Wall Street: Get Their Claws Out of the Real Economy

It's hard to believe this. Harder even to write it. But yesterday's announcements prove that the US Treasury is still afraid of the big bad wolf, Wall Street.

While Wall Street laps up taxpayer funds it continues to dig its claws into the body of the real economy. The Treasury seems in danger of pandering to the beast, rather than protecting the vulnerable -- those companies where real wealth is created.

There is some, but not enough, focus in the Treasury statement on foreclosures, debtors and debts. There is very little focus -- either from the Fed or the Treasury -- on the cost of debt for those productive companies and households buckling -- and going bust -- beneath the heavy load of their debt.

How can this be?

I can only think it is because America's leaders are still too fearful of Wall Street This makes them blind to the role that the private banking sector is playing in hurting the real economy.

Remember, Wall Street has the power to set interest rates -- market rates. And neither the Fed nor the Treasury seem willing to mess with that power.

By focusing on bailing out the banks, and by not helping the rest of the heavily indebted -- but productive -- economy, the Treasury team and the Fed are likely to make things worse. Not just for the economy -- but for Wall Street too.

Making banks more transparent -- belatedly -- won't solve the problem. Pumping in more capital won't help. The debts are too many, and unknowable. Geithner has to face this.

The focus must now be on protecting and reviving the body of the productive economy. That is the economy in which real -- not phony -- wealth is made.

Right now it is hurting. The finance sector has overwhelmed companies and households with debt -- which grows more expensive by the day -- and that's destructive.

The Cost of Debt

How can debt become more expensive, you ask? Interest rates seem low.

Here's how: because of a phenomenon very few of us have ever lived through, and even fewer (including orthodox economists) seem to understand: deflation.

Prices are falling. That is the prices of houses, stocks, goods and labor.

When prices, wages and salaries fall -- the cost and the value of debt rises. This is both because of deflation, and also because creditors -- i.e. the banks -- raise the price of debt (interest rates) to defray their own losses.

Think of it this way. The price of tomatoes in the market place can fall beneath the cost of growing those tomatoes. If tomato warehouses are filling up with tomatoes -- sellers run down stocks.

They sell below cost.

But the price of debt -- interest rates -- can never fall below zero. So if prices are minus 3% (i.e. deflation) and the Fed Funds Rate is zero, then the real rate of interest, i.e. the real cost of debt is 3%, not zero.

It is worse than that -- because very few pay the Fed Funds Rate on their overdraft; on their company loan; or on their mortgage.

Most pay interest rates set by Wall St .bankers -- or creditors.

So if the interest rate paid by a company is 15% -- then as deflation takes hold and prices fall to minus 3% the cost of their borrowing rises to 18%.

The US, like Japan in the 90s, is now experiencing deflation. Interest rates are actually rising, because creditors -- like those on Wall Street -- have literally run out of credit -- 'the credit crunch' -- and are trying to defray their losses.

Neither Fed Governor Ben Bernanke, Treasury Secretary Tim Geithner or the president seem to be paying attention to this phenomenon -- the rising cost and value of debt at a time that costly debt is bankrupting America's productive economy.

As our tomato-grower's loans and overdraft become unpayable -- he goes bust. Lays off his managers and workers. They have less money to buy tomatoes. Or pay their mortgages. Tomato prices fall further. They sell the house, another nail in the coffin of the housing market. And the spiral continues downwards.


The Fed and Treasury need to make a fresh start -- by bailing out debtors: homeowners, companies, local governments and individuals.

How to do this? In some cases debts will have to be written off. The fact that debts cannot be repaid will have to be faced. That is why we have bankruptcy laws.

But in many cases debtors -- good, productive companies and government departments that employ people, pay wages, grow the food we need, the goods we want, and provide vital services -- can be helped by dramatically lowering the cost of their debt.

This can be achieved by lowering interest rates -- across the board. Rates for short-term loans, long-term loans, safe loans and risky loans.

But most rates are fixed by Wall Street and other creditors -- not by the Fed.

If the Fed were to take control and bring these interest rates down -- and it has various 'technical' instruments for doing this including Quantitative Easing (buying up long-term Treasury bonds) -- then the productive economy could still be bailed out before deflation makes things much worse. But time is running out.

Right now the Fed is treating Wall Street with kid gloves. Allowing creditors to exercise their ferocious power. The power to fix -- and raise interest rates across the board -- when the United States is facing its biggest-ever debt crisis -and companies and individuals are bankrupted.

Wall Street in the meantime is bailed out.

Seems wrong to me.