Soros Backer: 'Widespread Moral Decline' Caused Debt Crisis

The Gnomes of Zurich were derogatory caricatures of secretive, greedy, stiff Swiss German bankers, pince-nez aquiver, who ruled over the land of secret numbered accounts for tax dodgers the world over.

With the world's best financial intelligence service, they knew their stuff and seldom spoke, even in retirement.

Their Geneva counterparts, in French-speaking Switzerland, were more sophisticated, relaxed in the company of global wheeler-dealers and weren't afraid to speak their minds, albeit off the record.

Such was George C. Karlweis, the brain behind Banque Privee, owned by the late Edmond de Rothschild. His biggest claim to fame: George Soros and the launch of his Quantum Fund in 1969.

An original $100,000 stake in Soros' fund was worth $150 million by 1994. Between 1970 and 2000, the return was 3,365 percent (for 10 consecutive years it did 42.6 percent per year). In 1992, Soros bet billions against the British pound — and broke the Bank of England ("Black Wednesday").

So the man behind Soros' original success is worth listening to today — unafraid to speak his mind in retirement.

The financial crises that have been blowing up for years are speeding up, Karlweis says, due to expenditure exceeding income, "borrowing hand over fist, even for no good reason, on ever shakier fundamentals."

"Everyone is realizing we have gone too far," he wrote, "The coffers are depleted . . . the excessive spending of the past has created a huge overhang, and no one knows how new borrowing can be financed."

People who live on their savings, adds Karlweis, "have been fleeced. Their investments yield nothing, chances are they have lost everything."

"Times ahead do not look pretty," he warns.

After turning their countries into Weimar Republics by printing more and more money, says Karlweis, "they will all need a currency commissioner like Hjalmar Schacht (German banker who headed Reichsbank and became an early Hitler supporter) to save them from hyperinflation.

"Let's just hope they don't turn their regimes into Third Reichs in the meantime."

"No one wants to predict the reactions of voters who constantly clamor for more bread and games to forget the looming disappointments that could give rise to black swans," adds the former giant gnome of Geneva.

Bear Stearns got a Triple A rating shortly before it went under, ditto Fannie Mae. Lehman Brothers made A2 before the shipwreck. The subprime mortgage scandal had gone global in the fall of 2008 as the new chairman of the Fed said "the worst is now behind us." Today, America's credit cards are all maxed out.

"Governments, public corporations, financial institutions, consumers — everyone is over their head in debt," says Karlweis. And "a huge part of the blame for the debacle of the past three years lies squarely with the U.S.

"By more or less shoving free trade down everyone's throat, America paved the way for globalization. This is what has destroyed jobs and driven down wages in the developed countries, hobbling economic growth and gouging tax revenues."

Karlweis argues: "It was a ridiculously low federal funds rate, reduced to 1 percent in the early 2000s, by former Fed Chairman Alan Greenspan, that opened the floodgates for subprime mortgages and the worst financial disaster ever, in 2007-08.

In 2007, the face value of securities backed by subprime mortgages was estimated at about $1 trillion. Karlweis says the total collateralized debt obligation and mortgages obligations issued "exceeded $7 trillion and the repercussions were devastating."

"Like a disease overrunning a body's already weakened defenses, subprime infected the entire global banking system. There were also many victims among small and medium-sized investors, even outside the United States," Karlweis says.

"Creative types even invented synthetic versions of subprime, with no underlying portfolio of mortgages, that guaranteed the same yields as the original junk," Karlweis' post-mortem says.

"These were earmarked for money managers who wanted to position themselves against subprime debt, namely by selling short to investors who were still lapping it up as a good bet" and this then generated a double commission for the investment bankers.

Where were the risk committees, credit committees, and others who should have taken the hour or two needed to read the prospectuses? "That and an ounce of common sense would have sufficed to see through Wall Street's slicing and packaging antics," he answers.

The bailout of Fannie Mae and Freddie Mac (also triple A before disaster hit) had what Karlweis calls "awesome consequences for America in particular."

The national debt leapt by about 50 percent to more than $14 trillion (excluding the debts of other "government-sponsored enterprises"). Next to America's net worth, estimated at $70 trillion, "that was an unsettling level," he argues.

Karlweis laments that "after a career in finance I look aghast on what has happened since the turn of the 21st century. The conclusion I have come to is that the present financial crisis was caused by, and is one of the most blatant manifestations of, widespread moral decline in our society."

The gnome-turned-sage says that "devoid of all common sense and consumed by greed, the big all-service banks led by Wall Street contrived a financial system that was nothing but a house of cards while adopting lending criteria based on equally flimsy mathematical hypotheses. Not that they cared; they unloaded their junk from their balance sheets onto duller players who snapped it up as a cash-flow booster, only to see it all go up in smoke later on."

At a minimum, Karlweis concludes, "we will need a full reinstatement of the Glass-Steagall Act (repealed in 1999), which made it impossible for a single legal entity to conduct or control all types of financial business."

This means institutions that receive deposits from the public must be clearly prohibited from speculating on their own behalf with the money of their depositors.