Diana Tussie

Every economic crisis buries some practices and gives rise to new ones. What we see today is a move away from what Robert Wade called the “High Command “of global finance and the rise of less formalized institutions. The G-20 may be one of these.

So far the G-20 summit agenda focused heavily on the question of the regulation of international financial markets. In addition, the G-20 leaders made a commitment at their first summit in November 2008 to press on with the reform of the Bretton Woods institutions in order to give greater voice and representation to emerging and developing economies. Two years later the Toronto summit closed on a dull tone.

The G-20 resolved to have all of its members halve their deficits by 2013 and to stabilize overall debt by 2016. Brazil and Argentina along with India and China were strongly against cutting back spending at this early point in the global economic recovery. It was Brazil’s Finance Minister, Guido Mantega, who warned the G-20 not to balance budgets on the backs of the world’s poor.  Other agendas remain mostly ignored. As these initiatives move with extreme paucity, it may be that other mechanisms, particularly those at a regional level, gain momentum.

After the East Asian crisis countries in the region made efforts to expand financial cooperation through the Chiang Mai Initiative. With the largest worldwide reserves, these countries have the capacity to create a quite-significant pooling arrangement.  In Latin America, after the Argentine meltdown, steps to expand the regional provision of development finance have gained momentum. The Andean Development Corporation has become a major project lender throughout South America while the newly inaugurated Bank of the South with an initial capital of $20 bn is also expected to start operations promptly. (See Vernengo, “Public Banks and Development.”)

Regional development banks have for a long time enabled the existence of alternative windows for access o finance. Many argue that the case for more pluralism may even be stronger in the area of balance of payments support given the controversy over the IMF’s hold and its conditionality.

Western Europe provides a prime example of regional financial cooperation in the post-war period. The U.S, through the Marshall Plan, catalyzed the initial phases of this process, which underwent step by step deepening until the emergence of the European Payments Union (EPU), eventually leading to the current monetary union. In its day the EPU played a reserve-sharing role. Today some supporters of regional institutions  have even suggested that the IMF could emerge in the future “as the apex of a network of regional reserve funds – that is, a system closer in design to the European Central Bank or the Federal Reserve System than to the unique global institution it currently is … A denser network of institutions seems better adapted to a heterogeneous international community, and it is likely to provide better services and give stronger voice to smaller countries”.

Hand in hand with the sprucing up of project lending, regional reliance on the IMF has dropped dramatically.  In 2005, Latin America made up 80% of the IMF’s lending portfolio, a share which had dropped to 1% by 2008.  While IMF loans to Latin America stood at $48 billion in 2003 they dropped to less than $1 billion before the crisis. With the onset of the crisis, three Central American countries, Mexico and Colombia have applied for loans. But the crisis has not changed the long term trend, which has been favored by booming commodity markets.  While most countries paid off their debts, Argentina is also refusing to follow precedent and go back to the IMF  in order to renew negotiations with the Paris Club. Reversing the trend from borrowers to lenders, in June 2009 Brazil, Russia and China announced that they would buy IMF bonds in order to reduce their dependence on the dollar and diversify foreign currency reserves.

Regional payments clearinghouses are also making progress towards decoupling trade operations from the US dollar. In October 2008, Argentina and Brazil agreed on a local currency payments system.  In Brazil, exporters may now operate in the real, while Argentines may operate in pesos.  With elimination of the need to go through a third currency exporter can set prices in their home currency, and hence thus being insulated from exchange risk. The system now covers about 20% of trade.  In a similar line, in October 2009, the SUCRE, or Unitary System for the Regional Compensation of Payments, was set up among Venezuela, Cuba, Bolivia, Ecuador, Nicaragua, Honduras, the Dominican Republic, Antigua and Barbados, as well as San Vicente and Granada.

If meaningful IMF reform continues to prove politically difficult, the relevance of these arrangements might grow. Not only would they allow for decentralization and greater pluralism in international financial governance. They can also contribute to global stability by reducing the US burden to provide liquidity to the world economy, much in the same way the EPU did in its time. But they might also throw some useful sand into an entirely free-flowing regime of finance.

Over the last thirty years there has been a significant change in the role of public banks.  Neoliberal policies suggested that central banks should be independent of the Treasury, and should concentrate their efforts on inflation targeting.  Further, development banks, where they existed, were discouraged as tools for industrial policy, that is, they were precluded from providing subsidized credit for specific economic sectors.  On the other hand, the tendency was to use development banks as instruments of the process of privatization, providing credit for mergers and acquisitions.  Finally, the international financial institutions (e.g. IMF, World Bank, etc.) were used to spearhead the process of liberalization, and credit was only available to those that adopted the neoliberal policies.

It is important to emphasize that central banks were established in Europe (e.g. the Bank of England) primarily to raise loans for the government, and that the role as fiscal agent of the Treasury still was one of the main purposes for their existence until very recently.  For example, the Federal Reserve during the Great Depression agreed to maintain the interest rate on long-term treasury bonds at 2.5%.  That allowed the fiscal expansion (with deficits that eventually were larger than 20% of GDP, double their current size in the US now) of the New Deal and War effort to be sustainable.  Low rates of interest imply that government debt grows at low rates, and as the economy grows and government revenues increase the Treasury can repay its loans without difficulty.

Almost as important as the low interest rate policy was the foreign exchange policy.  Central banks could, by intervening in the foreign exchange market, buying and selling foreign currencies and using exchange controls, maintain a depreciated currency, favoring domestic production over imported goods.  In reverse, high interest rates and appreciated currencies sometimes were used to favor the financial sector and importers, in order to weaken domestic industrial production and employment and to reduce the bargaining power of workers.

In addition, public banks have been not only important lenders to the state, but also they were heavily involved in lending directly to industry.  Central banks in the developed world provided subsidized credit for industrial activities.  In developing countries the role of development banks was more important, and the incredible rates of growth in South Korea and Brazil (until the 1980s) cannot be understood without the Korea Development Bank (KDB) and the Economic and Social Development National Bank (BNDES in Portuguese).

In South America, within the context of the rise of left of center governments over the last decade, there has been a significant change in the role played by public banks harking back to their role as promoters of development of the pre-neoliberal era.  At least three examples of institutional innovation that have changed the role of public banks in the region are worth noting.

In Brazil, BNDES received R$ 100 billion (approximately US $ 55 billion) loaned by the federal government in 2009 for its operations.  This loan allowed the Bank to increase significantly its funding capabilities to support long-term investment projects and made relevant anti-cyclical efforts feasible in the context of the crisis.  It must be noted that total investment in 2009 corresponded to 16.8% of GDP and of that about half corresponded to the purchase of new machinery.  Since, the BNDES total lending was about 4.5% of GDP in 2009, one may conclude that about half of all purchases of equipment were financed by the BNDES, which explains why the Brazilian economy will continue to have vigorous growth in the midst of the crisis, in spite of having the highest real rate of interest in the world.

Second, it has been recently announced that the Central Bank of Argentina will start to make subsidized loans to stimulate local production and reduce the dependency of imported inputs.  This follows the decision to use the central bank reserves to pay for external debt commitments, after the defenestration of the neoliberal head of the bank.

Finally, the region has moved ahead with the plans for the new Bank of the South, an alternative to the current financial architecture, that involves reduced dependence on external funds, with increasing use of the currencies of the region rather than the dollar, greater degree of cooperation in the region and a move towards a common monetary system underpinned by policies to promote full employment and poverty reduction.

What should we make of the financial reform laid out in the Congress’ bill? The approach is based on the assumption that the financial system is basically sound but needs “more government” in the form of more regulation — as distinct from structural change (for example, to downsize very large banks or to separate deposit-taking banks from investment banks). The Democrat who shepherded the legislation through the Senate, Christopher Dodd, said that improving regulation made more sense than restraining an industry that was critical to the American economy and that faced fierce competition from foreign banks which would not be placed under similar restrictions.

The bill grants more resources and more authority to those charged with supervising the industry, including to the Federal Reserve as the nation’s chief financial regulator; it requires most, but not all, derivatives to be backed by a third-party clearinghouse, so that if either side fails to meet its obligations the clearinghouse steps in to cover them; it creates a consumer protection agency; and it gives the government resolution authority to take over a failing bank and dismantle it in an orderly way.

Even this minimal package faced strong Republican opposition, so one should be grateful that it goes as far as it does. However, the danger of trying to control the banks through regulation (without bigger changes to the structure and scope of banking) is that it ignores the big lesson from the experience of 1970-2010: that the political strength of the US/EU financial sector enabled it to (a) erode banking regulation, and (b) create a parallel non-bank financial sector with almost no regulation.

In the resulting market framework, asymmetric incentives on money managers (to take big gambles confident that gains could be privatized and losses put onto others, as in bonuses based on short-term performance with no penalty for longer-term losses) and herding incentives on money managers (to crowd into investments others have already made, because their performance is judged relative to others’) generated a high and rising level of financial fragility in much of the Atlantic world, and also in developing countries which followed Western advice to open their financial systems.

Financial stability is only likely to be secured by one of two solutions. Either the political strength of the US/EU financial sector has to be curbed, or incentives on money managers have to be more fundamentally changed.

The conservative solution is to curb the political strength of the US/EU financial sector by taking all “very large” or “systemic” financial firms (in the US, with assets over $100 bn) into permanent public ownership (plus independent central bank prudential and macro-supervision). Small banks could be private, provided directors cannot interlock and are jailed if they collude; they would provide useful competition with the state banks.

The more radical solution is to change incentives by ending limited liability in ownership of financial firms. Shareholders would be jointly and severally liable, each up to the limits of their total assets. This was the situation in most rich countries for all sectors before the limited liability acts of the nineteenth century (in the UK, 1855). Today there is a good case for retaining limited liability outside of the financial sector; and a good case for removing it within finance, so that investors in South Sea Bubbles etc. lose their fortunes rather than making the state pay, and are induced to stop their money managers from gambling.

Without either of these changes – public ownership of big banks or removal of limited liability in finance – the existing push to give regulators more money, more information and more power is likely to be subverted by the political strength of the finance industry.  As a taste of what may be to come, when the Senate passed the new finance legislation in mid May Wall Street executives expressed relief, convinced that it would not fundamentally change the way they operate. The bill is 1,300 pages long, with 300 pages devoted to derivatives alone, and it will be a long time before anyone other than Wall Street lawyers understands it.

My guess is that it will take two or three more Lehman or Greece-like crises to generate sufficient political consensus to move in either of these two directions. Don’t hold your breath.

Robert Wade is professor of political economy and development at the London School of Economics.

The economic crisis in Greece, which has roiled all of Europe, has been presented by the mainstream media as arising from the mismanagement of economic resources.  In fact, the real roots of the crisis and others like it are in the malfunctioning of political institutions.

Politics, according to the famous formulation of Harold Lasswell, is about who gets what, when and how.  Although all political institutions produce an answer to these questions, well-functioning ones must produce answers that are, at a minimum, not manifestly irrational (for instance, in the sense that they are worse for nearly everyone than those which some alternative would have brought about) nor manifestly unjust  (for instance, in the sense that they systematically favor the already advantaged over the already disadvantaged).  However, many political institutions fail to satisfy one or both of these criteria.

One of the most common forms of such irrationality is that the public finances become hostage to a collective action problem involving different influential actors in the society, who treat the public fisc as a common pool resource, seeking to draw the maximum from it while contributing the minimum to it.  This collective action problem is not a necessary consequence of the plurality of actors and their interests, although that plurality is a necessary condition for its occurrence.  In fact, the crisis of the public exchequer is a reflection of the weakness of the state in relation to the society as a whole.

A weak state is very often, as a matter of description, the ineffective slave of many masters and the ineffective master of many slaves.  It is neither the effective slave of some nor the effective master of all.    The immediate consequence of this condition is that the weak state can neither effectively raise resources nor effectively spend them.  It raises too little to pay for what it spends.  It does not raise money where it should and it spends on the wrong things.

When this condition becomes deep-seated, it leads to a self-reproducing cycle, in which the weakness of the state contributes to its weakness.  The chronic fiscal deficits to which this political situation gives rise can be readily tolerated if the national economy is able to generate an increase in national income sufficient to counterbalance the increase in the national debt.  If not, the state must either attempt to overcome its weakness in relation to the society (even if initially through measures which reveal that weakness, such as the inflation tax) or face the consequence of its weakness, in the form of fiscal crisis. Fiscal crisis in turn implies the necessity of defaulting on debt wholly or partially, or raising revenue and lowering expenditure abruptly.  The former may provide a salve (especially if the situation is not so serious that fresh borrowing is needed even to maintain current expenditure) but risks punishment from creditors in the form of higher costs of borrowing and no guarantee that the drama will not be repeated.   The latter restores fiscal probity at the cost of generating severe adverse consequences for human beings, and for public investment in national development, while also providing no guarantee that the drama will not be repeated.

From the perspective of the accountant, there are only two routes out of this dilemma.  The first is to turn a relatively stagnant economy into a more dynamic one that is capable of growing enough to afford the cost of the broken relationship between state and society.  The second is to establish a new relationship between state and society in which the state is both more effective master and more effective slave of the social interests.  In practice, these two routes are not independent but are more often than not deeply intertwined.  The national economy is relatively stagnant in part because the state cannot act effectively to invest and to create the conditions of sustainable growth.  The repair of the relation between state and society is the sine qua non of sustainable growth and development.

What of Greece? Greece has had a rate of economic growth that has been respectable and may have sustainably accumulated debt were it not for the change of mood in the global market.  To this extent, Greece is not fully responsible for its situation.  Nonetheless, it has suffered a collapse of confidence because it was vulnerable to one.   Its national economy is unable credibly to promise the extent of future dynamism necessary to reassure its creditors (in part because fiscal constraint will undermine the public investment necessary for future growth and development).  The creditors would in turn not have been able to demand that reassurance had Greece not pursued a leveraged path.

Now that the crisis has struck, its golden chains to the Euro prevent Greece from pursuing the low road tactic of nominal exchange rate depreciation as a means of spurring growth.  The alternative low road tactic of real exchange rate depreciation (the lowering of real wages and costs) is available to it, but is socially painful in the extreme, and unlikely to be an ultimate solution.  Default may also not provide a salve even in the short run, due to the dependence of the Greek economy on borrowing to finance current consumption (i.e. its primary fiscal deficit).  Nor does it provide assurance in the long run, as the fundamental weakness of state in relation to society make it difficult to exclude recurrent crises or their endemic equivalent of chronic fiscal constraint, even if Greece continues to grow moderately.

Greece, like every country before it that has been in such a situation, has no alternative but to reform the relation between state and society, regardless of what desirable reforms may take place to the international economic system.  A functioning state must be capable of taxing and must be capable of saying no.  It must make sound investments and must productively organize economic life. However, none of this suffices for political institutions to be well functioning. Throughout the world there is a choice between a more democratic and socially inclusive route to the emergence of a capable state (which in turn serves the ends of democracy and social inclusion) and a more authoritarian and non-inclusive route (which serves the few).  Only one of these roads is desirable. Finding it is the work of politics.

The US Senate is currently debating an important financial reform bill that has the potential to rein in excessive speculation in commodities.  That speculation drives up the price of food all around the world, and helped contribute to the food crisis in 2008.  Some Wall Street lobbyists are working to weaken the bill, but its important for global food security that they aren’t successful.  To learn more visit StopGamblingonHunger.com and watch my videos on the subject:

China and India are often seen around the world as examples of successful developing strategies that should be emulated by other developing countries.  They are also often lumped together with Brazil and Russia, as part of the BRICs, the group of countries that would overtake the developed world by mid-century.  Brazil and Russia, however, are to great extent commodity exporters, and the Brazilian success story has been over-hyped.

The case of India is of particular interest for developing countries, since it suggests that high rates of growth are possible, in the context of a multicultural, multiethnic, democratic society.  Also, India seems to provide an alternative model in terms of the pattern of structural transformation of the productive sector, with a pronounced acceleration in the growth of the service sector in an early stage of the industrialization process.  The growth in services is, in part, associated with the expansion of services exports, which, in turn, are related to the offshoring process.

India has an edge because it provides English-speaking workers at a highly competitive price, which explains why it has become the preferred choice for offshoring.  The English speaking advantage, the relatively high levels of education of the labor force, and the relatively low wages by international standards are often used to explain the competitive advantage of the Indian economy in the services sector.

However, there are at least two concerns with the Indian development model that should be noted.  First, economic growth has translated in persistent trade deficits that have become increasingly larger after the boom in commodity prices since 2002.  These deficits have been made possible by financial flows, remittances and services exports.  In other words, even though India still has a relatively closed capital account, it depends on capital inflows.  India is certainly not close to a balance of payments crisis, with a current account deficit that shrank after the global crisis from around 3% in 2008 to close to 1.5% of GDP in 2010.

Yet, the current account deficit implies that Indian authorities are forced to be cautious in terms of their fiscal policy, to avoid upsetting financial markets, and the benefits of growth cannot be used to reduce massive poverty by more extensive fiscal transfer programs.  Further, a balance of payments crisis, as in 1991, cannot be ruled out if the prices of commodities (particularly oil) continue to be high, or if interest rates rise sharply, making the debt dynamics unsustainable.

Also, the dependence on remittances and export of business and communications services means that as much as certain Latin American countries, in particular Mexico and Central American countries, India depends on exporting people.  In the case of India the immigrants tend to be highly educated, and the low wage workers are not in the ‘maquila’ sector, but in the services sector.  As in the case of Latin America, the inability to incorporate surplus workers in the more dynamic sectors of the economy implies that disguised unemployment remains high.  Reflected in the Latin American mirror the Indian strategy seems less impressive.

Octavio Paz, the Mexican writer and ambassador to India, was fascinated by the similarities that he found between India and his native country, despite the incredible cultural differences.  The development strategy in India makes Octavio Paz’s conclusion more understandable: “The strangeness of India brought to mind that other strangeness: my own country.”

The Financial Times reports that banks in Europe have appealed to the European Central Bank to become a “buyer of last resort” of eurozone government bonds, to prevent another financial crisis. Though the European Central Bank (ECB) is yet to take a decision on the matter, the option has not been ruled out. The ECB is also planning on launching a loan facility which will offer funds to the tune of €600 billion to banks at a one per cent rate of interest to tide over the current funds crunch.

If true, these moves reflect an effort to provide cheap liquidity and take over currently doubtful (sovereign) assets, in order to keep credit moving. That is, the authorities concerned want to do in Greece precisely what was done during the 2008 crisis to banks overexposed to opaque assets that turned toxic. The argument then was that the presence of these assets had frozen the credit pipe, and if the flow was not restored the real economy would experience seizure. To prevent that, the government and the monetary authority should take over doubtful assets, pump in cheap liquidity and buy into bank equity. This time too, the reason being offered is that Greece could be the world’s new Lehman, inasmuch as its default could damage systemically important banks.

Such concern is not surprising. Barclays Capital has estimated that French and German banks and insurance groups hold close to €80 billion in Greek sovereign debt. Besides, there is substantial exposure to private Greek debt of various kinds, which is also in threat of default if the economy slips. Many of the banks exposed heavily to Greece are international giants and their collapse would have repercussions across the globe. Therefore, the desire to bail-out the banks seems perfectly reasonable.

There are, however, two differences between the current conjuncture and that which preceded the 2008-09 bailout. First, the assets under question today are sovereign debts. With governments having the right to tax and the ability to persuade lenders to restructure debt, dealing with sovereign assets should be easier than handling privately generated toxic junk. So rushing in with public money to bail out banks may not be the easy option.

Second, in 2008-09, there was a fair degree of consensus that the banks that were being bailed out were among those responsible for the crisis. So the bailout was presented as an unavoidable temporary measure that would have to precede initiatives to change the nature of the banking system.

In the case of the current “crisis”, the banks are not being seen as responsible. The fact that the banks had willingly lent huge sums to governments that were supposedly profligate is hardly seen as reflective of bad judgement. And the fact that they were otherwise overexposed in countries that were unstable is ignored. So in the current round of discussions on bailing out the banks, the issue of restructuring the banking system is missing. The argument seems to be that the banks should not be allowed to go under for doing their job, just because their services were being misused by governments.

For developing countries that have been through a series of debt and financial crises, especially since the Mexican debt crisis of 1982, this attitude towards the banks is not new. Even since the late 1970s, global banks have reached out to emerging markets in search of new investment avenues and pushed credit that encouraged the latter to over-borrow. But whenever a developing country found that it was caught in a debt trap, the adjustment had to be only on the borrower’s side, barring a few exceptional cases. The banks were bailed out and the country concerned was burdened with austerity measures that set back growth. Greece is seeing a repeat of that experience.

If the initiatives under consideration are indeed implemented the banks are bound to laugh their way back to their own vaults. It is now not news that the easy liquidity offered during the 2008-09 bailout was used to borrow cheap and invest in ventures that were as risky as the investments that generated the crisis. That speculative surge yielded the expected results and the profits of some banks swelled. This drama is likely to be repeated, with the liquidity from the ECB and elsewhere being used to invest in a similar basket of assets, including, perhaps, new Greek debt placed at extremely high interest rates!

The recent global economic crisis has been unprecedented since the great depression of 1929-32. The low-income countries have been affected by the crisis severely, particularly because of their low capacity to take external shocks. The commodity boom of 2003-08 allowed increases in national savings, investment and the acceleration of GDP and market value added (MVA) of low-income countries. Nevertheless, it was followed by a “bust” with detrimental impact on their long-term industrialization and development. Food and fuel importing countries, in particular, suffered from both the “boom” and the “bust”; the emergence of the financial crisis took place at the time they were facing high international prices of food and petroleum. In other words, they faced three ‘F’(food, fuel, financial)  crises.

As a result of the global economic crisis, the prices of non-oil primary commodities and petroleum fell, from the peak to the trough, by over 36 per cent and 68 per cent, respectively. Nevertheless, food prices did not fall as much as the prices of other commodities and have picked up faster than other commodities after they reached their trough in December 2008.

African countries will be particularly affected, some of which are predicted to show negative GDP growth in 2009. The demand for manufactures, in general, will suffer not only from the fall in exports, but also from changes in domestic demand as a result of the decline in the rate of growth of private consumption. That growth is projected to fall by 3 per cent, for example, in Sub-Saharan African countries — most of which are among low-income countries. The decline in workers’ remittances is another important cause of the decline in domestic demand for manufactured goods in many cases. For example, for six African countries remittances were equivalent to more than 100 per cent of their total exports in 2007; the fall in the remittances is projected to reach over three per cent of GDP in some cases, particularly in the case of low-income countries which are “manufactures exporter.” For example, in 2008, workers’ remittances as a percentage of GDP reached over 27 per cent in the case of Lesotho, and 18 per cent, 17.8 per cent and 11 per cent in the cases of Haiti, Nepal and Bangladesh, respectively. Moreover, what is axed more is investment which has detrimental effects on the growth of their production capacity. The deterioration in the balance of payments and fiscal constraints has led to a reduction in financial resources available for investment, and thus cancellation of some projects and a significant drop in investment outlays. For example, the rate of growth of investment is projected to decline, e.g. by over 12 per cent in Sub-Saharan Africa.

The combination of fall in external and domestic demand has imposed a shock on the fragile manufacturing sector of these countries, which had been increasingly exposed to competitive pressure in internal and international markets. Changes in the global economy — including rapid technological change, globalization, new methods of production, and the emergence of China as a massive exporter of labour intensive products, had already increased the competitive pressure on the manufacturing sector of low-income countries, particularly textiles and clothing, which account for over two-thirds of their manufactured exports. Such changes have increased the need for nurturing the manufacturing sector in countries which are at early stages of industrialization. Yet, the policy space available to them has diminished. The increased competitive pressure has taken place not only due to changes in the rules of the game on competition in the international market, but also due to the premature trade liberalization and the pursuance of “market oriented” strategies imposed on economies of low-income countries by International Financial Institutions (IFIs) and bilateral donors.

As a result, despite acceleration of growth in the MVA of some of the low-income countries during the boom years, most of them had already been facing de-industrialization. The global crisis caused closure of a number of their factories in low-income countries causing unemployment and further de-industrialization. Yet, during the crisis the IFIs imposed pro-cyclical macroeconomic policies on some low-income countries, such as Malawi, causing further fall in effective demand, sluggish, or negative growth, and further de-industrialization. The global economic crisis is a wake-up call, particularly for low-income countries.

Democratic Party leaders recently introduced their latest proposal to reform U.S. immigration policy.  The proposal, which is given little chance of passage in a polarized election year, offers carrots and sticks in an attempt to bring some semblance of order to a broken and outdated policy that has left nearly 12 million people in the United States without legal documents.

The carrots are few and shriveled: an arduous path to U.S. citizenship for those already in the country.  The sticks are large: a further crackdown on border enforcement and increased policing to catch and punish those without papers. No combination of carrots and sticks will address the immigration issue unless reform efforts also take up the agricultural, trade, and labor policies that feed migration.

The Meat of the Matter

Industrial livestock firms such as Smithfield and Tyson are among the big winners from the range of U.S. policies, which serve them both inside the United States and across the border in Mexico. These multinational giants are so dependent on immigrant labor – documented and undocumented – that they shut many of their packing houses to avoid the embarrassment of empty factories when labor protests on May 1, 2006 declared a “Day without Immigrants.”

These companies also benefit from U.S. agricultural policies.  Reforms in the 1996 Farm Bill deregulated the last vestiges of the supply-management policies the government had used to balance supply and demand and to maintain stable prices for consumers and remunerative prices for farmers.  With deregulation, land that had been held out of production came back in, production jumped, and prices fell 40 percent to levels well below the costs of production.

This policy change gave the industrial consumers of U.S. farm products an enormous gift: vast quantities of below-cost crops.  For industrial hog and chicken companies, the boon came in the form of discounted feed, which is made up mainly of corn and soybeans. From 1997-2005, corn prices were 23 percent below production costs while soy sold for 15 percent below cost.  For a company like Smithfield, this amounted to a 26 percent discount on feed, their main operating expense, a 15 percent “implicit subsidy” to their operating costs.  Smithfield saved an estimated $2.5 billion during that nine-year period.

The Trade Link

Agricultural policy connects to the immigration problem through trade policy. The North American Free Trade Agreement (NAFTA), which took effect in 1994, promised to allow Mexico to “export goods, not people.” NAFTA not only opened Mexico’s borders to U.S. meat, with pork exports increasing over 700 percent from their pre-NAFTA levels. The treaty also gave U.S.-based multinational firms greater freedom to invest in Mexico, where Smithfield dramatically expanded its operations. Through its joint-venture partners, the firm is now the largest hog producer in Mexico, with more than 15 percent of the market.

Still waiting for the immigration connection?  Smithfield’s Mexican hog operations put a lot of small-scale hog farmers out of business, as producer prices fell 56 percent in real terms. More importantly, U.S. exports of below-cost corn flowed south in a torrent thanks to NAFTA. U.S. exports increased over 400 percent while real prices in Mexico declined by two-thirds. These shocks to rural Mexico pushed an estimated 2.3 million people out of agriculture between 1993 and 2008, among them former corn and hog farmers desperate for work.

A few of them no doubt found work in Smithfield’s Mexican hog operations.  But with the Mexican economy floundering under the NAFTA economic model, many looked northward for their jobs. Migration to the United States doubled from the already high pre-NAFTA levels, despite stepped up enforcement along the U.S.-Mexico border. The border crackdown not only failed to slow the influx, it paradoxically encouraged those who survived the perilous journey to stay rather than risk repeated trips for seasonal work, as many had done before.

Hogs In, Workers Out

The new migrants have found work in the United States at Smithfield and other industrial livestock operations, among other places. Undocumented workers make up an estimated one-quarter of the workforce in packing houses. Once there, both documented and undocumented immigrants confront the final policy gift to multinational agribusiness: labor policies that make it hard for workers to organize to defend their rights.  Smithfield’s persistent violations of U.S. labor laws at its massive Tar Heel plant prevented unionization for over a decade, until a broad-based campaign brought a union to Smithfield in 2008.

Beyond a broken immigration system, U.S. policies make U.S. farm products cheap, open the borders so we can dump them on Mexico, promote an economic development model that fails to create jobs, and makes it easy for companies to use undocumented workers to drive down wages and prevent unionization.

The United States certainly needs a new immigration policy. But we also need new agricultural policies that allow farmers to earn a decent price for their products. We need new trade policies that help our trading partners grow and create jobs rather than opening the doors for agribusiness and dumping cheap products on poor farmers.  And we need new labor policies that protect the rights of workers – citizens and immigrants, with and without documents – rather than the rights of multinational firms.

This commentary was also published by Foreign Policy in Focus.

Goldman Sachs’ arrogant public response to the Securities & Exchange Commission accusation of fraud is another example of self-righteous overconfidence on Wall Street. Not that the SEC suit will be won by the government. In fact, that’s partly what’s given Goldman its chutzpah.  Odds are pretty high the investment bank will prevail in court. Whether it told investors that the hedge fund manager John Paulson shorted the portfolio of mortgage bonds in which they invested—or synthetically invested, so to speak — may be beside the point legally.

What is not defensible ethically or economically were the ratings on the collateralized debt obligation (CDO) itself — the structured investments that Goldman repeatedly sold, and the likes of which Merrill Lynch and Citigroup sold more of.

The fundamental deceit at the heart of the CDO requires more public understanding.  The CDO turned triple-B mortgage-backed securities into triple-A. On that simple alchemy, world finance almost collapsed. Merrill and Citigroup in particular rushed to issue CDOs from 2004 on, rapidly becoming the biggest in the field. But the esteemed Goldman also participated.  Did Goldman really believe these securities deserved a triple-A rating from Standard & Poor’s and Moody’s?   You can bet that they did not.

It is worth spending a moment to understand what was done.  It is not as simple as some journalistic accounts make it out to be.

Mortgages themselves—as distinct from mortgage-backed securities or mortgage  bonds, for short —have been “tranched” since the early 1980s.   They are put into a vehicle and investors buy bonds against them—the mortgages are the collateral and the mortgage interest is passed through to the investors. Eighty percent or so of the investors buy bonds in the senior tranche—and are entitled to receive interest first, so defaults have to be very high to jeopardize their income.  These mortgages bonds are rated triple-A and are paid the least interest—though still significantly more than triple-A corporate bonds.

The next ten percent get paid off next, and may be rated single-A, and so on, until we reach the mezzanine, maybe 2 to 5 percent of the bonds, which gets paid (almost) last, and are usually rated triple-B.  Thus if defaults rise only moderately, there is a good chance these triple-B bonds will lose value because interest payments will be reduced or cease altogether, and may even fall to zero.

But a collateralized debt obligation or CDO is not composed of mortgages. And increasingly they were composed largely, and even only, of these triple-B tranches.  Wall Street argued that these could also be made into a hierarchy—that is, tranched. But because all the triple-Bs are susceptible to even a modest rise in default rates, you can’t truly shield the senior 80 percent of the CDO bond holders from rising defaults. It’s not like a package of mortgages themselves.

Wall Street got the ratings agencies to assume that if these tranches are sufficiently diversified geographically, a hierarchy can be made. Default rates will rise in only one part of the country and not at all in others.  It was a mind-boggling assumption. In truth, the triple-A part of the CDO, supposedly the top of the barrel, was almost as vulnerable as those at the bottom.

Did anyone see through this? Yes, the now famous “big shorts.” Why did Goldman and others do it? Because the triple-Bs paid higher rates, and they could therefore create supposed triple-A investments with high rates.  And they took 1 to 2 percent of every deal off the top. Why did the supposed independent  CDO managers go along?  Because they made a fortune if the investments were sold.  Why did sophisticated financial managers buy them?  Because it improved their bottom line and, after all, Goldman agreed they were triple-A even if the financial manager had some doubts.

There was one more step. Wall Street ran out of mortgages and therefore tranches to throw into a CDO. So they created them out of thin air by selling credit default swaps to people like John Paulson. Paulson paid maybe 2 percent a year for the right to get the full amount of the loan back, should it collapse.  That annual payment served as interest on a synthetic CDO.  Debt was being created without additional collateral.  And Paulson picked especially fragile mortgage bonds on which to buy insurance.

Market rigging? You tell me.