Speculators circling Puerto Rico latest mode of colonialism

Puerto Rico’s governor may have said the commonwealth’s debt is unpayable, but that doesn’t mean Puerto Ricans aren’t going to pay for it. Vulture capitalists are circling the island, ready to extract still more wealth from the impoverished island.

You already know the drill: Capital is sucked out by corporate interests that pay little in taxes, budget deficits grow and speculators swoop in to take advantage, leaving working people holding the bag. Already, the Puerto Rican government is considering imposing an 11 percent cut to Medicare and Medicaid for 2016 and more than 600 schools may be closed in the next five years on top of the 150 already closed by budget cuts.

To ensure more austerity, a group of hedge funds hired three former International Monetary Fund economists to issue a report on what Puerto Rico should do. And — surprise! — the report, released this week, says to lay off teachers, cut education spending and sell public assets to provide money for hedge funds.

Caribbean National Rain Forest of El Yunque, Puerto Rico (photo by Alessandro Cai)

Caribbean National Rain Forest of El Yunque, Puerto Rico (photo by Alessandro Cai)

The crisis has already been profitable for Wall Street as banks and law firms racked up $1.4 billion in fees from 86 bond deals that raised $62 billion for the island between 2006 and 2013 alone. Because of downgrades in Puerto Rico’s credit rating, Wall Street can demand hundreds of millions more in lending fees, credit-default-swap termination fees and higher interest rates.

What has a century of colonialism — a century of domination by U.S. corporations — wrought? An activist with the island’s Party of the Working People, Rafael Bernabe, puts it in stark terms:

“Puerto Rico’s economy has not grown since 2006. During that period, total employment has fallen by 20 percent or 250,000 jobs. Since 1996 manufacturing employment in particular has fallen by half (from close to 160,000 to less than 80,000). The labor force participation rate has dipped under 40 percent. Through firings and attrition, since 2007 public employment has fallen by 20 percent or 50,000 jobs. Migration has accelerated to levels unseen since the 1950s. …

Not only does mass unemployment result in significant migration, it also depresses wages, which consequently deepens economic inequality and insures high levels of poverty. This helps explain the persistence of the wide gap in living standards between Puerto Rico and the U.S. mainland. Contrary to neoliberal dogma, after more than a century of a colonial experiment in free trade, free mobility of capital, and even the free movement of people between Puerto Rico and the United States, Puerto Rico’s per capita income is a third of the U.S. figure.”

Although the neoliberal clamp has recently tightened on the island, its current subaltern position is many years in the making.

A century of colonialism and the repression that goes with it

Puerto Rico’s tenure as an independent nation lasted exactly eight days in 1898, ending when the United States invaded it during the Spanish-American War. Quickly taking control of the island’s economy, the U.S. response to a hurricane that wiped out the coffee crop in 1899 was not to send aid but instead impose a 40 percent devaluation on Puerto Rico’s monetary holdings. (The source for this and the following two paragraphs is the “historical overview” page of Nelson Denis’ War Against All Puerto Ricans web site, an excellent trove of information.) The devaluation forced Puerto Rican farmers to borrow money from U.S. banks and within a decade, thanks to usurious interest rates, farmers defaulted on their loans, giving the banks possession of their land.

One of those banks was the Riggs National Bank, and a member of the family that owned the banks, E. Francis Riggs, became Puerto Rico’s chief of police. By 1931, Mr. Denis reports, 41 sugar syndicates, 80 percent of which were owned by U.S. corporations, owned essentially all of the island’s farmland. Just four of them controlled half the island’s arable land. When the island’s legislature enacted a minimum-wage law, the U.S. Supreme Court declared it illegal. An island-wide agricultural strike in 1934 was answered by Police Chief Riggs, the member of the banking family, with this response: “There will be war to the death against all Puerto Ricans.” The following years saw a series of massacres, and mass arrests and torture of independence activists, and a 1948 law criminalized advocacy of independence, with penalties of 10 years in jail and massive fines. Even owning a Puerto Rican flag was made illegal.

In 1976, the tax code was amended so that U.S. companies operating on the island would pay no corporate taxes. For the next 30 years, until 2006, U.S. pharmaceutical companies took advantage of this tax loophole to generate massive profits. Mr. Denis reports that in 2002 the combined profits for the ten drug companies in the Fortune 500 ($35.9 billion) were more than the profits for all the other 490 businesses combined ($33.7 billion).

An independent Puerto Rico could not exploited to such a degree, so repression was particularly aimed at anybody with independence sympathies but especially leaders of the Nationalist Party. In a Democracy Now! commentary in 2010 on the 60th anniversary of the Jayuya independence uprising, Juan Gonzalez said:

“Between a thousand, two thousand people were arrested. Anybody who had any kind of political leanings toward independence or was seen as a leader was thrown into jail. And for years afterwards, it was impossible for supporters of independence to get jobs in the government. It really was an enormous repression and crackdown that occurred in the years following.”

One legacy of these decades of repression is the electoral silencing of independence advocates. Voting on the island tends to split evenly between the parties of statehood and continued commonwealth status. Mr. Bernabe wrote:

“The vote for the Partido Independentista Puertorriqueño (the Puerto Rican Independence Party or PIP) was less than 3 percent in the 2008 and 2012 elections. Independentistas, of course, have a far more significant presence and often play a leading role in labor, environmental, student, and other struggles. Many vote for the [pro-commonwealth Popular Democratic Party] in accordance with the same ‘lesser-evil’ logic that leads many U.S. progressives into the orbit of the Democratic Party.”

Education, health care cuts so hedge funds get paid

Having profited on the backs of Puerto Ricans, can Wall Street really be the solution to the island’s massive $73 billion debt? Common sense says no, but the island’s political leaders believe otherwise. Lest there be any lingering doubt about what the vulture capitalists circling their next target have in mind, a group of them issued a report this week, “For Puerto Rico, There is a Better Way,” that complains Puerto Rico spends too much money on education, even though the island spends about 80 percent of the U.S. average on a per-student basis.

The report’s three authors each had long careers with the International Monetary Fund, and they have not strayed from the IMF’s usual “one size fits all” austerity model. Although there are a couple of reasonable suggestions in the report — most notably, increasing the island’s low tax-compliance rate — it calls for much sacrifice by working people and none by hedge-fund billionaires. Among other recommendations, it calls for an increase in the sales tax, a flat income tax (always a benefit for the richest), cuts to education and Medicaid, and loosening labor laws that protect pay and vacation.

Hedge funds that own a significant part of the island’s debt have had a series of meetings with officials. But just who these hedge funds are can be difficult to ascertain. Puerto Rico’s Center for Investigative Journalism reports it received “runarounds and silence” from several government officials when it requested a list of those who hold the debt and what conditions bondholders are seeking. But the Center has been able to put together what it calls “the most complete list of the companies that are getting ready to renegotiate or demand complete payment of the debt.”

Several of the hedge funds seeking payment have also held bonds issued by Argentina, Greece and the city of Detroit. Three of them — Aurelius Capital Management, Monarch Alternative Capital and Canyon Capital — have held bonds for all three plus Puerto Rico.

Aurelius is a notorious speculator that joined with vulture-capitalist Paul Singer to demand Argentina pay full face value on bonds bought at tiny fractions of that price. Aurelius is seeking a 1,600 percent profit on its Argentine bonds, regardless of the cost to others. The principal of Aurelius, Mark Brodsky, was previously involved in squeezing the Republic of Congo-Brazzaville, an episode in which $400 million was demanded on bonds bought for less than $10 million from a country where children die from malnutrition.

Another on the list is John Paulson, who has been busy buying up luxury properties, including spending $260 million to buy three resorts. Another billionaire, Nicholas Prouty, has invested more than $550 million so that San Juan’s marina can accommodate yachts larger than 200 feet.

Power-company ratepayers expected to pay for profits, too

In line with those speculators, a group of hedge funds that own Puerto Rico Power Authority bonds (a debt separate from the general-obligation government bonds discussed above) propose a plan that would pay bondholders 33 percent less than face value. That sounds like an offer to accept a “haircut,” to use the financial term, but those bonds are currently trading at about half of face value, so the hedge funders would be guaranteeing themselves a profit. The plan would also impose a surcharge on the power authority’s customers, so they would be paying more for electricity to guarantee hedge-fund profits.

Whether buying bonds or real estate, it is profits hedge-fund billionaires are after. Puerto Rican bonds are tax-exempt, one reason for their popularity. Extracting wealth from the island is not new, however. Mr. Bernabe of the Party of Working People, in his commentary, noted the imbalance between profits and what’s available for the common good:

“[T]wo dozen U.S. corporations extract around $35 billion a year in profits from or through their operations in Puerto Rico. Bear in mind that the total income of the government of Puerto Rico is around $9 billion. U.S. corporations benefit from the tax-exemption measures that have been the centerpiece of the government’s development policy since 1947.”

Puerto Rico is due to make $5.15 billion in debt payments in its 2016 fiscal year, which began on July 1, a total that represents more than half of its $9.8 billion budget. Given the previous experiences of Argentina and Detroit, the future does not look rosy for the working people of Puerto Rico.

It is not difficult to notice that, although it is always time for us to cut back, it is never time for financiers to cut back. The financial industry, in contrast to the mythology it loves to peddle, does not create wealth — it confiscates wealth, attempting to profit off every aspect of human activity. Attention is now focused on hedge funds’ manipulation of debt, and although that is a necessary focus, these circling vultures represent only the latest manifestation of a long history of colonialism.

Class warfare through stock markets

Income re-distribution is always in the eye of the beholder, but never seen as such by those for whom more is never enough. The insatiable greed of financiers has reached the point where large corporations are now spending almost all profits on stock buybacks and dividends. And, despite that largesse, those companies are sitting on trillions of dollars in cash.

All this at the same time that wages are stagnant and living expenses are rising. These developments, of course, are not independent of one another.

Stock buybacks and dividends are one form of ongoing class warfare, in which income flows upward. The corporations comprising the Standard & Poor’s 500 Index alone spent US$914 billion on buybacks and dividends in 2014, and they are on course to spend more than $1 trillion in 2015. That $1 trillion will be nearly equal to all of the operating earnings produced by S&P 500 companies.

New York Stock Exchange (photo by Elisa Rolle)

New York Stock Exchange (photo by Elisa Rolle)

Stock buybacks are also becoming more common in Europe. European firms bought back more than US$2 trillion in stock from 2009 and 2014, according to Reuters, and European firms are sitting on $1.5 trillion (€1.37 trillion) in cash.

As aggregate profits have increased, so have the payouts to financiers. Bloomberg reports that payouts by U.S. companies are outpacing income:

“Excluding the recession years 2001 and 2008, dividends and stock buybacks have represented, on average, 85 percent of corporate earnings since 1998. … Stock repurchases worth almost $2 trillion have helped buoy the bull market since March 2009. … Even as sales were stuck at an average growth rate of 2.6 percent a quarter in the past two years, per-share earnings expanded more than twice as fast, 6.1 percent, data compiled by Bloomberg show.”

Starving investment for short-term gains

To pay for that acceleration of money flowing to financiers, spending on investment is declining, The Wall Street Journal notes. In an analysis of these trends, the Journal reports:

“[C]ompanies in the S&P 500 index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003. At S&P 500 companies targeted by activists, the spending cuts were more dramatic. Targeted companies reduced capital expenditures in the five years after activists bought their shares to 29% of operating cash flow, from 42% the year before.”

Let’s unpack that paragraph. What the Journal is reporting is that Wall Street is applying pressure to corporate managements to hand over income to it, and those corporations who are particularly targeted are even more compliant than the average. The “activists” who are referenced aren’t activists in any customary sense. In ordinary language, an activist is someone who advocates and organizes for social advancement. But in the looking-glass language of the corporate world, an “activist” is a shareholder who has bought stock in a company for the purpose of demanding the maximum possible short-term profit, regardless of cost to others or even to the company itself.

Wall Street, and the financial industry in general, is both a whip and a parasite in relation to productive capital (producers and merchants of tangible goods and services). The financial industry is a “whip” because its institutions (stock, bond and currency-exchange markets and the firms that trade those and other instruments on those markets) bid up or drive down prices, and do so strictly according to their own interests. The financial industry is also a “parasite” because its ownership of stocks, bonds and other instruments entitles it to skim off massive amounts of money as its share of the profits. People in the financial industry don’t make tangible products; they trade, buy and sell stocks, bonds, derivatives and other securities, continually inventing new instruments to profit off virtually every aspect of commercial activity.

“Shareholder activists” are ultra-rich speculators who are particularly aggressive in demanding that profits be handed over to them. Financiers and industrialists fight over the money that workers produce — profits ultimately derive from the capitalist paying the employee much less than the value of what the employee produces — but they agree they should have all of it.

So although you and your co-workers make the pie, you don’t get anything more than crumbs. And there are a lot of pies out there.

Piles of cash, here, there and everywhere

Not all of those pies are siphoned into financiers’ bottomless pockets. The St. Louis branch of the Federal Reserve estimates that, in 2011, U.S. corporations were sitting on almost $5 trillion of cash, a hoard that had been increasing by 10 percent a year. No more recent estimates exist, but it is likely that total has increased. And much of that hoard is kept out of reach — as of early 2015, an estimated $2.1 trillion in cash was being held overseas by U.S. corporations.

That money is kept overseas for one reason, to avoid paying taxes. U.S. elites are encouraged to do this because U.S. tax law allows profits and income to be shifted offshore, where they remain untaxed. Profits booked in other countries are instead subject to the local tax rate, even if zero. Such financial engineering is simply another manifestation of “capitalist innovation.”

Sometimes it is suggested that a “tax holiday” be granted. That is, let multi-national corporations bring their money home tax-free and that hoard will be magically put to work. But such has not been in the case in the past. An analysis by research firm Capital Economics of a 2004 tax holiday found that 95 percent of the cash brought back home went to stock buybacks and dividends. Nor were any jobs created. An NBC News report said:

“A Democratic congressional report indicated that the biggest companies receiving the benefits of $360 billion in repatriated funds actually cut a net 20,000 jobs, and that the holiday cost Treasury coffers $3.3 billion. ‘This is supported by the results of a 2009 study by the (National Bureau of Economic Research), which found that every $1 that was repatriated during the tax holiday resulted in an increase of almost $1 in shareholder payouts,’ the Capital note said. ‘Around $0.80 went towards share buybacks and $0.15 to dividend payments.’ ”

Total after-tax profits of U.S. corporations, as compiled by the St. Louis Federal Reserve, totaled $7.3 trillion in 2014 — the highest ever recorded. Adjusted for inflation, that is nearly triple the aggregate profits of 2001.

So when we are continually told we must cut back because there is no money, it isn’t true.

Big raises if money were directed to employees

Let’s take Wal-Mart as an example. Wal-Mart has averaged $16 billion in annual profits during the past five years, helping make the Waltons the richest family in the world while Wal-Mart workers are forced to rely on food stamps, other social-welfare programs and charity. The Walton family owns about 50 percent of Wal-Mart’s stock, and thus haul in billions of dollars a year just from dividends. Additional billions are spent on stock buybacks, which benefits stockholders (especially the Walton family) because the profits are spread among fewer people.

What if, instead, those billions of dollars were directed to Wal-Mart employees so that they could at least be closer to a living wage? The public policy organization Demos makes this suggestion:

“We find that if Walmart redirected the $7.6 billion it spends annually on repurchases of its own company stock, these funds could be used to give Walmart’s low-paid workers a raise of $5.83 an hour, more than enough to ensure that all Walmart workers are paid a wage equivalent to at least $25,000 a year for full-time work. Curtailing share buybacks would not harm the company’s retail competitiveness or raise prices for consumers.”

Ah, but “competitiveness” is not the issue; rather it is shoveling as much money as possible into the pockets of the Walton family, other major shareholders and the top executives. Money that is extracted from Wal-Mart’s employees through low wages and benefits, augmented by the massive public subsidies the company extracts.

Earlier this year, General Motors announced it would spend $5 billion on stock buybacks, in an attempt to boost its stock price. PBS NewsHour summarized that development this way:

“To make those purchases, GM is reducing its cash reserves from $25 billion to $20 billion. (Recall that you, the taxpayer, helped prop up GM’s cash reserves with a $49.5 billion bailout in 2009.) The stock buyback, combined with higher dividends, is expected to result in $10 billion for shareholders through 2016. It’s a grand time to be holding GM stock. And a bad time to have been behind the wheel of one of the thousands of defective vehicles for which GM is currently under investigation by the Department of Justice.”

And what of the cost of those defective vehicles to General Motors? The company set aside $400 million — less than one-tenth of what it is spending to buy back stock — as compensation for serious injuries or deaths resulting from recalled automobiles. Not all that money will necessarily be paid; Kenneth Feinberg, the administration of the compensation fund, has ruled three-quarters of claimants ineligible.

These trends go hand in hand with the sharply increasing inequality that has seen incomes at the top skyrocket while most people’s wages stagnate or decline.

This is what plutocracy looks like: The vast majority work hard so that a minuscule layer at the top of the pyramid can earn fabulous wealth, more than they can spend or invest. This also fuels speculation because there aren’t enough investment opportunities for the massive amounts of wealth accumulated, so excess money goes into speculation instead. Stock buybacks are one more method for funneling money to speculators — profits are divided among fewer people and those who do sell their shares are paid a premium above the trading price.

In an economic democracy, the people who do the work would be the ones who earn the rewards. Our current economic plutocracy is far removed from that ideal.

Speculation for its own sake pays billions

The absurdity of the tsunami of money crammed into speculators’ bank accounts is illustrated in the fact that the 25 highest-paid hedge-fund managers vacuumed up a collective $11.6 billion in 2014 — and that was considered to be a bad year for them by the business press. Stratospheric though that total is, it is barely more than half of what the top 25 took in a year earlier.

All together now: Awwww. Yes, somehow these speculators will have to get by on a paltry average of $467 million.

Institutional Investor’s Alpha magazine — one can hear their editors’ teeth gnashing at their heroes’ bitter fate — lamented that 2014 was the worst year since the 2008 stock meltdown for hedge-fund managers in announcing its “Rich List.”

City of London expanding (Photo by Will Fox)

City of London expanding (Photo by Will Fox)

Nonetheless, some observers might believe that these moguls earned somebody serious money to collect such enormous paychecks. But that wasn’t necessarily the case. For the sixth consecutive year, hedge funds fell short of the average stock-market performance, returning a composite average of three percent. Perhaps the 25 hedge-fund managers who hauled in the most money for themselves were better? Not really. Alpha reports that the hedge funds of at least 12 of the individuals on its top 25 list posted gains below the 2014 average.

The S&P 500 Index, the broadest measure of U.S. stock markets, gained 11.4 percent in 2014 and the benchmark Dow Jones Industrial Average gained 7.5 percent. So somebody throwing darts, or parking their money in a passive fund that tracks a major index, would have done as well or better in many cases. Despite their subpar performances, hedge-fund managers continue to receive an annual fee of two percent of the value of the total assets under management and 20 percent of any profits. The fee gets paid even when the fund loses money.

So it’s heads, Wall Street wins and tails, Wall Street wins. And hedge funders pay less in taxes. Much of their income is classified as capital gains under U.S. tax law, and the tax rate on capital gains are much less than on regular income.

Imposing austerity on others is a job never finished

What is that hedge-fund managers do to “earn” such enormous sums of money? Let us take a look. The top person on the 2014 list is Kenneth Griffin of Citadel Capital, who hauled in $1.3 billion for the year. Citadel makes lots of money through computerized high-speed trading — buying and selling securities in microseconds to take advantage of momentary price changes. Apparently allowing computers to do the work leaves Mr. Griffin with time to pursue his hobby of widening inequality still more.

Not content with the fact that his 2014 earnings are equal to the combined median wage of 26,000 U.S. workers, he contributed $10 million to an Illinois campaign that seeks to cut workers’-compensation benefits, make it illegal for employees to contribute to political campaigns through their union, abolish prevailing-wage laws and render union dues collections much more difficult. He’s also contributed millions to the Koch brothers’ war chest. Mr. Griffin’s firm also owns a stake in ServiceMaster, a company that profits from the privatization of public services by firing employees and rehiring them at lower wages.

A Huffington Post article, noting that Mr. Griffin is also a major donor to Chicago Mayor Rahm Emanuel, nonetheless reports that he believes Mayor 1% is too soft on public employees despite the mayor’s attacks on pensions and teachers. The article said:

“Griffin, alone, could fund all of Chicago’s pension liabilities for [2014] (estimated at $692 million) and still have $208 million [from his 2013 income] left to scrap by on. Yet Griffin is terribly worried that the mayor is being too soft on retirees. He castigated Chicago and Illinois politicians for not making ‘tough choices,’ blaming Democrats who control city, county and state government for not fixing pension, education and crime problems.”

Second on the hedge-fund list is James Simons of Renaissance Technologies. Although Alpha reported that he no longer runs his firm on a day-to-day basis and “spends a good chunk of the year on his 226-foot yacht,” Mr. Simons hauled in $1.2 billion in 2014. His firm employs physicists, others scientists and mathematicians to develop models for its computerized trading. Alas, speculation pays much more than scientific research that might benefit humanity.

Buy, strip, profit, repeat

Third on the list is Raymond Dalio of Bridgewater Associates, who took in $1.1 billion in 2014. He specializes in bond and currency speculation. Fourth on the list is William Ackman of Pershing Square Capital Management, who is what the corporate media likes to call an “activist investor.” In other words, someone who buys stock in a company and immediately demands massive cuts so he can make a large short-term profit is an “activist investor” because he does this more loudly than others.

Mr. Ackman hauled in $950 million in 2014. Forbes magazine, as consistent a cheerleader for the corporate overclass as any institution, summed him up this way last year:

“[H]edge fund billionaire William Ackman has tried to destroy a company that sells diet shakes, played a prominent role in nearly driving a 112-year-old retailer into the ground [and] helped launch a hostile takeover of a pharmaceutical company in a way that the Securities & Exchange Commission is reportedly examining for potential violations of insider trading law. Now, Ackman is suing the U.S. government.”

He is suing the U.S. government because it is taking the profits from federal housing-loan programs Fannie Mae and Freddie Mac to recoup money used to bail them out rather than handing the profits over to speculators such as himself. Never mind that the government spent hundreds of billions of dollars bailing out speculators. Among his most recent exploits, he was involved in two separate deals that would have moved a U.S. corporation’s headquarters to Canada so that it could avoid paying taxes, savings that would be earmarked for speculators’ wallets.

No summation of hedge-fund greed would be complete without a mention of Paul Singer, another entrant on the rich list. The vulture capitalist specializes in buying debt at pennies on the dollar and then demands to be paid the full face value, regardless of human cost. Among other exploits, he has seized an Argentine naval ship, 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 banks he bought four years earlier.

The outsized renumeration of financiers is due to the disproportionate size of the financial industry. A rough calculation estimates that in 11 business days speculators trade instruments and contracts with a value greater than all the products and services produced by the entire world in one year. In other words, a year’s worth of gross world product is traded in about two weeks on the world’s stock, bond, derivative, futures and foreign-exchange markets.

Such frenzied trading, often involving high-speed computers and ever more exotic betting, has little to do with actual economic needs and much to do with extracting money by ever more imaginative needs. Such is a system that values financial engineering more than human life.

Sure billionaires deserve their money: Killing jobs is hard work

More is never enough. A few examples of the wrath of speculators illustrate the “whip” of finance capital as the world’s corporations announced their results in recent weeks.

Among the words that do not go together are “shareholder activist.” Whether a sign of the debasement of language, or that the corporate media’s myopia has degenerated to the point where speculators trying to extract every possible dollar out of a corporation is what constitutes “activism” to them, as if this was some sort of selfless activity, these are the words often used to describe wolf packs that grow ever hungrier. Not even one of the world’s biggest corporations, E.I. du Pont de Nemours & Company, is immune.

DuPont, a chemical multi-national that produces many products that dominate their market, has racked up about US$17.8 billion in profits over the past five years, including $3.6 billion in 2014. Its stock price increased by 20 percent last year, better than the benchmark S&P 500 Index. DuPont recently sold off its performance chemicals business, and will hand out $4 billion to shareholders from the proceeds of the sale. Surely enough you say? Nope.

A hedge-fund manager — yep, one those “shareholder activists” — has declared war on DuPont management. The hedge funder, Nelson Peltz, is demanding that DuPont be broken up into two companies, under the theory that more profit can be extracted, and he is demanding that four seats on the DuPont board be given to him. So far, at least, DuPont management is resisting the hedge funder, but did announce $1 billion in cuts in a bid to pacify Wall Street. That means that more employees will pay for heightened extraction of money with their jobs. Mr. Peltz’s hedge fund specializes in buying “undervalued stocks,” according to Bloomberg, which is code for corporate raiding. It must pay well, for he is worth $1.9 billion.

DuPont chemical plant on Houston Ship Channel (photo by Blair Pittman for the U.S. Environmental Protection Agency)

DuPont chemical plant on Houston Ship Channel (photo by Blair Pittman for the U.S. Environmental Protection Agency)

One company that has given into speculators by selling off its best asset is Yahoo Inc. Although widely attacked in the business press for having no coherent plan for growth, Yahoo did report net income of $1.3 billion on revenue of $4.7 billion for 2013, a hefty profit margin, and remained profitable in 2014. Nonetheless, Yahoo said it will spin off into a separate company its most valuable asset, its stake in the Chinese online merchant Alibaba. This is being done so that more of the profits can distributed to speculators.

If Yahoo were to simply sell its stake, it would have to pay taxes. By spinning off its holding into a separate company, there will be no taxes paid, and thus more money will be stuffed into financiers’ pockets. “The decision,” The New York Times reported, “cheered shareholders because they will directly reap all the remaining profit from Yahoo’s prescient investment.” Yahoo will also lose its most valuable asset, making the company weaker (and presumably more likely to get rid of some of its workforce), but speculators will make a windfall. That is all that matters in these calculations.

Even an Internet darling, Google Inc., is losing its Wall Street halo. Grumbling was heard when Google’s revenue for the fourth quarter of 2014 was “only” 10 percent higher than the fourth quarter of a year earlier, a slower rate of growth than in the past. For the full year 2014, Google reported net income of $14.4 billion on revenue of $66 billion. Based on these results, it looks as if Google will remain a going concern. Nonetheless, Google stock is down 12 percent since September, a sign of financiers’ displeasure.

But perhaps happier days are on their way. The Associated Press reports that a “pep talk” by the company’s chief financial officer “left open the possibility that the company might funnel some of its $64 billion in cash back to shareholders, especially if a law is passed to allow money stashed in overseas accounts to be brought to the U.S. at lower tax rates.”

Ah, yes, all would be well if only multi-national corporations did not have to pay taxes. But despite the ceaseless demands by the world’s financiers for more governmental austerity, more cuts to jobs, wages and benefits, more punishment, the world can afford a raise. An Al Jazeera report by David Cay Johnston concludes that U.S.-based corporations held almost $7.9 trillion of liquid assets worldwide. That is more than double the yearly budget of the U.S. government.

The results are those familiar to all who are paying attention: Rising inequality and persistent economic stagnation as working people can no longer spend what they don’t have. Almost all of the gains in income are going to the top: From 2009 to 2012, 95 percent of all gains in income went to the top one percent. The “efficiency” that financiers demand is that ever larger cascades of money flow upward. How long will we allow this to go on?

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.