Peter Willans
It is not an under-estimation to suggest that the epicentre of market dysfunction lies in the structural government and market hierarchy in Washington. The lobbyists, the free trade in finance specialists, the hedge funds connected to financing wars in Iraq and Afghanistan, politicians with interests in funds and fund managers with interests in politics abound in the arena that encompasses Washington and New York. Between Wall Street and Pennsylvania Avenue a new sophisticated financial architecture has been constructed, and endorsed as commercial user friendly, by people with vested interests only in profit and wealth creation. The governance and structural linkages are not often revealed. The names of the well-placed indicate the persuasion and influence at the highest levels.
TWO DECADES of growth in the United States (US) market economy has delivered over US$8 trillion in housing wealth. This accumulation regime peaked in 2007. Housing wealth has risen as global capital markets have flourished during recent periods where the US Federal Reserve has enacted monetary policy based on low interest rates. In recent years there has also been weak corporate governance with an extensive cross pollination of corporate and government leaders, and, concomitantly, a laissez-faire approach to any forms of market intervention to correct bull financial market conditions. These conditions changed in March 2007 with the collapse of two subsidiary hedge funds attached to major institutional investor Bear Stearns, triggering systemic dysfunction through all levels of society and economy.
In the last year (April 2007-April 2008) the wealth accumulated in housing markets has dropped across the United States by an average 15-16% with many newly developed suburbs being hardest hit. Home owners with mortgages have taken the brunt of the equity decline. Most commentators have focused on the sub-prime borrowers who have been (in many cases, fraudulently) sold mortgages packages that were not repayable and represented far more that the values of the homes they signed up for. The fall in house prices across the United States, and recently in Australia, comes at a time when commentators have noted the signs of physical and social disorder spreading to suburban areas which once boasted huge growth and now has spurned decay as a consequence of wave after wave of foreclosures.
Arthur C. Nelson of the Metropolitan Institute at Virginia has studied the trends emerging from the housing crisis and the sub prime contagion. His focus has been on future demand for housing in the US. The results are “bracing”. Before the sub prime instigated crisis Americans were choosing to leave the sprawling suburbs and take residence again in cities. This process is triggered by high energy costs related to transport and for baby-boomers in retirement, a need to be closer to services. Nelson estimates that this process in tandem with the other major housing crisis will leave a surplus of 22 million large lot homes in American suburbs by 2025. The McMansion subdivisions may become what inner city living was prior to the push to suburbia – slums characterised by poverty, crime, and decay.[1] At a critical period in social and economic terms it would be assumed that the highest echelons of governance would provide a framework of leadership to allay citizens fears related to personal financial issues and the wider political economy of state. Sadly this has not been the case.
The Federal Bureau of Investigation (FBI) currently has targeted fourteen corporations in the US for improper sub-prime lending practices, including investment banks, and lending originators. Neil Powers, of the FBI’s Economic Crimes Unit, estimates that 20% of defaults were associated with individuals lying to qualify but fully 80% of current investigations are related to fraudulent activity by lenders for profit.[2] Similar investigations on corporate fraud are being conducted by the Securities and Exchange Commission. The market is now seeing prime mortgage holders defaulting at record rates[3]. A recent ABN AMRO Morgan survey reported mortgage delinquency rates in the US the highest since 1986 and the rates of foreclosures is the highest ever recorded.
It is estimated that nearly 10 million families in the United States are at risk of defaulting on loans. Financial institutions that have bought and sold securitised tranches of home loan debt (backed by loan interest repayment and home equity) have triggered panic in markets. The tranches have been depleted of value as defaults, and home equity values drop, and increasing numbers of people head to the banks and non-regulated lending institutions with their house keys.
This is the end of an era of solid and continuous wealth creation at many levels of society and the end of a prolonged period of business growth both in the United States and almost every other country in the world. It is the end of an era of excess at the top political and institutional levels. An excess that has flowed through to citizens of countries around the world with the assent (encompassed in free trade agreements and trade in financial services) of governments, ratings agencies, institutional players, hedge funds and anonymous capital tycoons secreted in tax havens. Most obvious has been the influence and lobbying power of capital interests in the United States. They include individuals and institutional interests with strong government connections in Washington who resist any government interference and any discussion about market regulation.
It is not an under-estimation to suggest that the epicentre of market dysfunction lies in the structural government and market hierarchy in Washington. The lobbyists, the free trade in finance specialists, the hedge funds connected to financing wars in Iraq and Afghanistan, politicians with interests in funds and fund managers with interests in politics abound in the arena that encompasses Washington and New York. Between Wall Street and Pennsylvania Avenue a new sophisticated financial architecture has been constructed, and endorsed as commercial user friendly, by people with vested interests only in profit and wealth creation. The governance and structural linkages are not often revealed. The names of the well-placed indicate the persuasion and influence at the highest levels.
Two individuals with significant influence joined hedge fund firms in late 2006 as global financial markets were accommodating new and sophisticated instruments of trade including Collateralised Debt Obligations (CDO’s) and Structured Investment Vehicles (SIV’S); both mainly off-the-record financial tools used exclusively to leverage and trade. Another newly defined financial instrument is the derivative asset class of credit-default swaps (CDS) which enable a buyer to separate the risk of default from a bonds other features, such as its interest rate.[4] The two individuals are John Snow and Lawrence Summers, both former US Treasury Secretaries.
Snow served three years under President George W. Bush and became chairman of Cerebus Capital Management, a US$16 billion hedge fund and private equity business. Summers is an economist who worked in the Clinton Administration, and President of Harvard University. He joined hedge fund D.E.Shaw & Company to manage US$25 billion in client’s investment[5]. Paul O’Neill the Treasury Secretary before Snow is now with Blackstone Group, a buyout firm that advises hedge funds. The Treasury Department is currently leading a task force to examine the impact of the US$3 trillion hedge fund industry on financial markets. The Secretary of Treasury is Henry Paulson, a Bush appointee, who until recently had been CEO of Goldman Sachs.
Former Secretary of State and US Ambassador to the United Nations, Madeleine Albright recently opened her own hedge fund: Albright Capital Management. The London based Centaurus Capital announced that it had hired ex- Spanish premier Jose Maria Aznar along with ex-British finance minister Kenneth Clarke and French economist Thierry de Montbrial. Perseus Capital has another former US Ambassador to the United Nation, Richard Holbrooke as its vice-chair. Former Secretary of State Colin Powell is a strategic partner with Kliener Perkins Caulfield and Byers, a venture capital firm in California.
The cross pollination of politicians/political life and capital players has occurred over the past two or three years as hedge funds and private equity firms face regulatory overtures from United States and United Kingdom policymakers. Bulking up the “names” associated with funds gives firms increased access to government officials, strong anti-regulation lobbying power, and inter-connection between the hedge fund registered office base in off shore tax havens such as Guernsey (home of Carlyle Capital) and the Cayman Islands ( the registered offices of 60% of hedge funds). Arthur Levitt, the former head of the Securities and Exchange Commission in the United States and the person who called for tighter controls on funds during 1998 (for which he was virtually forced out of office) is now on the Board of the Carlyle Group.
Former US President George H.W. Bush and former US Secretary of State James Baker III, along with former British Prime Minister John Major all work within the Carlyle Group. Both the Carlyle Group (through the default of its off-shoot Carlyle Capital) and Blackstone Group have recently been in the headlines as capital market failure takes its toll on even the headiest and stronger global players[6]. The default notice issued to the Carlyle Capital Corporation (after it failed to meet margin calls) sent further shock waves through capital markets around the world. Carlyle Capital is the eighteen month old hedge fund and the public arm of the parent company Carlyle Group. The Carlyle Group is the leveraged firm that lies at the nexus of corporate and government power in the United States. Carlyle epitomises the Bush family power base and the influence that family traverses across the globe through to the war zones of Iraq. Carlyle is associated with major contracts in war zones, including Iraq.
The off-shoot Carlyle Capital was formed in August 2006 with US$300 million of public investment capital from which it leveraged US$22 billion in AAA rated securitised mortgages, including sub-prime loans. These were mainly in the form of CDO’s. Whilst the parent company is based in Washington, Carlyle Capital based itself in Britain’s off-shore dependency Guernsey to minimise or to avoid tax. Carlyle Capital has recently (March 2008) defaulted with US$16 billion in debts outstanding. This default clearly demonstrates the levels of leverage on financial transactions at this level.
Financial market dysfunction induced several of Carlyle’s lenders to make margin calls or to directly call the firm into default on its outstanding loans. On March 12, 2008 BBC News Online reported (in response to the Carlyle Capital default) that “instead of (the Federal Reserve) underpinning the mortgage-backed securities market, it seems to have the had the opposite effect, giving lenders an opportunity to dump the risky asset” and that Carlyle Capital Corporation will collapse if, as expected, its lenders seize remaining assets”[7]
Both the parent company and its hedge fund epitomise the things that are so desperately wrong with the global financial sector at the top end. They are secretive, obstructionist, unregulated and unaccountable and run by people who actively exploit every loop- hole to avoid taxes and reporting. Until recently they were virtually untouchable. The Carlyle Group is the modern day source of the enormous wealth of the very influential Bush family[8].
The list of shareholders and board members of the Carlyle group is both instructive and insightful. It shares high government and high net worth individuals equally. Policymakers and capital movers blend together in powerful display of financial sector capacity. Other than those individuals mentioned above Fidel Ramos (ex Philippines president), William Kennard, (former chair of the US Federal Communications Commission), Saudi prince Al-Walid, along with Colin Powell (former US Secretary of State) Caspar Weinberger (long time confident of the Bush family, George Soros (Quantum hedge fund) and the most influential members of the bin Laden family (long time friends of George H.W. and George W. Bush[9].
Ironically Carlyle Group emerged out of the carnage of September 11 2001. On that day a group of five hundred leading Carlyle investors met at the Ritz Carlton Hotel in Washington. George Bush senior attended the meeting, as did James Baker III, and Shafiq bin Laden wearing his badge with his name prominently displayed. The Carlyle Group’s meeting was interrupted with the news of the terrorist attacks on the World Trade Centre and the nearby Pentagon Building. The bin Laden family were secretly removed from the US immediately after the terrorist attacks in the only airplane given permission to fly in US air space.
Connections between the Bush family and the Carlyle Group have inspired intense controversy particularly in relation to the Iraq War, and The War on Terror. These issues become more prominent as policy makers and social analysts grapple with the detail as the market has moved from the displacement of citizens who have defaulted on risky loans to a full blown economic dysfunction affecting superannuants savings, stock market investments, housing equity, across continents.
Corporate governance in all areas of capital markets is a major concern at a time when citizens in the US and Australia have been caught in a credit squeeze that commentators are predicting will worsen. A strong focus on leadership is most obvious but the timing of US elections weakens the political responses to a crisis which is effecting all levels of society, particularly in Australia where foreclosures are hitting record levels, a stock market downturn of 17% has been recorded and superannuation investments are down by over Au$70 billion.
Refs
1 “Fringe Dwellers” Christopher Leinberger. Australian Financial Review at [email protected] and http://www.theatlantic.com/doc/200803/subprime also see “Suburbia’s March to Oblivion” New York Times http://www.nytimes.com/2008/02/23/business/23online.html?ref=technology
2 “Sub-prime Crackdown targets Hedge Fund Industry Fraud” Hedge Fund News January 21 2008. at http://www.hedgeco.net/news/01/2008/subprime-hedge-fund-industry-players.html
3ABN AMRO Morgan/Michael Knox Economic Strategy “Prime becomes Sub prime” 19 December 2007.
4 “Caveat Counterparty” Briefing Wall Street Crisis. The Economist, March 22 2008 Special Section.
5 “Shakers: 2 Ex-Treasury chiefs join hedge fund firms”. International Herald Tribune 14/3/2006. and http://www.iht.com/articles/2006/10/22/bloomberg/bxshake.php
6 “Carlyle Empire” by Eric Leser, Le Monde Diplomatique. April 26, 2004,
7 Hedge Fund on the verge of collapse” BBC News Online 13 March 2008. available at: http://news.bbc.co.uk/2/hi/business/7293663.stm
8 Wikipedia. Carlyle Group. Available at; http://wikipedia.org/wiki/Carlyle_Group
9 Centre for Media and Democracy, Source Watch “Carlyle Group.” Available at http://www.sourcewatch.org/index.php?title=carlyle_group Le Monde Diplomatique,
