bond sales to skim off ever more money. Explaining how Wall Street plunders public finances, Alexander Arapoglou and Jerri-Lynn Scofield, wrote on AlterNet:

“Many municipalities invested in flawed ‘structured finance’ deals on the advice of bankers who said these complex transactions would give them a better deal than simpler, traditional products. So trusting public finance officials lined up to follow their advice — only to be told later that advice was not to be relied upon.

“Tellingly, few (if any) corporations used similar structures to meet their funding needs. Nor did the banks themselves. Unfortunately, these products didn’t work as advertised, and public funding costs exploded as a result.”

A common structure, the authors wrote, combines three instruments: variable-rate demand bonds, letters of credit and interest-rate swaps. These are supposed to be forms of insurance to protect cities from rising interest rates, but in actuality are designed to siphon money to the banks, in a classic game of “heads I win, tails you lose.” Municipal treasurers sought to pay below-market fixed interest rates for paying back long-term debt. But institutional investors want to be able to rapidly buy and sell such bonds. Variable-rate demand bonds enable bond buyers to get their money back on demand, in periods as short as a week. The AlterNet authors wrote:

“Alas, there’s no such thing as a free lunch. A bond that can be returned, with no penalty charges, every week doesn’t sound at all like the long-term infrastructure financing the city or state wanted. So banks promised municipal clients that if investors wanted to return bonds, the bank would find another buyer. Sounds like it might work out okay, right? But what would happen if no one wanted to buy these returned bonds?”

The necessity of answering that question leads to the letters of credit and interest-rate swaps, which are forms of insurance. On paper. When financial markets froze in the wake of the Lehman Brothers collapse in September 2008, nobody would buy the variable-rate demand bonds. The interest-rate swaps were sold to local governments as a hedge against rising interest rates. But the buyers of these products had to pay penalties because the bank’s credit ratings dropped and interest rates fell.

Interest rates fell because central banks like the Federal Reserve wanted to shovel piles of cheap money at “too big to fail” banks to keep them solvent. That interest rates would fall was quite predictable, as cutting rates is a standard tool of central banks during recessions.

Financial derivatives cost Detroit dearly

Here’s how this scam worked for Detroit, according to Bloomberg, far from a news source hostile to the financial industry:

“The swaps were a bet on the direction of interest rates. Because rates fell rather than increasing, the city owes the banks. Under the terms of the contracts, cuts to the city’s credit ratings allowed the companies to demand the money. Under agreements in 2009, the city pledged casino revenue to cover the payments. [Emergency manager Kevyn] Orr gave the swaps payments, as secured debt, priority over retirees and holders of unsecured debt, including the pension borrowings. While swaps holders would take a 25 percent cut in payments, other creditors would receive much less.”

That last sentence refers to a deal that Emergency Manager Orr attempted to make before the declaration of bankruptcy, in which derivatives speculators would be paid far more than pensioners. Detroit absorbed losses totaling hundreds of millions of dollars due to these derivatives. The Financial Times reports that, due in part to the extra costs sustained from the derivatives, Detroit owes nearly double the principal — in other words, Detroit is effectively paying nearly 100 percent interest:

“As of the end of June, the negative value of the derivatives was almost $300m, according to material from Ernst & Young submitted as part of the bankruptcy court filings. By the time the city ultimately pays off the $1.4bn in borrowing, the total bill just from 2013 onwards will be over $2.7bn, or almost double the original debt, of which $770m will be the cost of the derivatives — far more than the $502m in interest payments, these filings add.”

Merrill Lynch (a subsidiary of Bank of America) and UBS sold Detroit the interest-rate swaps, and when interest rates fell and Detroit’s credit rating was cut, the city signed a deal that pledged tax revenues from the city’s casinos to cover its extra costs, according to the Financial Times. That transaction transformed UBS and Merrill Lynch from unsecured into secured creditors, putting them at the head of the payment line. Prior to the bankruptcy, the two investment banks offered to absorb a 25 percent cut to what they are owed, but at the same time municipal workers were asked to take a 90 percent cut.

Remember that government workers are not eligible for Social Security, so their pensions are what they will have to live on. The average Detroit city government pension is $19,000 a year.

Secured creditors are those who hold debt backed by some kind of legal claim to a physical asset of the city, such as, for example, Detroit’s bond obligations relating to its water and sewer department. Unsecured creditors face steep cuts, including the pension funds scapegoated for the fiscal crisis. Hedge funds are said to be buying up other unsecured Detroit debt, and the more these hedge funds extract, the less there will be for city workers. This is a tactic, used recently by hedge funds speculating on Argentine debt, in which debt is bought at pennies to the dollar with an eye toward getting much more out of the issuer.

A tool for financiers to extract billions of dollars per year

The cost to taxpayers from derivatives is enormous. A group called the ReFund Transit Coalition recently released a study, “Riding the Gravy Train,” in which it reported that researchers have found about 1,100 swap deals in the United States entered into by 100 government agencies that cumulatively are losing more than $2.5 billion per year. The coalition believes that there hundreds of other such deals out there not yet added to the total.

This comes at a time when four out of five transit agencies are cutting service or increasing fares in the wake of the economic downturn. Getting out of these deals is costly — for example, New York state recently paid $243 million to terminate a swaps deal, and $191 million of that fee is being financed by more borrowing.

But there’s plenty of money for corporate subsidies

As Detroit headed toward its declaration of bankruptcy, Michigan Governor Rick Snyder handed some presents to his wealthy benefactors. In December 2011, he signed two anti-union bills that render union membership as a condition of employment illegal; the language of the bills was virtually identical to “model” bills written by the infamous American Legislative Exchange Council (ALEC), a lavishly funded group that writes legislation for state legislatures that will directly benefit its corporate funders.

A less noticed gift by Governor Snyder is a massive tax cut for Michigan businesses that will be paid for by severe reductions in social spending and higher individual taxes. Taking effect in 2012, business taxes were cut by 80 percent (or $1.7 billion per year) under the excuse that such cuts will lead to job creation, although there is no evidence that such cuts actually lead to more jobs. In real life, jobs are created by demand for a product, not tax rates. Low-income people were already paying the largest share of their income in state and local taxes while those making more than $385,000 a year paid the smallest, and lower- and middle-income people are being hit with the highest increases in taxes.

And yes friends, that’s not all. Michigan, on a per capita basis, spends more money on corporate subsidies than any other U.S. state — a total of $6.2 billion per year. When we add these corporate subsidies with the business tax cuts, that’s almost $8 billion per year of subsidies handed out. Note that the total amount of unfunded pension obligations cited by Emergency Manager Orr is $3.5 billion — and that number may be inflated. (More on that below.) Yet there is a steady propaganda barrage that insists the problem is retirees and current workers expecting to be able to retire some day.

So the problem of pensions is easily solvable. Michiganders outside Detroit shouldn’t have to pay, some might say. But that ignores that the state, certainly the counties surrounding Detroit, benefits from the city’s infrastructure. Corporations that once had operations in Detroit benefited from the investments the city made in its physical environment and from the workers who were educated in public schools and universities. The city’s social amenities also provide benefits that cross borders. Corporations and better-off people fled to the suburbs — to the north, crossing county lines — to avoid paying for such services, a familiar tactic of capital.

But some infrastructure, evidently, is worth an investment. At the same time pensioners on fixed incomes are facing large cuts and city services are drastically reduced, $283 million of public money are proposed to be lavished on a new ice hockey arena, for a team (the Detroit Red Wings) owned by Mike Ilitch, who is worth $2.7 billion. This in an area that is already paying off two football stadiums, and has two arenas in current use.

Detroit can do this because a separate entity, the Detroit Development Authority, will hand out the subsidies, and the authority has a special stream of revenue from property taxes that its can tap before revenues are sent to the city treasury. Ultimately, the state is said to control these funds, and as it is the state that forced Detroit’s declaration of bankruptcy, it could divert that money to, say, fixing street lights or repairing ambulances.

Is the size of Detroit’s pension shortfall being inflated?

One final question is: What is the size of the pension shortfall? As recently as February 2013 — five months before the bankruptcy filing — Detroit’s unfunded pension liability was listed as $650 million by the state, yet Emergency Manager Orr has claimed the liability is $3.5 billion without providing any details as to the reasons for the fivefold increase. The investment management firm BlackRock, in an analysis on the ramifications of Detroit’s bankruptcy filing, said:

“There is question as to whether the [emergency manager’s] plan is inflating pension and [other post-employment benefits] liabilities. … This $3.5 billion now represents nearly one-third of the amount Detroit owes to its unsecured creditors, and raises required pension contributions to approximately 100% of the city’s $1 billion forecasted budget deficit over the next five years.”

The dramatic increase in the size of the pension liabilities seems to be based on a report prepared by an actuarial consultant that used a different methodology to calculate the liabilities — but the emergency manager refuses to release the report. Meanwhile, there are indications that the consultant did a less than rigorous job of tallying its numbers. Cate Long, writing in the MuniLand blog, in discussing this issue, asked:

“A ‘very rough preliminary guesstimate’ is what Orr was using in his ‘good faith’ negotiations and is now taking to bankruptcy court? … Pension calculations can seem to be a form of voodoo. Moody’s applies a lower discount rate, like the [consultant’s] report did, to pension liabilities, while the two other major raters do not. Pension liability methodologies are, in essence, just opinions. … Orr could help everyone understand his case by releasing the [consultant’s] report for study by actuaries and others.”

As recently as 2005, Detroit’s pension obligations were fully funded. But when the pensions’ portfolios suffered losses from the economic downturn, the city government decided to issue bonds to fulfill its obligations. A series of refinancings, underwriting fees and penalties for credit-rating cuts has cost the city hundreds of millions of dollars. It is currently impossible to say definitively that Emergency Manager Orr is artificially inflating the pension shortfall, but it is not difficult to see the rationale for doing so: The greater the liability, the deeper the cuts that can be imposed, especially on pensions.

Austerity comes in many flavors, but it is never the financial industry that has to cut back. Detroit’s mayors and councilmembers can, and should, be taken to task for failing to investigate the snake oil financiers were selling them, but that does not ameliorate the rapacious grabbing of public money by the snake-oil salespeople. The financial industry does not create wealth, it confiscates wealth. The time is long past to chop off the vampire squid’s tentacles and reduce banking to a public utility serving the public interest under democratic control.

Speculators trade in two weeks what the world makes in a year

Speculation rests on phenomenal amounts of money sloshing around the globe. We could call this endless wave a permanent tsunami, except that would grossly understate the size of the financial wave.

If we could pile up all the money that is exchanged in financial markets and make a literal wave out of it, it would make for an astounding sight were we on the International Space Station, towering above the clouds. The wave would rise so high it might swamp the space station itself.

All right, I am getting fanciful here. And we wouldn’t want to contemplate having to bail out the space station in zero-G conditions. But we are talking about an international financial industry that has truly grown to monstrous proportions, beyond any reasonable necessity.

How big? The combined daily trading average on the world’s foreign-exchange, bond and stock markets is very roughly about US$6 trillion. If that total seems amazing, it is for good reason: By way of comparison, the gross domestic product of the world is about $65 trillion. To put it another way, in 11 business days financial speculators trade instruments and contracts valued at more than all the products and services produced by the entire world in one year.

Most of us are familiar with stock exchanges, and that is the financial market that draws the lions’ share of corporate mass media attention. But that is actually only a tiny portion; an average day’s turnover on the world’s stock markets amounts to $270 billion. Bond markets (government debt, corporate debt and the myriad of “asset-backed” securities continually cooked up) are several times larger, and foreign exchange is vastly larger than bond markets.

Much of this daily $6 trillion turnover is in derivatives, swaps, futures contracts and assorted legerdemain. Almost all of this is nothing more than self-interested speculation; trading for the sake of the largest possible short-term profits regardless of the cost to the rest of the economy or the destabilizing social costs of these giant pools of capital sloshing around the world, pouring in capital here and pulling capital there as opportunities for short-term profits wax and wane.

Why do stock markets exist?

In theory, stock markets exist to distribute investment capital to where it is needed and to enable corporations to raise money for investment or other purposes. In real life, neither is really true. A corporation with stock traded on an exchange can use that status to issue new shares, raising money without the burden of dealing with lenders and paying them interest. But large corporations can raise money in a variety of ways, for example by issuing bonds or other interest-bearing debt, or by selling shares directly to private investors.

Nor do corporations necessarily wish to float new stock — doing so is disliked by investors because profits are diluted when spread among more shares. Instead, it is more common for large companies to buy back shares of their stock (at a premium to the trading price), which means less sharing of distributed profits.

From 1981 to 1997, for example, non-financial corporations in the United States bought back $813 billion more in stock through buyback programs and corporate takeovers than they issued.* That is money that was diverted from investment, employee compensation or community development, and constitutes still more money stuffed into financiers’ pockets.

Most of the action on stock exchanges is simply speculation, and as computers become more sophisticated, the speculation drives higher trading volumes and becomes more remote from the actual business of the company in which stock is bought. “Day trading,” where speculators buy and sell stock within minutes to earn profits on price fluctuations became common in the 1990s, but in the following decade the big Wall Street firms showed their muscle while bringing speculation to an unprecedented level.

These firms created sophisticated computer programs that buy and sell stocks in literally milliseconds. The programs issue thousands of buy orders that are canceled in minuscule fractions of a second in order to manipulate prices to the benefit of the computer owner. These price differences are only pennies, but are done on such enormous scale that the profits skimmed in this fashion are estimated to be as high as $21 billion per year — only a “handful” of these high-speed computer traders account for a majority of all stock-exchange trades.**

Speculation for its own sake

Speculation tends to reinforce itself. During the two years I spent working on a financial news service during the 1990s stock-market bubble, I repeatedly heard traders say the dramatic price rises could not last but they would continue to ride the bubble as long as the consensus view that the long bull market would continue remained in place. The primary reason for why market players believe stock prices will rise at a given time is because they believe other market players believe stock prices will rise. Not nearly as “scientific” as financiers would have you believe.

Bond and foreign-exchanges markets are no less fueled by speculation, and it is the gargantuan size of these markets that give the larger players in them the power to dictate to the world’s governments, extracting budget-busting bailouts, imposing austerity and raising their needs above all social considerations.

Their size is truly monstrous: the world’s 1,000 largest banks held an estimated US$102 trillion of assets in 2011. Separately, the “shadow banking” system (hedge funds, private-equity firms and other investment companies) is worth an additional $67 trillion.*** Financiers hold an amount of capital that is more than two and a half times larger than the world’s gross domestic product.

As more money is diverted into speculation because there are insufficient opportunities for investment, the size of the financial industry and the percentage of corporate profits claimed by the financial industry steadily grows — the size of both banks and unregulated “shadow banks” have increased since the beginning of the economic crisis in 2008. This capital is a function of the amount of money flowing upward to the rich becoming larger than they can use for personal luxury consumption or investment; these torrents of money are diverted into increasingly risky pure speculation.

Too much money comes to chase too few assets, rapidly bidding up prices until there is no possible revenue stream that can sustain the price of assets bought at inflated levels, triggering a crash. The very size of financial markets is a major contributing cause of economic instability. That size is in turn a product of the continual downward pressure on wages — an increasing share of corporate revenues go toward executive pay and profits as the share going toward wages declines.

A financial industry swollen to such gargantuan sizes have no relation to the actual needs of the economy. It is money that could be used for wages (which would strengthen the economy) or for productive investment were it not so concentrated and under-taxed. Austerity, after all, is only for working people.

* Doug Henwood, Wall Street [Verso, 1998], page 3
** Charles Duhigg, “Stock Traders Find Speed Pays, in Milliseconds,” The New York Times, July 24, 2009
*** TheCityUK; the Financial Stability Board