Steve Watson
Infowars.com
Full vote on transparency bill next month?
The House Oversight Committee approved a bill Wednesday introduced by Congressman Ron Paul that would see a full audit of the Federal Reserve for the first time in its history.
The bipartisan vote was almost completely unanimous in it’s favor of Federal Reserve Transparency Act, with no vocal opposition and the legislation will now advance to the floor of the House of Representatives next month.
If it is successful, the bill would require the Government Accountability Office (GAO) to conduct a top to bottom audit of the Fed’s board of governors and 12 regional banks, and reveal details of its private monetary policy deliberations.
The only opposition came from the ranking Democrat on the committee, Elijah Cummings (D-Md.), who attempted to introduce an amendment that would prevent the GAO from auditing the Fed’s discussions on monetary policy. Cummings withdrew the amendment after Chairman Darrell Issa (R-Calif.) noted that it “essentially guts this bill.”
Issa noted that “It is long past time for a real audit,” and was backed up by Rep. Justin Amash, who highlighted the deficiencies in the current system of monitoring the Federal Reserve’s secret actions:
Ron Paul has made an audit of the Fed a long term goal during his time in Congress.
After introducing his original audit the Fed bill in 2009, a watered down version was added to the Dodd-Frank financial reform law signed into law last year. However, much of Paul’s bill had been stripped away, and even the Congressman himself voted against the final bill.
However, the bill did allow for a rare one off audit of the Federal Reserve’s crisis-response emergency lending programs of 2008. In October of last year, in his role as chairman of the Domestic Monetary Policy subcommittee, Paul relished the glimmer of transparency and led the hearing into the GAO’s audit.
“More people now are starting to realize that the Fed isn’t independent of political independence because indirectly and some times more directly it is involved in political decisions or at least private decisions to serve some political interest.” Paul noted during the hearing last year.
Along with Paul, Republicans in attendance argued that the audit should pave the way for regular reviews of the Fed’s policies, as well as more complete disclosure of exactly who has received upwards of $27 trillion in bail out funds since 2008.
“Would it be much of a problem if we were doing this every year?” Paul asked.
Although the one time GAO audit was extremely limited in its scope, the report found several instances of conflicts of interest and questionable practices involving Fed officials. It was also revealed that the Fed made $16.1 trillion in secret loans to Wall Street firms at the height of the crisis.
The full audit the Fed bill would repeal specific limitations that were applicable to the previous one off audit of the Fed. Currently, any audits of the Board and Federal reserve banks may not include—
(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;
(2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations;
(3) transactions made under the direction of the Federal Open Market Committee; or
(4) a part of a discussion or communication among or between members of the Board and officers and employees of the Federal Reserve System related to clauses (1)–(3) of this subsection.
In order for the legislation to be signed into law, it will have to pass both Chambers of Congress. The Senate version of the bill, introduced by Paul’s son Rand (R-KY), has yet to be marked-up for debate.
In an emailed press release this morning, Sen. Paul said:
“Today, I applaud the unanimous passage of Audit the Fed out of committee and commend House leadership for promising a vote on Audit the Fed next month.”
“It is important that we get our economy growing again through savings and investment, not more debt and deficit spending. But we can’t turn the economy around until we fix the root of the problem: an unaccountable Federal Reserve. A complete and thorough audit of the Fed will finally allow the American people to know exactly how their money is being spent by Washington.” Sen. Paul continued.
“I have introduced similar legislation in the Senate and will continue to fight on the frontlines of this battle to get Audit the Fed passed through Congress,” he added.
Ron Paul has previously highlighted the importance of bringing full Transparency to the Federal Reserve, noting that it would pave the way for a return to sound monetary policy and help mark an end to the practices that have plunged the economy into deep crisis.
“The Federal Reserve behind the scenes has the power to create money out of thin air, I mean it’s absolutely bizarre. Never in the history of the world has any one single bank been given the power to create the reserve currency of the world like we have had since 1971. So yes, they can bailout their friends and let the people they don’t like fail, and create a trillion dollars or more out of thin air in order to prop up some companies at the expense of others, it’s not viable, it makes no sense.” Paul urged in a 2010 interview with CNBC.
“When the history of this time is written, people will say ‘how in the world did they believe that a few people in a secret room can decide what interest rates should be, how much the money supply should be, who should fail, what bad assets, what worthless assets the tax payers have to buy?’ it’s absolutely bizarre, yet the American people right now I think are waking up to it.”
Editor's Note: if you agreed, call your Representative and let them know
Thursday, June 28, 2012
JP Morgan: We Were Full Of Crap
by Karl Denninger
$2 billion eh? I said 20 when it was first announced, and maybe more. Now it looks like after several "revisions" (all higher) the current "estimate" is that it might be $9 billion.
Morgan Chase & Co. (JPM) fell more than 6 percent in European trading after the New York Times (NYT) reported the lender’s trading losses from credit derivatives may total as much as $9 billion, exceeding the firm’s initial estimate.
Exceed? By more than 400%, right?
Usually one would say that something "exceeded" an original estimate if it was 10 or 20% higher. What's 450%? I'd say that the original "estimate" was a complete load of crap, or if you prefer, a lie.
Of course the other alternative is that Dimon had absolutely no clue what the final exposure might be and simply pulled a number out of his ass. That wouldn't shock me either.
The stock is down a buck pre-market.
Disclosure: No position but if we were to ever see anyone held to account for this sort of crap I'd go long handcuffs, leg irons and iron maidens.
$2 billion eh? I said 20 when it was first announced, and maybe more. Now it looks like after several "revisions" (all higher) the current "estimate" is that it might be $9 billion.
Morgan Chase & Co. (JPM) fell more than 6 percent in European trading after the New York Times (NYT) reported the lender’s trading losses from credit derivatives may total as much as $9 billion, exceeding the firm’s initial estimate.
Exceed? By more than 400%, right?
Usually one would say that something "exceeded" an original estimate if it was 10 or 20% higher. What's 450%? I'd say that the original "estimate" was a complete load of crap, or if you prefer, a lie.
Of course the other alternative is that Dimon had absolutely no clue what the final exposure might be and simply pulled a number out of his ass. That wouldn't shock me either.
The stock is down a buck pre-market.
Disclosure: No position but if we were to ever see anyone held to account for this sort of crap I'd go long handcuffs, leg irons and iron maidens.
Liebor - No, It Was NOT Just Barclays
by Karl Denninger
market-ticker.org
No folks, it's not just one bank.
It appears it was basically all of them.
If you transacted in any loan that was tied to this rate at any time in the last several years, you probably got rooked, whether it was for pennies or thousands.
According to the WSJ:
Other banks that have disclosed they are under investigation include Citigroup Inc., C -2.77% HSBC Holdings HBC -3.88% PLC, J.P. Morgan Chase JPM -3.45% & Co., Lloyds Banking Group LLOY.LN -5.79% PLC and Royal Bank of Scotland Group PLC. None of these banks have been charged with any wrongdoing in the matter by U.S. or U.K. regulators.
Isn't that special? Why yes, it is.
Now if we could just see something approaching accountability.
But we won't, you know, just as we didn't when JP Morgan was involved in the disastrous Jefferson County Alabama scheme that landed several local folks in Alabama in prison on various corrupted-related charges.
The people -- who got screwed blind and sideways with permanently-larger sewer bills as a result of the corruption, got nothing back from the banksters -- they are still paying for the screwing they had inflicted on them.
I'm not one for vigilante justice, but one does have to wonder -- at what point do the people simply stop putting up with this crap?
market-ticker.org
No folks, it's not just one bank.
It appears it was basically all of them.
If you transacted in any loan that was tied to this rate at any time in the last several years, you probably got rooked, whether it was for pennies or thousands.
According to the WSJ:
Other banks that have disclosed they are under investigation include Citigroup Inc., C -2.77% HSBC Holdings HBC -3.88% PLC, J.P. Morgan Chase JPM -3.45% & Co., Lloyds Banking Group LLOY.LN -5.79% PLC and Royal Bank of Scotland Group PLC. None of these banks have been charged with any wrongdoing in the matter by U.S. or U.K. regulators.
Isn't that special? Why yes, it is.
Now if we could just see something approaching accountability.
But we won't, you know, just as we didn't when JP Morgan was involved in the disastrous Jefferson County Alabama scheme that landed several local folks in Alabama in prison on various corrupted-related charges.
The people -- who got screwed blind and sideways with permanently-larger sewer bills as a result of the corruption, got nothing back from the banksters -- they are still paying for the screwing they had inflicted on them.
I'm not one for vigilante justice, but one does have to wonder -- at what point do the people simply stop putting up with this crap?
Wednesday, June 27, 2012
Fiat Money Kills Productivity
From John Aziz of Azizonomics
I have long suspected that a money supply based on nothing other than faith in government is a productivity killer.
Last November I wrote:
During 1947-73 (for all but two of those years America had a gold standard where the unit of exchange was tied to gold at a fixed rate) average family income increased at a greater rate than that of the top 1%. From 1979-2007 (years without a gold standard) the top 1% did much, much better than the average family.
As we have seen with the quantitative easing program, the newly-printed money is directed to the rich. The Keynesian response to that might be that income growth inequality can be solved (or at least remedied) by making sure that helicopter drops of new money are done over the entire economy rather than directed solely to Wall Street megabanks.
But I think there is a deeper problem here. My hypothesis is that leaving the gold exchange standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by just pumping money into the system.
And now I have empirical evidence that my hypothesis has been true — total factor productivity.
In 2009 the Economist explained TFP as follows:
Productivity growth is perhaps the single most important gauge of an economy’s health. Nothing matters more for long-term living standards than improvements in the efficiency with which an economy combines capital and labour. Unfortunately, productivity growth is itself often inefficiently measured. Most analysts focus on labour productivity, which is usually calculated by dividing total output by the number of workers, or the number of hours worked.
A better gauge of an economy’s use of resources is “total factor productivity” (TFP), which tries to assess the efficiency with which both capital and labour are used.
Total factor productivity is calculated as the percentage increase in output that is not accounted for by changes in the volume of inputs of capital and labour. So if the capital stock and the workforce both rise by 2% and output rises by 3%, TFP goes up by 1%.
Here’s US total factor productivity:
Only a wilful and ideological Keynesian could ignore the salient detail: as soon as the USA left the gold exchange standard, total factor productivity began to dramatically stagnate.
Coincidence? I don’t think so — a fundamental change in the nature of the money supply coincided almost exactly with a fundamental change to the shape of the nation’s economy. Is the simultaneous outgrowth in income inequality a coincidence too?
Keynesians may respond that correlation does not necessarily imply causation, and though we do not know the exact causation, there are a couple of strong possibilities that may have strangled productivity:
1.Leaving the gold exchange standard was a free lunch for policymakers: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by just pumping money into the system.
2.Leaving the gold exchange standard was a free lunch for businesses: revenue growth could be achieved without any real gains in productivity, or efficiency.
And it’s not just total factor productivity that has been lower than in the years when America was on the gold exchange standard — as a Bank of England report recently found, GDP growth has averaged lower in the pure fiat money era (2.8% vs 1.8%), and financial crises have been more frequent in the non-gold-standard years.
The authors of the report noted:
Overall the gold standard appeared to perform reasonably well against its financial stability and allocative efficiency objectives.
Still think it’s a barbarous relic?
I have long suspected that a money supply based on nothing other than faith in government is a productivity killer.
Last November I wrote:
During 1947-73 (for all but two of those years America had a gold standard where the unit of exchange was tied to gold at a fixed rate) average family income increased at a greater rate than that of the top 1%. From 1979-2007 (years without a gold standard) the top 1% did much, much better than the average family.
As we have seen with the quantitative easing program, the newly-printed money is directed to the rich. The Keynesian response to that might be that income growth inequality can be solved (or at least remedied) by making sure that helicopter drops of new money are done over the entire economy rather than directed solely to Wall Street megabanks.
But I think there is a deeper problem here. My hypothesis is that leaving the gold exchange standard was a free lunch: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by just pumping money into the system.
And now I have empirical evidence that my hypothesis has been true — total factor productivity.
In 2009 the Economist explained TFP as follows:
Productivity growth is perhaps the single most important gauge of an economy’s health. Nothing matters more for long-term living standards than improvements in the efficiency with which an economy combines capital and labour. Unfortunately, productivity growth is itself often inefficiently measured. Most analysts focus on labour productivity, which is usually calculated by dividing total output by the number of workers, or the number of hours worked.
A better gauge of an economy’s use of resources is “total factor productivity” (TFP), which tries to assess the efficiency with which both capital and labour are used.
Total factor productivity is calculated as the percentage increase in output that is not accounted for by changes in the volume of inputs of capital and labour. So if the capital stock and the workforce both rise by 2% and output rises by 3%, TFP goes up by 1%.
Here’s US total factor productivity:
Only a wilful and ideological Keynesian could ignore the salient detail: as soon as the USA left the gold exchange standard, total factor productivity began to dramatically stagnate.
Coincidence? I don’t think so — a fundamental change in the nature of the money supply coincided almost exactly with a fundamental change to the shape of the nation’s economy. Is the simultaneous outgrowth in income inequality a coincidence too?
Keynesians may respond that correlation does not necessarily imply causation, and though we do not know the exact causation, there are a couple of strong possibilities that may have strangled productivity:
1.Leaving the gold exchange standard was a free lunch for policymakers: GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by just pumping money into the system.
2.Leaving the gold exchange standard was a free lunch for businesses: revenue growth could be achieved without any real gains in productivity, or efficiency.
And it’s not just total factor productivity that has been lower than in the years when America was on the gold exchange standard — as a Bank of England report recently found, GDP growth has averaged lower in the pure fiat money era (2.8% vs 1.8%), and financial crises have been more frequent in the non-gold-standard years.
The authors of the report noted:
Overall the gold standard appeared to perform reasonably well against its financial stability and allocative efficiency objectives.
Still think it’s a barbarous relic?
It's Ok To Manipulate Markets
by Karl Denninger
market-ticker.org
This sort of scam ought to lead to prison time. Instead, as has been the pattern, we find ourselves with tiny little wrist-slap fines and nothing more -- and the crooks get to keep the profits besides.
Barclays Plc (BARC), Britain’s second-biggest bank by assets, agreed to pay 290 million pounds ($452.3 million) in penalties to settle U.S. and U.K. probes into whether it sought to rig the London and euro interbank offered rates.
Barclays Chief Executive Officer Robert Diamond and other executives will forgo their bonuses as a result, the bank said in a statement.
“The events which gave rise to today’s resolutions relate to past actions which fell well short of the standards to which Barclays aspires in the conduct of its business,” Diamond said in the statement.
So it's perfectly ok to rig one of the biggest markets in the world -- on which hundreds of trillions of dollars of derivative contracts rest and where extremely tiny moves turn into monstrous profits (or losses) -- and just pay a tiny fine?
I thought corruption was actually illegal?
Employees responsible for Libor submissions have said in interviews with Bloomberg they regularly discussed where to set the measure with traders sitting near them, interdealer brokers and counterparts at rival banks. The talks became common practice after money markets froze in 2007, they said, making it difficult for individual bankers to gauge the cost of borrowing from other lenders.
The obvious answer to the question is that you can rig all the markets you want and steal all the money you want so long as you're a big bankster, and if you get caught -- just pay a tiny fine.
The obvious incentive to do this more often and with ever-larger amounts of money (which has to come from someone -- in this case it comes from the bank's customers and others in the market -- that ultimately means you and I!) should be clear to everyone.
Of course if you steal $50 from the corner Stop-N-Rob, now that deserves prison time.
market-ticker.org
This sort of scam ought to lead to prison time. Instead, as has been the pattern, we find ourselves with tiny little wrist-slap fines and nothing more -- and the crooks get to keep the profits besides.
Barclays Plc (BARC), Britain’s second-biggest bank by assets, agreed to pay 290 million pounds ($452.3 million) in penalties to settle U.S. and U.K. probes into whether it sought to rig the London and euro interbank offered rates.
Barclays Chief Executive Officer Robert Diamond and other executives will forgo their bonuses as a result, the bank said in a statement.
“The events which gave rise to today’s resolutions relate to past actions which fell well short of the standards to which Barclays aspires in the conduct of its business,” Diamond said in the statement.
So it's perfectly ok to rig one of the biggest markets in the world -- on which hundreds of trillions of dollars of derivative contracts rest and where extremely tiny moves turn into monstrous profits (or losses) -- and just pay a tiny fine?
I thought corruption was actually illegal?
Employees responsible for Libor submissions have said in interviews with Bloomberg they regularly discussed where to set the measure with traders sitting near them, interdealer brokers and counterparts at rival banks. The talks became common practice after money markets froze in 2007, they said, making it difficult for individual bankers to gauge the cost of borrowing from other lenders.
The obvious answer to the question is that you can rig all the markets you want and steal all the money you want so long as you're a big bankster, and if you get caught -- just pay a tiny fine.
The obvious incentive to do this more often and with ever-larger amounts of money (which has to come from someone -- in this case it comes from the bank's customers and others in the market -- that ultimately means you and I!) should be clear to everyone.
Of course if you steal $50 from the corner Stop-N-Rob, now that deserves prison time.
Breaking Up Big Banks Hard to Do as Market Forces Fail
By Christine Harper
Bloomberg
Seventeen years ago fund manager Michael F. Price spurred the merger of Chase Manhattan Corp. and Chemical Banking Corp., creating what was then the biggest U.S. bank and laying the foundation for JPMorgan (JPM) Chase & Co.
Now he has a new message: It’s time to break up.
The stocks of five of the six biggest U.S. banks -- JPMorgan, Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) -- are languishing at or below tangible book value. That means the pieces are worth more than the whole, Price said.
“Within the banks are wonderful assets,” said Price, who sold his fund-management company for $610 million in 1996 and now runs MFP Investors LLC in New York. “How long are the boards of directors going to stand by and take no action and let them be pounded? So far there’s no indication that any of these banks or boards of banks is willing to do anything about it.”
Politicians and regulators have resisted calls from some investors to split up conglomerates that were assembled over two decades by executives such as former Citigroup Chief Executive Officer Sanford “Sandy” Weill and former Bank of America CEO Ken Lewis. These universal banks offered customers everything from checking accounts and insurance to derivatives trading and merger advice. The 2008 financial crisis and subsequent performance of the companies is calling that into question.
Broken Model
Some investors, tired of unpredictable losses, costly regulation and legal headaches, have abandoned the banks in favor of more focused lenders such as Wells Fargo (WFC) & Co. and U.S. Bancorp. (USB) Bank of America has traded below book value since 2009, while New York-based Citigroup has done so since 2010, according to data compiled by Bloomberg.
“It is not clear why a bank needs to do lots of activities in financial services that aren’t banking,” Ken Fisher, CEO and founder of Woodside, California-based Fisher Investments, which manages about $44 billion, said in an interview. “It is not clear to me, other than perhaps in some very specialty cases, that being a bank helps you be an investment bank or an asset manager or an insurer.”
JPMorgan and Citigroup would be worth more broken up, David Trone, an analyst at JMP Securities LLC in New York, told Stephanie Ruhle and Erik Schatzker in a June 22 interview on Bloomberg Television’s Market Makers.
“The universal bank model is broken,” Trone said.
Getting Bigger
There’s little sign that market forces are changing the universal-banking strategy. Corporate raiders or potential takeovers don’t provide the same impetus for banks as they do in other industries. Laws prohibit non-financial firms from buying lenders, and banks can’t make purchases that give them more than 10 percent of U.S. deposits. JPMorgan, Bank of America and Wells Fargo were already at or above that level at the end of March, according to data from the Federal Reserve and the companies.
Some banks have gotten bigger since the financial crisis. The Fed, U.S. Treasury Department and other regulators supported JPMorgan’s purchase of Bear Stearns Cos. and Washington Mutual Inc. in 2008, as well as Bank of America’s acquisition of Countrywide Financial Corp. and Merrill Lynch & Co. JPMorgan’s balance sheet has increased 49 percent to $2.3 trillion since the end of 2007. Bank of America’s assets have grown 27 percent to $2.18 trillion in the same period.
Citigroup, the third-biggest bank by assets after JPMorgan and Bank of America, was given more federal aid during the crisis than any other U.S. bank. Its $1.94 trillion balance sheet is 11 percent smaller than at the end of 2007.
Bernanke, Geithner
After the crisis, policy makers, politicians and former bankers began calling for a breakup of too-big-to-fail banks. They’ve included former Citigroup co-CEO John Reed, U.S. Senator Sherrod Brown, an Ohio Democrat, former Federal Reserve Bank of Kansas City President Thomas Hoenig and Dallas Fed President Richard Fisher.
Morgan Stanley became the biggest U.S. securities firm in 1997, when it agreed to be acquired by Dean Witter, Discover & Co., a brokerage run at the time by Philip J. Purcell. Purcell, who oversaw the combined company until a revolt by some shareholders and former employees led to his departure in 2005, now thinks that breaking up the banks would be better for shareholders, according to an opinion piece in yesterday’s Wall Street Journal.
“The market is now discounting the stock prices of financial institutions with investment banking and trading,” Purcell wrote in the piece. “Breaking these companies into separate businesses would double to triple the shareholder value of each institution.”
‘More Valuable’
Former Fed Chairman Alan Greenspan, commenting at New York’s Council on Foreign Relations in October 2009, said he thought breaking up the banks might make them more valuable.
“In 1911, we broke up Standard Oil -- so what happened?” he said. “The individual parts became more valuable than the whole. Maybe that’s what we need to do.”
That wasn’t the course taken by Greenspan’s successor, Ben S. Bernanke, and Timothy F. Geithner, who led the New York Fed before President Barack Obama appointed him Treasury secretary. They supported legislation that allowed the banking conglomerates to remain intact and sought to address the risks of future collapse by requiring them to hold more capital, submit to new regulations and prepare living wills to help the government dismantle them in the case of a calamity.
Antitrust Concerns
The five biggest U.S. banks accounted for 52 percent of the industry’s assets in 2010, up from 17 percent in 1970, according to a report this year by the Dallas Fed. Four banks account for 93 percent of the notional derivatives holdings in the U.S. banking system, according to the Office of the Comptroller of the Currency. Wells Fargo, the fourth-biggest U.S. bank, made 33.9 percent of the mortgage loans originated in the first quarter, the highest share ever recorded and more than triple its closest competitor, according to Inside Mortgage Finance.
To Ira M. Millstein, a senior partner at New York law firm Weil Gotshal & Manges LLP and a veteran antitrust attorney, such statistics indicate that the Federal Trade Commission and the Justice Department should view banking conglomerates the same way the government once looked at Standard Oil -- as an anti- competitive oligopoly.
“This kind of size or concentration is something that antitrust always looks at,” Millstein said at a March 27 conference in New York on financial risk and regulation. Instead “we’re simply allowing regulators who missed the boat the first time to try again with even more regulation.”
JPMorgan Loss
When JPMorgan last month disclosed a $2 billion trading loss, it reignited concerns that a bank with $2.3 trillion of assets has too much risk for managers and regulators to monitor.
“I just don’t see how you manage those kinds of institutions effectively,” Gary Stern, a former Minneapolis Fed president, said at a June 14 Bloomberg Link conference in Boston. “But I think the responsibility for dealing with that is principally with the management and boards asking themselves: What businesses should we really be in?”
Price, Trone and other advocates for breaking up the biggest lenders cite new regulatory burdens, including Basel Committee on Banking Supervision capital requirements and the Dodd-Frank Act, as core threats to profitability.
“They worked well together in the old world,” said Price, 61, who forecast in August 1995 that the merged Chase and Chemical would become a $100 stock. Shares soared to more than $138 before splits in 1998 and 2000. “That was the analog world. This is the digital world.”
‘Uninvestable’ Stocks
Those regulatory constraints will become even tighter after the JPMorgan trading loss, according to Trone, who calls the biggest U.S. banks “uninvestable” because of new regulation and risks from the European sovereign-debt crisis. Dodd-Frank’s so-called Volcker rule, which restricts trading at deposit- taking banks, will be such a limitation on profits that “market forces” will lead companies to split off trading and investment banking from deposit-taking, Trone said.
That isn’t happening at two of the market’s worst performers: Charlotte, North Carolina-based Bank of America, with 278,688 employees as of the end of March, and New York- based Citigroup, with 263,000.
“Our customers need us to do this, and that’s why we do it,” Bank of America CEO Brian T. Moynihan, 52, told investors on a May 30 conference call to explain why his bank needs to be in consumer and corporate and investment banking. Vikram Pandit, Citigroup’s CEO, said the bank’s “central mission” over its 200-year history has been “to support economic progress.”
“We’re going to continue to serve our clients by putting our unique capabilities to work for them,” Pandit, 55, said in defending the bank’s model during an April 16 conference call.
Book Value
That hasn’t been serving shareholders. Over the past five years, those two stocks were the worst performers in the 24- company KBW Bank Index (BKX), dropping 84 percent and 95 percent, respectively. Bank of America is trading at 60 percent of its tangible book value, while Citigroup is at 52 percent, according to data compiled by Bloomberg. Tangible book value is the best estimate of what shareholders would get if all of the banks’ assets were sold and its liabilities paid off.
By contrast, a bank a fraction the size -- Minneapolis- based U.S. Bancorp, with $341 billion in assets -- chalked up the third-best performance in the KBW Bank Index and is trading at 2.6 times tangible book.
Weill, Dimon
JPMorgan, led by former Weill protege Jamie Dimon, 56, is trading at about tangible book value even after posting record profit for 2011. Wells Fargo, its smaller and more U.S.-centric competitor, is valued at 1.72 times tangible book.
“That’s a valid question, we should look at it,” Dimon, JPMorgan’s CEO, said at a Feb. 28 investor event when asked if the bank would be worth more broken up. “But I can’t imagine that the units of this company would perform better if they were parts of a much smaller company.”
Spokesmen for Bank of America, Morgan Stanley and Goldman Sachs declined to comment on whether their boards are considering breaking them up. A JPMorgan spokesman didn’t return calls seeking comment. Jon Diat, a spokesman at Citigroup, said in an e-mailed statement that the bank has been profitable for more than two years and that its presence in emerging markets and history of helping finance trade make it well-suited for today’s economy.
“We know what trends will define the global economy,” Diat wrote. “We have positioned our company to seize and capitalize on nearly all of them.”
Empire Building
Fisher, who said he has been underweight bank stocks compared with benchmark indexes for three years, sees another explanation for why banks stick to their model.
“The inherent nature of a lot of CEOs is to love empire building,” Fisher said. “The ones that love empire-building will do whatever he or she can to dissuade the board of directors” from breaking their companies up.”
High compensation for bank CEOs and their boards of directors is another reason they’re resistant to change, according to David Ellison, president of FBR Fund Advisors Inc. in Arlington, Virginia, and chief investment officer of FBR Equity Funds.
A pay package for Pandit that would have awarded him about $15 million for 2011, along with a retention plan that could be worth about $40 million, was opposed by shareholders this year in a non-binding advisory vote. Citigroup’s non-employee board members received between $56,250 and $625,000 in 2011, including a mix of cash and stock, according to the company’s proxy.
No Incentive
“The motivation is not there really,” Ellison said at the June Bloomberg Link conference. “They’re not going to do it unless they’re forced to do it.”
Managements and boards also are protected from market forces in ways they wouldn’t be at industrial conglomerates, said Amar Bhide, a professor at the Fletcher School of Law at Tufts University. Regulators won’t permit leveraged buyouts of banks, and the largest U.S. lenders are too large to be candidates for LBOs, he said.
“Unless somebody comes in and says, ‘Aha, this bank is trading so far below book value that I can come in and break it up and sell the pieces,’ what’s the incentive for the boards of directors?” Bhide said. “Banking is an industry where these things are simply not allowed.’”
Because regulators only allow banks to acquire banks, eventually some of the smaller lenders, perhaps supported by private-equity companies as shareholders, could attempt to acquire parts of the larger conglomerates, Fisher said.
Ant, Elephant
“The ant will swallow the elephant and disgorge the pieces,” Fisher said. Regulators are unlikely to balk at such a deal “if the avowed purpose is to set the bank to banking and the other pieces off on their own.”
In April 1995, when Price’s Heine Securities Corp. became Chase Manhattan’s biggest shareholder and said the bank’s stock wasn’t being properly valued, Chase took action. Its $10.9 billion merger with Chemical four months later created the biggest U.S. bank at the time, with almost $300 billion in assets. Price reaped a profit.
About 18 months ago, Price said on a Bloomberg Television interview with Tom Keene that New York-based Goldman Sachs should break itself into separate trading, banking and money- management businesses. Price said the parts could reward Goldman Sachs shareholders, whose stock was then worth about $162, with a value of $250 a share.
Goldman Sachs, with $951 billion of assets, closed yesterday in New York at $91.03, or about 74 percent of tangible book value. Greenhill & Co., which operates as a stand-alone investment bank, is valued by shareholders at more than six times tangible book value. Asset-management companies such as Legg Mason Inc. and Blackstone Group LP (BX) trade at more than six and four times tangible book, respectively.
“I talked about Goldman doing it, and Goldman doesn’t want to hear it,” Price said. “I’m just a small money manager now, so there’s nothing I can do. These are big banks now.”
Bloomberg
Seventeen years ago fund manager Michael F. Price spurred the merger of Chase Manhattan Corp. and Chemical Banking Corp., creating what was then the biggest U.S. bank and laying the foundation for JPMorgan (JPM) Chase & Co.
Now he has a new message: It’s time to break up.
The stocks of five of the six biggest U.S. banks -- JPMorgan, Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) -- are languishing at or below tangible book value. That means the pieces are worth more than the whole, Price said.
“Within the banks are wonderful assets,” said Price, who sold his fund-management company for $610 million in 1996 and now runs MFP Investors LLC in New York. “How long are the boards of directors going to stand by and take no action and let them be pounded? So far there’s no indication that any of these banks or boards of banks is willing to do anything about it.”
Politicians and regulators have resisted calls from some investors to split up conglomerates that were assembled over two decades by executives such as former Citigroup Chief Executive Officer Sanford “Sandy” Weill and former Bank of America CEO Ken Lewis. These universal banks offered customers everything from checking accounts and insurance to derivatives trading and merger advice. The 2008 financial crisis and subsequent performance of the companies is calling that into question.
Broken Model
Some investors, tired of unpredictable losses, costly regulation and legal headaches, have abandoned the banks in favor of more focused lenders such as Wells Fargo (WFC) & Co. and U.S. Bancorp. (USB) Bank of America has traded below book value since 2009, while New York-based Citigroup has done so since 2010, according to data compiled by Bloomberg.
“It is not clear why a bank needs to do lots of activities in financial services that aren’t banking,” Ken Fisher, CEO and founder of Woodside, California-based Fisher Investments, which manages about $44 billion, said in an interview. “It is not clear to me, other than perhaps in some very specialty cases, that being a bank helps you be an investment bank or an asset manager or an insurer.”
JPMorgan and Citigroup would be worth more broken up, David Trone, an analyst at JMP Securities LLC in New York, told Stephanie Ruhle and Erik Schatzker in a June 22 interview on Bloomberg Television’s Market Makers.
“The universal bank model is broken,” Trone said.
Getting Bigger
There’s little sign that market forces are changing the universal-banking strategy. Corporate raiders or potential takeovers don’t provide the same impetus for banks as they do in other industries. Laws prohibit non-financial firms from buying lenders, and banks can’t make purchases that give them more than 10 percent of U.S. deposits. JPMorgan, Bank of America and Wells Fargo were already at or above that level at the end of March, according to data from the Federal Reserve and the companies.
Some banks have gotten bigger since the financial crisis. The Fed, U.S. Treasury Department and other regulators supported JPMorgan’s purchase of Bear Stearns Cos. and Washington Mutual Inc. in 2008, as well as Bank of America’s acquisition of Countrywide Financial Corp. and Merrill Lynch & Co. JPMorgan’s balance sheet has increased 49 percent to $2.3 trillion since the end of 2007. Bank of America’s assets have grown 27 percent to $2.18 trillion in the same period.
Citigroup, the third-biggest bank by assets after JPMorgan and Bank of America, was given more federal aid during the crisis than any other U.S. bank. Its $1.94 trillion balance sheet is 11 percent smaller than at the end of 2007.
Bernanke, Geithner
After the crisis, policy makers, politicians and former bankers began calling for a breakup of too-big-to-fail banks. They’ve included former Citigroup co-CEO John Reed, U.S. Senator Sherrod Brown, an Ohio Democrat, former Federal Reserve Bank of Kansas City President Thomas Hoenig and Dallas Fed President Richard Fisher.
Morgan Stanley became the biggest U.S. securities firm in 1997, when it agreed to be acquired by Dean Witter, Discover & Co., a brokerage run at the time by Philip J. Purcell. Purcell, who oversaw the combined company until a revolt by some shareholders and former employees led to his departure in 2005, now thinks that breaking up the banks would be better for shareholders, according to an opinion piece in yesterday’s Wall Street Journal.
“The market is now discounting the stock prices of financial institutions with investment banking and trading,” Purcell wrote in the piece. “Breaking these companies into separate businesses would double to triple the shareholder value of each institution.”
‘More Valuable’
Former Fed Chairman Alan Greenspan, commenting at New York’s Council on Foreign Relations in October 2009, said he thought breaking up the banks might make them more valuable.
“In 1911, we broke up Standard Oil -- so what happened?” he said. “The individual parts became more valuable than the whole. Maybe that’s what we need to do.”
That wasn’t the course taken by Greenspan’s successor, Ben S. Bernanke, and Timothy F. Geithner, who led the New York Fed before President Barack Obama appointed him Treasury secretary. They supported legislation that allowed the banking conglomerates to remain intact and sought to address the risks of future collapse by requiring them to hold more capital, submit to new regulations and prepare living wills to help the government dismantle them in the case of a calamity.
Antitrust Concerns
The five biggest U.S. banks accounted for 52 percent of the industry’s assets in 2010, up from 17 percent in 1970, according to a report this year by the Dallas Fed. Four banks account for 93 percent of the notional derivatives holdings in the U.S. banking system, according to the Office of the Comptroller of the Currency. Wells Fargo, the fourth-biggest U.S. bank, made 33.9 percent of the mortgage loans originated in the first quarter, the highest share ever recorded and more than triple its closest competitor, according to Inside Mortgage Finance.
To Ira M. Millstein, a senior partner at New York law firm Weil Gotshal & Manges LLP and a veteran antitrust attorney, such statistics indicate that the Federal Trade Commission and the Justice Department should view banking conglomerates the same way the government once looked at Standard Oil -- as an anti- competitive oligopoly.
“This kind of size or concentration is something that antitrust always looks at,” Millstein said at a March 27 conference in New York on financial risk and regulation. Instead “we’re simply allowing regulators who missed the boat the first time to try again with even more regulation.”
JPMorgan Loss
When JPMorgan last month disclosed a $2 billion trading loss, it reignited concerns that a bank with $2.3 trillion of assets has too much risk for managers and regulators to monitor.
“I just don’t see how you manage those kinds of institutions effectively,” Gary Stern, a former Minneapolis Fed president, said at a June 14 Bloomberg Link conference in Boston. “But I think the responsibility for dealing with that is principally with the management and boards asking themselves: What businesses should we really be in?”
Price, Trone and other advocates for breaking up the biggest lenders cite new regulatory burdens, including Basel Committee on Banking Supervision capital requirements and the Dodd-Frank Act, as core threats to profitability.
“They worked well together in the old world,” said Price, 61, who forecast in August 1995 that the merged Chase and Chemical would become a $100 stock. Shares soared to more than $138 before splits in 1998 and 2000. “That was the analog world. This is the digital world.”
‘Uninvestable’ Stocks
Those regulatory constraints will become even tighter after the JPMorgan trading loss, according to Trone, who calls the biggest U.S. banks “uninvestable” because of new regulation and risks from the European sovereign-debt crisis. Dodd-Frank’s so-called Volcker rule, which restricts trading at deposit- taking banks, will be such a limitation on profits that “market forces” will lead companies to split off trading and investment banking from deposit-taking, Trone said.
That isn’t happening at two of the market’s worst performers: Charlotte, North Carolina-based Bank of America, with 278,688 employees as of the end of March, and New York- based Citigroup, with 263,000.
“Our customers need us to do this, and that’s why we do it,” Bank of America CEO Brian T. Moynihan, 52, told investors on a May 30 conference call to explain why his bank needs to be in consumer and corporate and investment banking. Vikram Pandit, Citigroup’s CEO, said the bank’s “central mission” over its 200-year history has been “to support economic progress.”
“We’re going to continue to serve our clients by putting our unique capabilities to work for them,” Pandit, 55, said in defending the bank’s model during an April 16 conference call.
Book Value
That hasn’t been serving shareholders. Over the past five years, those two stocks were the worst performers in the 24- company KBW Bank Index (BKX), dropping 84 percent and 95 percent, respectively. Bank of America is trading at 60 percent of its tangible book value, while Citigroup is at 52 percent, according to data compiled by Bloomberg. Tangible book value is the best estimate of what shareholders would get if all of the banks’ assets were sold and its liabilities paid off.
By contrast, a bank a fraction the size -- Minneapolis- based U.S. Bancorp, with $341 billion in assets -- chalked up the third-best performance in the KBW Bank Index and is trading at 2.6 times tangible book.
Weill, Dimon
JPMorgan, led by former Weill protege Jamie Dimon, 56, is trading at about tangible book value even after posting record profit for 2011. Wells Fargo, its smaller and more U.S.-centric competitor, is valued at 1.72 times tangible book.
“That’s a valid question, we should look at it,” Dimon, JPMorgan’s CEO, said at a Feb. 28 investor event when asked if the bank would be worth more broken up. “But I can’t imagine that the units of this company would perform better if they were parts of a much smaller company.”
Spokesmen for Bank of America, Morgan Stanley and Goldman Sachs declined to comment on whether their boards are considering breaking them up. A JPMorgan spokesman didn’t return calls seeking comment. Jon Diat, a spokesman at Citigroup, said in an e-mailed statement that the bank has been profitable for more than two years and that its presence in emerging markets and history of helping finance trade make it well-suited for today’s economy.
“We know what trends will define the global economy,” Diat wrote. “We have positioned our company to seize and capitalize on nearly all of them.”
Empire Building
Fisher, who said he has been underweight bank stocks compared with benchmark indexes for three years, sees another explanation for why banks stick to their model.
“The inherent nature of a lot of CEOs is to love empire building,” Fisher said. “The ones that love empire-building will do whatever he or she can to dissuade the board of directors” from breaking their companies up.”
High compensation for bank CEOs and their boards of directors is another reason they’re resistant to change, according to David Ellison, president of FBR Fund Advisors Inc. in Arlington, Virginia, and chief investment officer of FBR Equity Funds.
A pay package for Pandit that would have awarded him about $15 million for 2011, along with a retention plan that could be worth about $40 million, was opposed by shareholders this year in a non-binding advisory vote. Citigroup’s non-employee board members received between $56,250 and $625,000 in 2011, including a mix of cash and stock, according to the company’s proxy.
No Incentive
“The motivation is not there really,” Ellison said at the June Bloomberg Link conference. “They’re not going to do it unless they’re forced to do it.”
Managements and boards also are protected from market forces in ways they wouldn’t be at industrial conglomerates, said Amar Bhide, a professor at the Fletcher School of Law at Tufts University. Regulators won’t permit leveraged buyouts of banks, and the largest U.S. lenders are too large to be candidates for LBOs, he said.
“Unless somebody comes in and says, ‘Aha, this bank is trading so far below book value that I can come in and break it up and sell the pieces,’ what’s the incentive for the boards of directors?” Bhide said. “Banking is an industry where these things are simply not allowed.’”
Because regulators only allow banks to acquire banks, eventually some of the smaller lenders, perhaps supported by private-equity companies as shareholders, could attempt to acquire parts of the larger conglomerates, Fisher said.
Ant, Elephant
“The ant will swallow the elephant and disgorge the pieces,” Fisher said. Regulators are unlikely to balk at such a deal “if the avowed purpose is to set the bank to banking and the other pieces off on their own.”
In April 1995, when Price’s Heine Securities Corp. became Chase Manhattan’s biggest shareholder and said the bank’s stock wasn’t being properly valued, Chase took action. Its $10.9 billion merger with Chemical four months later created the biggest U.S. bank at the time, with almost $300 billion in assets. Price reaped a profit.
About 18 months ago, Price said on a Bloomberg Television interview with Tom Keene that New York-based Goldman Sachs should break itself into separate trading, banking and money- management businesses. Price said the parts could reward Goldman Sachs shareholders, whose stock was then worth about $162, with a value of $250 a share.
Goldman Sachs, with $951 billion of assets, closed yesterday in New York at $91.03, or about 74 percent of tangible book value. Greenhill & Co., which operates as a stand-alone investment bank, is valued by shareholders at more than six times tangible book value. Asset-management companies such as Legg Mason Inc. and Blackstone Group LP (BX) trade at more than six and four times tangible book, respectively.
“I talked about Goldman doing it, and Goldman doesn’t want to hear it,” Price said. “I’m just a small money manager now, so there’s nothing I can do. These are big banks now.”
Save the Euro? Who for?
By
http://www.opendemocracy.net/freeform-tags/writing-on-wall-for-eurozone
The strongest force holding the Euro together is the political force of creditors. Were the currency to collapse, much of the debt would collapse with it. So the question is, who are we saving the Euro for?
Once again, George Soros exhorts European leaders to save the Euro. But what does this curious phrase ‘Save the Euro’ actually mean?
The Euro is not like the Giant Panda: a cuddly creature that ornaments our world. The Euro is not one thing. It is different things to different groups. It’s a currency used in day to day transactions by people who live in a group of semi-sovereign nations. It is part of the underpinning of the European political experiment we call the EU. It is a settlement currency which rivals the Dollar. As such it is part of Europe’s challenge to American hegemony both financial and political. It is the currency in which a huge amount of wealth is denominated. And last but by absolutely no means least it is one of the global currencies in which a truly titanic amount of private and sovereign debt is denominated.
So when George Soros and various politicians and bankers insist on exhorting us to ‘Save the Euro’ might it not be helpful if they could at least be clear what exactly they have in mind to be saved, who will benefit if it is, who will lose if it isn’t and who will pay either way?
One question we could ask about the Euro is what exactly will be lost if the Euro were not ‘saved’? Funnily enough, given all the Chicken Little hyperventilating and shrieking of our political class about the end of civilization should the Euro collapse, nations do not depend on the euro. Certainly they would be disrupted and there would be widespread suffering if their currency collapsed. One look at Germany between the wars makes that clear. But it also makes rather clear that nations and their people continue on.
It’s an interesting thing about currencies, that because we use them to buy things day to day and get paid in them, we equate currencies with wealth. But when talking about a nation of people, a political and cultural entity,
it turns out that the wealth of nations will not be lost if the euro dies. But their debts could well be. And this, I think, is a clue to the panic that emerges – in certain quarters – when default or collapse of the euro is mentioned. It is also one fairly simple thing amidst all the confusion and intimations of doom.
Currencies do not create wealth they merely denote it and allow its exchange. On the other hand, debt actually depends on the currency in which the debt contract is written. Wealth comes from productive activities. Debt comes from honouring an agreement to pay someone an agreed amount. Wealth creation carries on after a currency collapses and soon enough a new currency takes over the job of conveying arbitrary units of the wealth created. Again please see Germany or any other nation – and there are many – who have defaulted or whose currency has collapsed. Debt, however, either does not survive the death of the currency in which it was agreed or does so as a fragment of its former worth.
It is a troubling aspect of our present financial and political situation that there has been a tendency, I would say a deliberate desire, to confuse wealth with debt; to present them as flip sides of each other when they are, in fact, entirely different. Why should this be? Well it might be because much of Mr Soros’ wealth, the wealth of the institutions he owns shares in, the wealth of banks and other financial institutions and the wealth of those who own and run them, is tied up in debt agreements of one kind or another. Your wealth and mine is probably in sovereign issued ‘money’. Most of us don’t have investments. Many don’t have savings to speak of. The wealth of the top 10%, on the other hand, is tied up in debt of one kind or another.
Since the advent of securitization, that process whereby debts can circulate as a form of currency, which can be used as collateral for issuing loans and can be counted as capital, debt has become a larger repository of wealth than sovereign currencies. Why do you think no one talks about the money supply the way they did in the 80’s? Governments do not control the money supply. The issuers of private debt control it.
This may seem an odd claim, but the amount of debt issued by private banks denominated in euros, dollars, yen and Yuan, is far greater than the amount of those currencies issued by the sovereign nations. Derivative agreements denominated in sovereign currencies run to the tens if not hundreds of trillions.
Were the debt backed currency in which those private debt agreements are denominated to collapse, then those agreements would be worth very little, if anything. They would be like finding a parchment of a debt owed in golden pazoozas from a long lost kingdom. Good luck cashing it.
I suggest that it is not a concern for the people of Greece, Spain or indeed any of the people’s of Europe that fuels concerns among the banks and the super wealthy about the Euro and its future. If the Euro were to evaporate what would happen to all of their wealth that is tied to debt agreements denominated in Euros?
Now of course people will argue that were the euro to collapse then Greece or Spain would be thrown into the street, so to speak, with nothing in their pockets and no one would lend them a dime for their daily bread. On a larger scale it is argued that civilization would become paralyzed were the Euro to go bust.
Let’s get a few things straight. First, Europe is one of the three largest economic entities in the world. If we think JP Morgan is too big to fail, what do you think that makes Europe?
If any nation were to be ejected from the Euro it would survive. The fate of the Euro and the wider European Political experiment would be more drawn out. The country involved would issue its own currency and yes it would find it difficult to borrow. But then again as a sovereign nation with its own currency it would, once again, be able to do what neither Greece nor Spain nor Ireland can currently do: print. Would its newly minted currency become instantly worthless? No, of course not. Would it be worth less than the Euro? Yes.
The nation with its new currency would find it was less able to borrow and that imports would be expensive. On the other hand exports would be cheaper by far. And the currency it would print would allow its citizens to continue to carry tokens of their productive labour around with them and exchange them with other citizens. Greece should take a look at Iceland.
I think the fall out would be more profound for the remaining Euro zone than it would be for the ejected country. For a start if one country goes it is quite likely others would follow. If any of them had any sense they would make common cause and find themselves part of another grouping who would not be as powerless as our present leaders would have us and them believe.
Although that is a large statement to make I feel it justified because the nation involved would still be able to produce wealth. What is more it would do so without the crushing burden of its debts. Many of those would have gone much like a fart does in a healthy breeze.
It is worth remembering that there is international precedent for debt commissions to look at a nation’s debts and dismiss those found to be odious. The idea of a debt commission was in fact discussed by the US government as a way of helping in the ‘liberation’ of Iraq. The discussions only stalled, it is said, when it was pointed out that many of the odious debts were held by US banks.
But what about the remaining Euro countries and the European Union project? Could it survive the exit of one or more of its members?
According to John Mauldin in his article, “The Bang! Moment is now”,
Europe is down to two choices. Either allow the eurozone to break up or go for a full fiscal union with central budget controls.
I agree those are two possible choices, but I think he is wrong to declare they are the only two.
This crisis is not about which countries leave the Euro or which countries default on their debt, it is about which countries remain in the Euro but continue to bail out the bad private debts of their banks. If our leaders insist on saving the private debts in the private banks within the Euro system then it will break apart.
It is too easy to become transfixed by Greece and its public debts. Spain is far larger and its problems are private debts not public ones. The same is true for Belgium, Ireland and Cyprus. Sure the private debts have been made public but such debts can and should be repudiated and thereby thrown back on to the private parties who were stupid and feckless enough to make the bad loan agreements in the first place.
On the charade of national agency, Tony Crurzon Price, Argues that,
The game is up not because Europe has won, but because the powerlessness of the nation is being revealed. Watch Rajoy, Hollande, Merkel, Holande, Tsipras and more trip form crisis to crisis as they try to wear the myth of power to the very end.
I agree this crisis has shown the powerlessness of the nation. But for me it is powerlessness not in the face of Europe but in the face of international finance. And the powerlessness is not so much financial as political.
There is simply no political will to force the losses to be taken by those who made them. But this, we are told, we cannot do. We can. We put men on the moon and brought them home again. It is not beyond us to close insolvent banks and open new ones. We need a banking system. But it does not have to be made up of the banks, the insolvent banks, that we currently are crippling ourselves trying to ‘save’.
Would this destroy the Euro? It might. It would certainly destroy much debt backed wealth that is currently held by the wealthiest 1% and is on the balance sheets of Europe’s largest banks. And of course if any nation did leave the Euro then those banks holding their sovereign euro debts might have a hard time collecting those too.
The Bundesbank could find itself holding agreements under Europe’s Target2 agreement, whereby central banks hold IOU’s from other central banks and nations, amounting to over €600 billion in a currency that no longer existed. That alone is reason to expect that the Euro will survive in some form.
Of course this is just one aspect of a complicated situation. I understand that. But I think in a world where it suits some to have as much confusion as possible and for economic matters, especially concerning their wealth and our debts, to be presented as being too complicated for us ‘little people’ to follow, let alone have an opinion about, it is important to sometimes hold on to certain simple facts. Like a torch on a dark night, even though they leave most things still shrouded in darkness, they do at least illuminate a way forward.
Our present crisis is one of democracy even more than it is of finance. It is about a lack of honesty as much as it is a lack of growth. Debt and dishonesty are together strangling European democracy.
We should rid ourselves of both.
http://www.opendemocracy.net/freeform-tags/writing-on-wall-for-eurozone
The strongest force holding the Euro together is the political force of creditors. Were the currency to collapse, much of the debt would collapse with it. So the question is, who are we saving the Euro for?
Once again, George Soros exhorts European leaders to save the Euro. But what does this curious phrase ‘Save the Euro’ actually mean?
The Euro is not like the Giant Panda: a cuddly creature that ornaments our world. The Euro is not one thing. It is different things to different groups. It’s a currency used in day to day transactions by people who live in a group of semi-sovereign nations. It is part of the underpinning of the European political experiment we call the EU. It is a settlement currency which rivals the Dollar. As such it is part of Europe’s challenge to American hegemony both financial and political. It is the currency in which a huge amount of wealth is denominated. And last but by absolutely no means least it is one of the global currencies in which a truly titanic amount of private and sovereign debt is denominated.
So when George Soros and various politicians and bankers insist on exhorting us to ‘Save the Euro’ might it not be helpful if they could at least be clear what exactly they have in mind to be saved, who will benefit if it is, who will lose if it isn’t and who will pay either way?
One question we could ask about the Euro is what exactly will be lost if the Euro were not ‘saved’? Funnily enough, given all the Chicken Little hyperventilating and shrieking of our political class about the end of civilization should the Euro collapse, nations do not depend on the euro. Certainly they would be disrupted and there would be widespread suffering if their currency collapsed. One look at Germany between the wars makes that clear. But it also makes rather clear that nations and their people continue on.
It’s an interesting thing about currencies, that because we use them to buy things day to day and get paid in them, we equate currencies with wealth. But when talking about a nation of people, a political and cultural entity,
it turns out that the wealth of nations will not be lost if the euro dies. But their debts could well be. And this, I think, is a clue to the panic that emerges – in certain quarters – when default or collapse of the euro is mentioned. It is also one fairly simple thing amidst all the confusion and intimations of doom.
Currencies do not create wealth they merely denote it and allow its exchange. On the other hand, debt actually depends on the currency in which the debt contract is written. Wealth comes from productive activities. Debt comes from honouring an agreement to pay someone an agreed amount. Wealth creation carries on after a currency collapses and soon enough a new currency takes over the job of conveying arbitrary units of the wealth created. Again please see Germany or any other nation – and there are many – who have defaulted or whose currency has collapsed. Debt, however, either does not survive the death of the currency in which it was agreed or does so as a fragment of its former worth.
It is a troubling aspect of our present financial and political situation that there has been a tendency, I would say a deliberate desire, to confuse wealth with debt; to present them as flip sides of each other when they are, in fact, entirely different. Why should this be? Well it might be because much of Mr Soros’ wealth, the wealth of the institutions he owns shares in, the wealth of banks and other financial institutions and the wealth of those who own and run them, is tied up in debt agreements of one kind or another. Your wealth and mine is probably in sovereign issued ‘money’. Most of us don’t have investments. Many don’t have savings to speak of. The wealth of the top 10%, on the other hand, is tied up in debt of one kind or another.
Since the advent of securitization, that process whereby debts can circulate as a form of currency, which can be used as collateral for issuing loans and can be counted as capital, debt has become a larger repository of wealth than sovereign currencies. Why do you think no one talks about the money supply the way they did in the 80’s? Governments do not control the money supply. The issuers of private debt control it.
This may seem an odd claim, but the amount of debt issued by private banks denominated in euros, dollars, yen and Yuan, is far greater than the amount of those currencies issued by the sovereign nations. Derivative agreements denominated in sovereign currencies run to the tens if not hundreds of trillions.
Were the debt backed currency in which those private debt agreements are denominated to collapse, then those agreements would be worth very little, if anything. They would be like finding a parchment of a debt owed in golden pazoozas from a long lost kingdom. Good luck cashing it.
I suggest that it is not a concern for the people of Greece, Spain or indeed any of the people’s of Europe that fuels concerns among the banks and the super wealthy about the Euro and its future. If the Euro were to evaporate what would happen to all of their wealth that is tied to debt agreements denominated in Euros?
Now of course people will argue that were the euro to collapse then Greece or Spain would be thrown into the street, so to speak, with nothing in their pockets and no one would lend them a dime for their daily bread. On a larger scale it is argued that civilization would become paralyzed were the Euro to go bust.
Let’s get a few things straight. First, Europe is one of the three largest economic entities in the world. If we think JP Morgan is too big to fail, what do you think that makes Europe?
If any nation were to be ejected from the Euro it would survive. The fate of the Euro and the wider European Political experiment would be more drawn out. The country involved would issue its own currency and yes it would find it difficult to borrow. But then again as a sovereign nation with its own currency it would, once again, be able to do what neither Greece nor Spain nor Ireland can currently do: print. Would its newly minted currency become instantly worthless? No, of course not. Would it be worth less than the Euro? Yes.
The nation with its new currency would find it was less able to borrow and that imports would be expensive. On the other hand exports would be cheaper by far. And the currency it would print would allow its citizens to continue to carry tokens of their productive labour around with them and exchange them with other citizens. Greece should take a look at Iceland.
I think the fall out would be more profound for the remaining Euro zone than it would be for the ejected country. For a start if one country goes it is quite likely others would follow. If any of them had any sense they would make common cause and find themselves part of another grouping who would not be as powerless as our present leaders would have us and them believe.
Although that is a large statement to make I feel it justified because the nation involved would still be able to produce wealth. What is more it would do so without the crushing burden of its debts. Many of those would have gone much like a fart does in a healthy breeze.
It is worth remembering that there is international precedent for debt commissions to look at a nation’s debts and dismiss those found to be odious. The idea of a debt commission was in fact discussed by the US government as a way of helping in the ‘liberation’ of Iraq. The discussions only stalled, it is said, when it was pointed out that many of the odious debts were held by US banks.
But what about the remaining Euro countries and the European Union project? Could it survive the exit of one or more of its members?
According to John Mauldin in his article, “The Bang! Moment is now”,
Europe is down to two choices. Either allow the eurozone to break up or go for a full fiscal union with central budget controls.
I agree those are two possible choices, but I think he is wrong to declare they are the only two.
This crisis is not about which countries leave the Euro or which countries default on their debt, it is about which countries remain in the Euro but continue to bail out the bad private debts of their banks. If our leaders insist on saving the private debts in the private banks within the Euro system then it will break apart.
It is too easy to become transfixed by Greece and its public debts. Spain is far larger and its problems are private debts not public ones. The same is true for Belgium, Ireland and Cyprus. Sure the private debts have been made public but such debts can and should be repudiated and thereby thrown back on to the private parties who were stupid and feckless enough to make the bad loan agreements in the first place.
On the charade of national agency, Tony Crurzon Price, Argues that,
The game is up not because Europe has won, but because the powerlessness of the nation is being revealed. Watch Rajoy, Hollande, Merkel, Holande, Tsipras and more trip form crisis to crisis as they try to wear the myth of power to the very end.
I agree this crisis has shown the powerlessness of the nation. But for me it is powerlessness not in the face of Europe but in the face of international finance. And the powerlessness is not so much financial as political.
There is simply no political will to force the losses to be taken by those who made them. But this, we are told, we cannot do. We can. We put men on the moon and brought them home again. It is not beyond us to close insolvent banks and open new ones. We need a banking system. But it does not have to be made up of the banks, the insolvent banks, that we currently are crippling ourselves trying to ‘save’.
Would this destroy the Euro? It might. It would certainly destroy much debt backed wealth that is currently held by the wealthiest 1% and is on the balance sheets of Europe’s largest banks. And of course if any nation did leave the Euro then those banks holding their sovereign euro debts might have a hard time collecting those too.
The Bundesbank could find itself holding agreements under Europe’s Target2 agreement, whereby central banks hold IOU’s from other central banks and nations, amounting to over €600 billion in a currency that no longer existed. That alone is reason to expect that the Euro will survive in some form.
Of course this is just one aspect of a complicated situation. I understand that. But I think in a world where it suits some to have as much confusion as possible and for economic matters, especially concerning their wealth and our debts, to be presented as being too complicated for us ‘little people’ to follow, let alone have an opinion about, it is important to sometimes hold on to certain simple facts. Like a torch on a dark night, even though they leave most things still shrouded in darkness, they do at least illuminate a way forward.
Our present crisis is one of democracy even more than it is of finance. It is about a lack of honesty as much as it is a lack of growth. Debt and dishonesty are together strangling European democracy.
We should rid ourselves of both.
Monday, June 25, 2012
Time to Take off the Blinders about Obama Taking off the Gloves
By William K. Black
On June 13, 2011, the New York Times wrote an exasperated editorial entitled “Nearly a Year After Dodd-Frank.” It began by warning that:
Without strong leaders at the top of the nation’s financial regulatory agencies, the Dodd-Frank financial reform doesn’t have a chance. Whether it is protecting consumers against abusive lending, reforming the mortgage market or reining in too-big-to-fail banks, all require tough and experienced regulators.
The editorial ended with this sentence: “It’s past time for President Obama to take off the gloves.”
It’s been nearly two years since the passage of the Dodd-Frank Act. A year ago, it was indeed “past time” for President Obama “to take off the gloves.” Today, if anyone still believes that President Obama ever desired to “take off the gloves” it is past time to take off the blinders and see the reality of crony capitalism. The international competition in laxity in financial regulation continues, but the domestic competition in regulatory laxity is between the Republicans and Democrats. It was on display at the Senate hearing on JPMorgan’s losses which morphed into an assault on Dodd-Frank and regulation and represented such a nadir in congressional oversight that the American Banker – the trade press – slammed the Senators’ competition in sycophancy towards Jamie Dimon as “obsequious.”
The first action that the NYT was urging the administration to take was to criticize publicly the Republican’s blockage of the appointment of financial regulatory leaders. (Republican readers: consider for a moment what the Republican Party would have done had a Democratic Senate minority used the filibuster to block the nomination by a Republican President of a Nobel prize winning economist to the Board of Governors of the Federal Reserve – on the purported grounds that he lacked economic competence.) The editorial noted that President Obama had selected Martin J. Gruenberg to head the FDIC. A year later, Gruenberg remains an “acting” head of the FDIC. Gruenberg is a lawyer and long-time congressional aide to former Senator Sarbanes. No one seriously thinks he will “take off the gloves” and lead the vital transformations of the banking industry.
The editorial also supported Thomas Curry, Obama’s choice as head of the Office of the Comptroller of the Currency (OCC) and the appointment of Elizabeth Warren to run the Consumer Financial Protection Bureau. President Obama refused to appoint Warren because of industry opposition. Curry is a lawyer and the rare professional regulator. He has a long career as a senior state banking regulator for Massachusetts and has served as an FDIC Director since January 2004. That means, however, that he was in a position of power during the developing crisis – and took no effective action to prevent or limit the crisis. I know of no evidence that he protested the FDIC’s disastrous MERIT examination system, which crippled FDIC examination or fought publicly to prevent the evisceration of the agency by personnel cuts. He was in a position of power when the FBI warned in September 2004 that there was an “epidemic” of mortgage fraud that would cause a financial “crisis” if it were not contained. He was in a position of power when the mortgage industry’s own anti-fraud unit (MARI) warned that liar’s loans were “an open invitation to fraudsters” and had a fraud incidence of 90 percent. I know of no evidence that he warned of the coming catastrophe and pushed to take emergency action against the raging epidemic of mortgage fraud.
The FDIC regulates smaller banks. It had the strongest regulatory leader during the crisis (Sheila Bair). Though she had far more power than Curry, she did not take off the gloves and protect the nation from the fraudulent lenders. The FDIC has the strongest regulatory tradition. The OCC, by contrast, regulates the largest (national) banks. The OCC, the Federal Reserve, and the late Office of Thrift Supervision (OTS) all disgraced themselves during the crisis as virulent anti-regulators. In particular, the OCC viewed financial derivatives with great favor and opposed adoption of the Volcker rule. The OCC was the most aggressive opponent of state regulation and enforcement against predatory and fraudulent lenders through preemption. Curry, therefore, faced an exceptionally difficult task if he intended to clean house at the OCC and turn the agency into a leading part of the solution instead of a major contributor to the problem.
Curry, therefore, was exceptionally unlikely to “take of the gloves” and get in a bare knuckled brawl with the industry. There was no realistic prospect that he would remove the fraudulent CEOs from office, take on the systemically dangerous institutions (SDIs) treated as “too big to fail,” crack down on speculation in derivatives, conduct vigorous investigations of the frauds and unsafe and unsound practices, and make the necessary criminal referrals.
Regulatory “cops on the beat” are essential for honest financial markets in large economies. When cheaters gain a competitive advantage markets become perverse. A Gresham’s dynamic causes bad ethics to drive good ethics out of the market. Crony capitalism creates the illusion of free markets and competition, but is actually a massive extraction of “rents” in favor of the officers that control the favored firms and their political and business cronies. JPMorgan, and the other SDIs, are the new Fannie Maes.
Any serious effort by the administration to “take off the gloves” would require a replacement for Attorney General Holder. The nation’s chief law enforcement officer has been missing in action when it comes to the elite frauds that drove the fraud epidemic and the resultant financial crisis and Great Recession. Choosing new financial regulatory leaders for the SEC, OCC, and the FDIC willing to take off the gloves and transform the financial industry to end the increasingly criminogenic environments that drive our recurrent, intensifying crises is essential. Regulators, however, cannot prosecute and Holder has shown that he will not take off the gloves when it comes to the elites that drove the crisis.
We also must not forget the destructive role that Timothy Geithner plays in the Obama administration. He is the man who failed catastrophically as a regulator when he was President of the Federal Reserve Bank of New York. Obama’s elevation of this failure to be his principal economic leader and advisor signaled that Obama had no desire to take off the gloves, end the criminogenic environment, and hold the elite frauds accountable. Instead, Geithner has claimed that we must not prosecute, or even investigate the elite frauds lest they destroy the economy. It is vain to debate whether Geithner’s doctrine of impunity for elite bankers is more disturbing as a matter of practicality or ethics because it fails utterly on both dimensions.
The quaint aspect of the NYT editorial is that the editors still hoped in mid-2011 that the problem was that Obama wanted to take the gloves off and take on the elite frauds, but was blocked by Republicans from doing so. Had they editorial writers considered the significance of Obama choosing Larry Summers, Holder, and Geithner (and reappointing Bernanke) – all great supporters of the financial elites and opponents of effective financial regulation – they could not have written such a naïve piece. A year later, nearly two years after the Dodd-Frank bill was adopted by Congress, there is no chance that the NYT would write an editorial premised on the implicit assumption that Obama wants to “take the gloves off” and knock out the elite bank frauds. No one thinks that either political party has any desire to take the gloves off and go after the elite bank frauds. Crony capitalism is our only truly bipartisan policy. It typically wins by a TKO because there is no opponent in its weight class willing to answer the bell and come out of the corner to fight. No politician wants to fight his or her leading source of political contributions.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
On June 13, 2011, the New York Times wrote an exasperated editorial entitled “Nearly a Year After Dodd-Frank.” It began by warning that:
Without strong leaders at the top of the nation’s financial regulatory agencies, the Dodd-Frank financial reform doesn’t have a chance. Whether it is protecting consumers against abusive lending, reforming the mortgage market or reining in too-big-to-fail banks, all require tough and experienced regulators.
The editorial ended with this sentence: “It’s past time for President Obama to take off the gloves.”
It’s been nearly two years since the passage of the Dodd-Frank Act. A year ago, it was indeed “past time” for President Obama “to take off the gloves.” Today, if anyone still believes that President Obama ever desired to “take off the gloves” it is past time to take off the blinders and see the reality of crony capitalism. The international competition in laxity in financial regulation continues, but the domestic competition in regulatory laxity is between the Republicans and Democrats. It was on display at the Senate hearing on JPMorgan’s losses which morphed into an assault on Dodd-Frank and regulation and represented such a nadir in congressional oversight that the American Banker – the trade press – slammed the Senators’ competition in sycophancy towards Jamie Dimon as “obsequious.”
The first action that the NYT was urging the administration to take was to criticize publicly the Republican’s blockage of the appointment of financial regulatory leaders. (Republican readers: consider for a moment what the Republican Party would have done had a Democratic Senate minority used the filibuster to block the nomination by a Republican President of a Nobel prize winning economist to the Board of Governors of the Federal Reserve – on the purported grounds that he lacked economic competence.) The editorial noted that President Obama had selected Martin J. Gruenberg to head the FDIC. A year later, Gruenberg remains an “acting” head of the FDIC. Gruenberg is a lawyer and long-time congressional aide to former Senator Sarbanes. No one seriously thinks he will “take off the gloves” and lead the vital transformations of the banking industry.
The editorial also supported Thomas Curry, Obama’s choice as head of the Office of the Comptroller of the Currency (OCC) and the appointment of Elizabeth Warren to run the Consumer Financial Protection Bureau. President Obama refused to appoint Warren because of industry opposition. Curry is a lawyer and the rare professional regulator. He has a long career as a senior state banking regulator for Massachusetts and has served as an FDIC Director since January 2004. That means, however, that he was in a position of power during the developing crisis – and took no effective action to prevent or limit the crisis. I know of no evidence that he protested the FDIC’s disastrous MERIT examination system, which crippled FDIC examination or fought publicly to prevent the evisceration of the agency by personnel cuts. He was in a position of power when the FBI warned in September 2004 that there was an “epidemic” of mortgage fraud that would cause a financial “crisis” if it were not contained. He was in a position of power when the mortgage industry’s own anti-fraud unit (MARI) warned that liar’s loans were “an open invitation to fraudsters” and had a fraud incidence of 90 percent. I know of no evidence that he warned of the coming catastrophe and pushed to take emergency action against the raging epidemic of mortgage fraud.
The FDIC regulates smaller banks. It had the strongest regulatory leader during the crisis (Sheila Bair). Though she had far more power than Curry, she did not take off the gloves and protect the nation from the fraudulent lenders. The FDIC has the strongest regulatory tradition. The OCC, by contrast, regulates the largest (national) banks. The OCC, the Federal Reserve, and the late Office of Thrift Supervision (OTS) all disgraced themselves during the crisis as virulent anti-regulators. In particular, the OCC viewed financial derivatives with great favor and opposed adoption of the Volcker rule. The OCC was the most aggressive opponent of state regulation and enforcement against predatory and fraudulent lenders through preemption. Curry, therefore, faced an exceptionally difficult task if he intended to clean house at the OCC and turn the agency into a leading part of the solution instead of a major contributor to the problem.
Curry, therefore, was exceptionally unlikely to “take of the gloves” and get in a bare knuckled brawl with the industry. There was no realistic prospect that he would remove the fraudulent CEOs from office, take on the systemically dangerous institutions (SDIs) treated as “too big to fail,” crack down on speculation in derivatives, conduct vigorous investigations of the frauds and unsafe and unsound practices, and make the necessary criminal referrals.
Regulatory “cops on the beat” are essential for honest financial markets in large economies. When cheaters gain a competitive advantage markets become perverse. A Gresham’s dynamic causes bad ethics to drive good ethics out of the market. Crony capitalism creates the illusion of free markets and competition, but is actually a massive extraction of “rents” in favor of the officers that control the favored firms and their political and business cronies. JPMorgan, and the other SDIs, are the new Fannie Maes.
Any serious effort by the administration to “take off the gloves” would require a replacement for Attorney General Holder. The nation’s chief law enforcement officer has been missing in action when it comes to the elite frauds that drove the fraud epidemic and the resultant financial crisis and Great Recession. Choosing new financial regulatory leaders for the SEC, OCC, and the FDIC willing to take off the gloves and transform the financial industry to end the increasingly criminogenic environments that drive our recurrent, intensifying crises is essential. Regulators, however, cannot prosecute and Holder has shown that he will not take off the gloves when it comes to the elites that drove the crisis.
We also must not forget the destructive role that Timothy Geithner plays in the Obama administration. He is the man who failed catastrophically as a regulator when he was President of the Federal Reserve Bank of New York. Obama’s elevation of this failure to be his principal economic leader and advisor signaled that Obama had no desire to take off the gloves, end the criminogenic environment, and hold the elite frauds accountable. Instead, Geithner has claimed that we must not prosecute, or even investigate the elite frauds lest they destroy the economy. It is vain to debate whether Geithner’s doctrine of impunity for elite bankers is more disturbing as a matter of practicality or ethics because it fails utterly on both dimensions.
The quaint aspect of the NYT editorial is that the editors still hoped in mid-2011 that the problem was that Obama wanted to take the gloves off and take on the elite frauds, but was blocked by Republicans from doing so. Had they editorial writers considered the significance of Obama choosing Larry Summers, Holder, and Geithner (and reappointing Bernanke) – all great supporters of the financial elites and opponents of effective financial regulation – they could not have written such a naïve piece. A year later, nearly two years after the Dodd-Frank bill was adopted by Congress, there is no chance that the NYT would write an editorial premised on the implicit assumption that Obama wants to “take the gloves off” and knock out the elite bank frauds. No one thinks that either political party has any desire to take the gloves off and go after the elite bank frauds. Crony capitalism is our only truly bipartisan policy. It typically wins by a TKO because there is no opponent in its weight class willing to answer the bell and come out of the corner to fight. No politician wants to fight his or her leading source of political contributions.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
4-minute video: Matt shows humanity wants dancing, not 1%’s wars, lies, debt
by Carl Herman
Let’s be clear: current US-led wars are only possible by a 1% “leadership” in government and corporate media who blatantly violate war law, and then lie with whatever shifting BS they think will sell. War law is crystal-clear in letter and intent; the legal victory all our families sacrificed to win from two world wars: no nation can use military armed attack unless under attack by another nation’s government.
Let’s be clear: debt-damned economics is only possible by the same 1% “leadership” joined by a banking/finance 1% who create debt out of nothing and then lie to us that it’s the same as debt-free money.
Let’s be clear: these 1% “leaders” employ the strategy exposed by Gandhi to keep the 99% distracted and confused:
First they ignore you. Then they laugh at you. Then they fight you. And then you win.
Matt shows us humanity’s heart wants cooperation, love, and our literal and figurative dancing together in building a brighter future.
Our 1% want more war and debt. We know that’s what they want because that’s what they do in the face of obvious alternatives of lawful peace and obvious economic reforms.
Do you notice the 1% never talk about love and what that means policies should look like?
The 99%’s endgame and freedom is the 1%’s surrender or arrests for obvious crimes centering in war and money. Every year, the 1%’s crimes kill millions, harm billions, and loot trillions of the 99%’s dollars. The 99% must have stronger thoughts, voices, and lawful acts for endgame victory.
The 1% have two options: a “Scrooge” conversation to reclaim their hearts and dance with us, or to double-down as minions for death, lies and debt.
This choice for all of us is perhaps our most important of this lifetime. If Life is just and we receive what we earn, this time now is the truest test of character.
Let’s be clear: current US-led wars are only possible by a 1% “leadership” in government and corporate media who blatantly violate war law, and then lie with whatever shifting BS they think will sell. War law is crystal-clear in letter and intent; the legal victory all our families sacrificed to win from two world wars: no nation can use military armed attack unless under attack by another nation’s government.
Let’s be clear: debt-damned economics is only possible by the same 1% “leadership” joined by a banking/finance 1% who create debt out of nothing and then lie to us that it’s the same as debt-free money.
Let’s be clear: these 1% “leaders” employ the strategy exposed by Gandhi to keep the 99% distracted and confused:
First they ignore you. Then they laugh at you. Then they fight you. And then you win.
Matt shows us humanity’s heart wants cooperation, love, and our literal and figurative dancing together in building a brighter future.
Our 1% want more war and debt. We know that’s what they want because that’s what they do in the face of obvious alternatives of lawful peace and obvious economic reforms.
Do you notice the 1% never talk about love and what that means policies should look like?
The 99%’s endgame and freedom is the 1%’s surrender or arrests for obvious crimes centering in war and money. Every year, the 1%’s crimes kill millions, harm billions, and loot trillions of the 99%’s dollars. The 99% must have stronger thoughts, voices, and lawful acts for endgame victory.
The 1% have two options: a “Scrooge” conversation to reclaim their hearts and dance with us, or to double-down as minions for death, lies and debt.
This choice for all of us is perhaps our most important of this lifetime. If Life is just and we receive what we earn, this time now is the truest test of character.
The Consequences Of The Unthinkable: Here Is What Happens When The Euro Breaks Up
by Tyler Durden
As the following image from Spiegel summarizes, three things will happen simultaneously when the unthinkable finally occurs: i) economic output plummets, ii) unemployment rate soars, and iii) consumer prices explode. Of course, this is nothing but merely deferred consequences for Europe partying for over a decade under an unsustainable regime that borrowed from the future (sound familiar?). And now the inevitable hangover. In other words: payback is a bitch.
As the following image from Spiegel summarizes, three things will happen simultaneously when the unthinkable finally occurs: i) economic output plummets, ii) unemployment rate soars, and iii) consumer prices explode. Of course, this is nothing but merely deferred consequences for Europe partying for over a decade under an unsustainable regime that borrowed from the future (sound familiar?). And now the inevitable hangover. In other words: payback is a bitch.
The Jester Has A **Problem**
by Karl Denninger
I really hope you're paying attention here folks....
First up this morning is this "glitch":
Royal Bank of Scotland is facing calls to make payments as soon as possible to customers affected by its long-running computer crisis, as it admitted NatWest branches would again be opened for extended hours on Monday.
Uh huh. There isn't a wee funding problem involved here, is there? I mean, nobody would ever lie about what's going on at a bank, would they? That would be flatly unacceptable.
Of course in a world where nobody goes to jail when they lie (so long as they're a bankster), why not lie? And this leads to the problem of trust by the public -- how do you know that this is just a "computer glitch" and not something more serious, like, for example, the bank being actually bust?
But it gets better...
Central bankers are finding it easier to support their economies than to spur expansion as the prospect of Japanese-like lost decades looms across the developed world.
---
The rub is that even as they renew their rescue efforts, policy makers are postponing forecasts for fuller recoveries and run the risk that their latest actions pack a smaller punch. This raises the prospect of longer-term anemic expansion akin to the doldrums Japan has suffered since the early 1990s.
The only thing they're "supporting" is a bunch of insolvent financial institutions.
But the problem with this "solution" is that it fixes nothing and in fact makes the problem worse, as it gives politicians cover to do the wrong thing (like borrow and blow 10% of GDP, as is happening here) rather than the right thing (like allow those who made bad bets to eat them and the resulting loss, going out of business and clearing the market for those who made good bets.)
Far worse is what it does to pension funds and other defined benefit programs such as annuities. These systems are still using 8% annualized returns (on an indefinite forward basis!) as their internal rate of return. In a zero-interest rate environment you can't even approach that return, which forces these funds into stocks and other risky asset classes.
Now look at Japan. Their stock market is at 20% of where it was in its hayday. If you assumed 8% forward returns there you've been underwater for 20 years and long since dead and buried.
That is coming here, and when it does it is going to be yet another instance where people claim to be "surprised" and that "nobody saw it coming."
The hell they didn't. I've been writing on the detonation of pensions and annuities now since 2007 and 2008, and will continue to do so. At the same time it is clear that on our current path government policy will also force a massive and uncontrolled contraction in government spending, as the governments in the US are simply unable to say "No!" to constituents and stop the deficit spending.
The market will therefore force them to do so, and probably in an extraordinarily-violent, uncontrolled and unpleasant manner.
You're being lied to folks, and I hope you're prepared when the cold, hard recognition of reality strikes -- because if you're not, you're going to be in a lot of trouble.
I really hope you're paying attention here folks....
First up this morning is this "glitch":
Royal Bank of Scotland is facing calls to make payments as soon as possible to customers affected by its long-running computer crisis, as it admitted NatWest branches would again be opened for extended hours on Monday.
Uh huh. There isn't a wee funding problem involved here, is there? I mean, nobody would ever lie about what's going on at a bank, would they? That would be flatly unacceptable.
Of course in a world where nobody goes to jail when they lie (so long as they're a bankster), why not lie? And this leads to the problem of trust by the public -- how do you know that this is just a "computer glitch" and not something more serious, like, for example, the bank being actually bust?
But it gets better...
Central bankers are finding it easier to support their economies than to spur expansion as the prospect of Japanese-like lost decades looms across the developed world.
---
The rub is that even as they renew their rescue efforts, policy makers are postponing forecasts for fuller recoveries and run the risk that their latest actions pack a smaller punch. This raises the prospect of longer-term anemic expansion akin to the doldrums Japan has suffered since the early 1990s.
The only thing they're "supporting" is a bunch of insolvent financial institutions.
But the problem with this "solution" is that it fixes nothing and in fact makes the problem worse, as it gives politicians cover to do the wrong thing (like borrow and blow 10% of GDP, as is happening here) rather than the right thing (like allow those who made bad bets to eat them and the resulting loss, going out of business and clearing the market for those who made good bets.)
Far worse is what it does to pension funds and other defined benefit programs such as annuities. These systems are still using 8% annualized returns (on an indefinite forward basis!) as their internal rate of return. In a zero-interest rate environment you can't even approach that return, which forces these funds into stocks and other risky asset classes.
Now look at Japan. Their stock market is at 20% of where it was in its hayday. If you assumed 8% forward returns there you've been underwater for 20 years and long since dead and buried.
That is coming here, and when it does it is going to be yet another instance where people claim to be "surprised" and that "nobody saw it coming."
The hell they didn't. I've been writing on the detonation of pensions and annuities now since 2007 and 2008, and will continue to do so. At the same time it is clear that on our current path government policy will also force a massive and uncontrolled contraction in government spending, as the governments in the US are simply unable to say "No!" to constituents and stop the deficit spending.
The market will therefore force them to do so, and probably in an extraordinarily-violent, uncontrolled and unpleasant manner.
You're being lied to folks, and I hope you're prepared when the cold, hard recognition of reality strikes -- because if you're not, you're going to be in a lot of trouble.
Joseph Stiglitz Sees Terrifying Future for America If We Don't Reverse Inequality
AlterNet / By Lynn Parramore
What will life look like down the road if we don't reverse economic inequality? We must see through the myths of capitalism and build a mass movement if we are to save ourselves.
Nobel Prize-winning economist Joseph Stiglitz, one of America's most prescient voices, wrote an article for Vanity Fair several months before Occupy Wall Street was born. "Of the 1%, by the 1%, for the 1%" called attention to the widening gap between rich and poor and its deadly impact on our society and its democratic institutions. In his newly released book, The Price of Inequality, Stiglitz returns to this theme of a divided society, delving into the origins and consequences of economic unfairness. I caught up with Professor Stiglitz and talked to him about how the persistent myths and beliefs associated with our capitalist system help to drive this trend, turning America from a land of opportunity to a land of broken dreams.
Lynn Parramore: An argument has been made, particularly since the end of the Cold War, that capitalism is great at producing things that can improve our lives, and so we ought to therefore tolerate some unfairness. What's wrong with that narrative?
Joseph Stiglitz: Well, capitalism does have a lot of strengths, including producing things that are very innovative. But what drives capitalism is the profit motive. You can profit not only by making good things, but also by exploiting people, by exploiting the environment, by doing things that are not so good. The narrative that you describe ignores the extent to which a lot of the inequalities in the United States are not the result of creative activity but of exploitive activity. And if you look at the people at the top, what is so striking is that the people who've made the most important creative contributions are not there.
By that I mean the really foundational things like the computer, the transistor, the laser. And how many people at the top are people who made their money out of monopoly -- exercising monopoly power? Like bankers who exploited through predatory lending practices and abusive credit card practices. Or CEOs who took advantage of deficiencies in corporate governance to get a larger share of the corporate revenues for themselves without any regard to the extent to which they have actually contributed to increasing the the sustainable well-being of the firm.
LP: How does our current situation compare to other eras in terms of the differences between ordinary Americans and the richest among us?
JS: Doing a precise comparison is difficult because we don't have data sets that go back that far. But we do have data sets that go back more than 30 years and what is clear is that the share of the top 1 percent has almost tripled since 1980. So, this kind of inequality at the top has unambiguously gotten much, much, much worse. We also have data on the extent to which there's been a hollowing out of the middle class. The data that recently came out from the Fed indicated that we've wiped out 20 years of increases and wealth for the middle American.
LP: So for most of us, 20 years of economic progress just went up in smoke. But the super-rich are doing very well. What happened?
JS: It's the peculiar nature of the American economy, which is that's it's a very powerful machine that is working for a very few people, and has not been delivering for most Americans. If you had an economic machine that worked the way it was supposed to, everybody would be getting better. And an economy that's normally growing, say, 3 percent, even over a 20-year period. Steady accumulation would lead to their wealth more than doubling in that period. And it clearly hasn't happened. And adjusted for inflation, it would have even increased even before, unadjusted for inflation, would have increased it even more. And that clearly hasn't happened.
LP: There's a persistent myth that America is still the "land of opportunity." Why is that myth so prevalent, even in the face of so much evidence to the contrary?
JS: Well, there are two reasons for this. One of them is that the myth is so much part of our sense of identity as Americans that it is devastating for us to give it up -- for us to say we are less of a land of opportunity than old ossified Europe. It was one of the things we were most proud of, and clearly, it's not true. When you have something that's so inconsistent with your self image, it's really, really hard to face the facts.
The second reason has to do with the nature of evidence. Everybody know examples of people who make it from the bottom or the middle-bottom to the top. And our press talks about them. The media calls attention to the successes. But when they call attention to successes they don't say this is one of a million or one of a thousand. In fact, the reason they write about it is because they are so unusual. If most people did it, it wouldn't be an unusual story. So, in a sense that's how our media works. It encourages us to think of the exceptions as the norm.
LP: Some say that if we redistribute income in a more equitable way, people won't want to work as hard. Is that true? What happens to our motivation to work when things are so inequitable?
JS: One of the myths that I try to destroy is the myth that if we do anything about inequality it will weaken our economy. And that's why the title of my book is The Price of Inequality. What I argue is that if we did attack these sources of inequality, we would actually have a stronger economy. We're paying a high price for this inequality. Now, one of the mischaracterizations of those of us who want a more equal or fairer society, is that we're in favor of total equality, and that would mean that there would be no incentives. That's not the issue. The question is whether we could ameliorate some of the inequality -- reduce some of the inequality by, for instance, curtailing monopoly power, curtailing predatory lending, curtailing abusive credit card practices, curtailing the abuses of CEO pay. All of those kinds of things, what I generically call "rent seeking," are things that distort and destroy our economy.
So in fact, part of the problem of low taxes at the top is that since so much of the income at the very top is a result of rent seeking, when we lower the taxes, we're effectively lowering the taxes on rent seeking, and we're encouraging rent-seeking activities. When we have special provisions for capital gains that allow speculations to be taxed at a lower rate than people who work for a living, we encourage speculation. So that if you look at the design bit of our tax structure, it does create incentives for doing the wrong thing.
LP: When ordinary people see this speculation and unfairness, do you think it disincentivizes them to work harder, to take risks?
JS: Oh, very much so. It has a very enervating effect on our society and our economy. I describe experimental results in in my book where peoples' incentives to work hard are reduced when they believe they are part of an unfair system.
LP: We also hear that deregulation and downsizing government is somehow supposed to make capitalism work better for all of us. Why has that persistent belief failed us?
JS: A lot of these are questions about perception. To the extent that we can see waste, obviously we say that if we could get rid of that waste, we would be a better economy. By definition, waste is waste. The Republican rhetoric has focused on waste in the public sector. But waste, at some level, is an inherent consequence of human fallibility. We're going to make mistakes, and that's going to be true in the public and the private sector. No government program has ever wasted resources on the scale of America's private financial sector in the run-up to the crisis. So the first thing you realize is there is waste everywhere including in the private sector.
Now if you ask people about things there are important to them ... obviously they care a lot about the school their children go to. They worry about too-large classes. They worry about police protection. Those are all things that people value a lot. They value the Internet, which was created by government-funded research. Health care and drugs were are all based on government-funded research. So the bottom line is that government services have proved highly valuable. And this is where the big lie, the big distortion is. By talking about the few instances of inefficiency, they try to direct the attention away from the teachers, the policeman, the fireman, the researchers, the people building the roads to make our society function. And they turn our attention away from the failures in the private sector.
LP: What is the connection between the increase of deregulation and the rise of inequality?
JS: I think there are a couple of things going on simultaneously. The most important aspect for deregulation was in the financial sector. And that deregulation led to this over-bloated financial sector, predatory lending, abusive credit card practices and so forth. That did double function. It lead to more wealth at the top. It took away wealth and income from the bottom. So that really was very bad for American inequality. Not good for American economic growth. So that's one aspect of it.
Deregulation was, in part, the result of an ideology. A lot of weight was given to the business community and the people of the top. Corporations and the one percent. It reflected the increasing influence of money in politics. That itself again led to more inequality. Under Bush, you get bills where the government said that it would not bargain with the drug companies, giving the drug companies over a half trillion dollars over 10 years, lowering progressive income taxes, special provisions for capital gains and dividends. Things in turn which created a more distorted economy and a more unequal society. So some of the forces that gave rise to deregulation gave rise to these other activities that also gave rise to inequality.
LP: Obviously there are lot of costs that this inequality imposes upon us. What, in your view is the biggest cost, particularly to young people?
JS: One aspect of it is the problem about student debt. Market forces are global. America's inequality is distinctive because of the way we shape those market forces and a good example are our bankruptcy laws which are the kind of laws that regulate our economy. Our bankruptcy law gave priority to the banks, to derivatives, to risky products and AIG and so forth. But when you do that, you expand risk-taking by the banks. You encourage the banks to go into risk, into gambling, rather than into lending.
At the other extreme, we passed a change in the bankruptcy code. There's a provision that students in bankruptcy cannot discharge their debt -- even if the school doesn't provide what was promised. Then you combine that with this austerity going on today, where we're forcing many of the states to raise their tuition enormously. So what you have is the situation in which the students who want access to education have no choice but to borrow. Their parents' incomes are doing very badly, and yet if they borrow, there's no way, no matter what they do, to get out from under this debt. Even if their education doesn't pay off. That's compounded by the fact that we have this very high unemployment, and particularly high youth unemployment. And data show very clearly that if a young person graduates from college in a period in which there's high unemployment, the income prospect for your entire life is going to be greatly diminished.
LP: You've talked about the corruption in our political system. What is our best hope in the political realm of reversing this trend in economic inequality?
JS: On the positive side, let me just say that there are a number of reasons for hope. One of them is that if we look at countries like Brazil that seemed to be over the precipice, people saw where it was going and the country came together and did things like education under Cardoso. And hunger and nutrition and health programs. You can already see in the data that inequality has been coming down. The United States faced high levels of inequality in the Gilded Age, in the period in the Roaring '20s. But it backed off. The social legislation of the '30s reversed the trend. So there is hope that societies that are moving in this direction that we've been moving will see the light and change.
And there's lots that you can do. In my book, I described this very comprehensive economic agenda. It's not hard. And you don't have to do everything. What I try to put forward are two hypotheses of how that might happen. In one of them, what I call the "1 percent" will finally realize that it's in their enlightened self interest, rightly understood, to care about the rest of society. You cannot do well at the top of the pyramid unless the base of the pyramid is strong. And the other one is that the 99 percent realize that they've been sold a bill of goods. And they realize that some of these ideas that we've been talking about -- trickle-down economics that destroy the interests of the poor, the middle class -- are just wrong. They come to realize that the United States is not the land of opportunity, that the United States has higher level of inequality of any of the other advanced industrial countries. As they come to realize this, then maybe they'll wake up and say, why is that?
LP: And if we wake up, if we understand it, how do we get our politicians to listen to us? What can we do to fix our political system?
JS: Well, you know, just as in the case of the economic agenda, I don't think there is any single magic bullet that is going to make a big difference -- one that will be definitive. There are lots of things. Economic inequality has many dimensions and has manifested in many levels of our complex political system. I guess I have to believe that the single thing that probably distorts our democracy the most is campaign finance. So that would be a place to start. Public funding of all campaigns would probably take away a lot of the power of money.
So in one way, you have to ask the fundamental question, how is it that we've become a country that's more accurately described as one dollar, one vote, than one person, one vote? And one has to say it has something to do with that power of money in the political process. There are other changes in legislation that would make a great deal of difference. We have a system where you need a lot of money to get out the vote. So if you went to the Australian route, and said you have to vote, that would also have an impact.
LP: I want to paint a picture, particularly for the young people. What might life actually look for them 20 years down the road, 30 years down the road, if we can reverse this trend? And what might life look like if we don't?
JS: Let me step back and say that economists always like to think about the counter-facts or what life would be if we go down one course versus another. We're not gonna to be entering the Garden of Eden. But if we go down the route that we're going, we're going to a world where people live in gated communities. We already have by far the largest fraction of our population locked up in prison. We will have an increasingly insecure society. Americans will be facing insecurity, of economic insecurity, healthcare insecurity, a sense of physical insecurity. We will be worrying politically about the role of extremism. Extremism on the right, extremism on the left. So that's the kind of picture that I can see as going down towards. I see so many other countries that have these divided societies going down this directions.
The other one is a society where most Americans are actually better off. I mean, the reality is that Americans are wonderfully optimistic. Even when things are not going very well, they'll smile and say well, you know, we're just having a temporary setback. A 20-year, zero-increase in wealth is not a small setback, and so I think the alternative is that they can see a world in which our increasing wealth is more equitably shared, and that will be a world where they will have more security, more wealth, more time to spend doing what they really care about. Some individuals will be absorbed in their work, other individuals will have sufficient income that they'll be able to have a hobby. A society in which everybody will be able to exercise their creativity in their own way.
LP: Has there been any reaction to your book that you didn't anticipate as you were writing?
JS: I guess the thing that was most moving in a number of the talks that I've given is the large number of young people that have come to the microphone and asked questions where you can sense their sense of despair, their sense of frustration at being saddled by student loans, their sense of job prospects being not very good. A couple of them really articulated a sense of unfairness. One kid said "To get a job, you have to have an internship. I don't have the connections. I don't have the money to live on to accept one of these low-paying internships."
And then another one said "You know, to get a job now, you need a master's degree. I can't afford it. I already have too much student debt." And these were, you know, intelligent kids, who obviously played by the rules, done everything right, worked hard at school. But they were hitting the kind of frustration that you shouldn't be getting from young people. To me, that was really heart-rending. And it came from not just one kid. Not in just one talk.
LP: Do you sense that they have energy for action? Political action or participation in social movements?
JS: I don't see them enervated. These are kids who have not dropped out. They really have a thirst. They want to know what could we do. But I didn't get the sense that they felt very confident that either the political system or protest movements work. So they were expressing a sense of frustration, despair, that, you know, "Occupy Wall Street didn't work, the political system hasn't been reformed, the economy's not functioning, we're saddled with these debts, job prospects are bleak. And, we don't have the money like a rich kid to stay in school. What do we do?"
LP: And what's your answer to them?
JS: Well, all I can say is that I just felt enormously empathetic with them. And I think the only hope at this point is to try to get political activism, including protests like Occupy Wall Street. But also engaging in the political movements. Or trying to make the protest movements more linked to our political process.
LP: When you were saying that young people felt a sense that Occupy Wall Street didn't work, do you think that's really true?
JS: I think it did move the conversation. What is clear is that it hasn't yet reached fruition. It did move the conversation, but certainly, in the context of one of the political parties, things haven't really changed where they're going. It may have succeeded in getting President Obama to talk a little bit more forthrightly about the problems of inequality in our society. And in that sense, it has made, I think, Americans more receptive to the fact that economic inequality is one of the major problems we're facing today.
What will life look like down the road if we don't reverse economic inequality? We must see through the myths of capitalism and build a mass movement if we are to save ourselves.
Nobel Prize-winning economist Joseph Stiglitz, one of America's most prescient voices, wrote an article for Vanity Fair several months before Occupy Wall Street was born. "Of the 1%, by the 1%, for the 1%" called attention to the widening gap between rich and poor and its deadly impact on our society and its democratic institutions. In his newly released book, The Price of Inequality, Stiglitz returns to this theme of a divided society, delving into the origins and consequences of economic unfairness. I caught up with Professor Stiglitz and talked to him about how the persistent myths and beliefs associated with our capitalist system help to drive this trend, turning America from a land of opportunity to a land of broken dreams.
Lynn Parramore: An argument has been made, particularly since the end of the Cold War, that capitalism is great at producing things that can improve our lives, and so we ought to therefore tolerate some unfairness. What's wrong with that narrative?
Joseph Stiglitz: Well, capitalism does have a lot of strengths, including producing things that are very innovative. But what drives capitalism is the profit motive. You can profit not only by making good things, but also by exploiting people, by exploiting the environment, by doing things that are not so good. The narrative that you describe ignores the extent to which a lot of the inequalities in the United States are not the result of creative activity but of exploitive activity. And if you look at the people at the top, what is so striking is that the people who've made the most important creative contributions are not there.
By that I mean the really foundational things like the computer, the transistor, the laser. And how many people at the top are people who made their money out of monopoly -- exercising monopoly power? Like bankers who exploited through predatory lending practices and abusive credit card practices. Or CEOs who took advantage of deficiencies in corporate governance to get a larger share of the corporate revenues for themselves without any regard to the extent to which they have actually contributed to increasing the the sustainable well-being of the firm.
LP: How does our current situation compare to other eras in terms of the differences between ordinary Americans and the richest among us?
JS: Doing a precise comparison is difficult because we don't have data sets that go back that far. But we do have data sets that go back more than 30 years and what is clear is that the share of the top 1 percent has almost tripled since 1980. So, this kind of inequality at the top has unambiguously gotten much, much, much worse. We also have data on the extent to which there's been a hollowing out of the middle class. The data that recently came out from the Fed indicated that we've wiped out 20 years of increases and wealth for the middle American.
LP: So for most of us, 20 years of economic progress just went up in smoke. But the super-rich are doing very well. What happened?
JS: It's the peculiar nature of the American economy, which is that's it's a very powerful machine that is working for a very few people, and has not been delivering for most Americans. If you had an economic machine that worked the way it was supposed to, everybody would be getting better. And an economy that's normally growing, say, 3 percent, even over a 20-year period. Steady accumulation would lead to their wealth more than doubling in that period. And it clearly hasn't happened. And adjusted for inflation, it would have even increased even before, unadjusted for inflation, would have increased it even more. And that clearly hasn't happened.
LP: There's a persistent myth that America is still the "land of opportunity." Why is that myth so prevalent, even in the face of so much evidence to the contrary?
JS: Well, there are two reasons for this. One of them is that the myth is so much part of our sense of identity as Americans that it is devastating for us to give it up -- for us to say we are less of a land of opportunity than old ossified Europe. It was one of the things we were most proud of, and clearly, it's not true. When you have something that's so inconsistent with your self image, it's really, really hard to face the facts.
The second reason has to do with the nature of evidence. Everybody know examples of people who make it from the bottom or the middle-bottom to the top. And our press talks about them. The media calls attention to the successes. But when they call attention to successes they don't say this is one of a million or one of a thousand. In fact, the reason they write about it is because they are so unusual. If most people did it, it wouldn't be an unusual story. So, in a sense that's how our media works. It encourages us to think of the exceptions as the norm.
LP: Some say that if we redistribute income in a more equitable way, people won't want to work as hard. Is that true? What happens to our motivation to work when things are so inequitable?
JS: One of the myths that I try to destroy is the myth that if we do anything about inequality it will weaken our economy. And that's why the title of my book is The Price of Inequality. What I argue is that if we did attack these sources of inequality, we would actually have a stronger economy. We're paying a high price for this inequality. Now, one of the mischaracterizations of those of us who want a more equal or fairer society, is that we're in favor of total equality, and that would mean that there would be no incentives. That's not the issue. The question is whether we could ameliorate some of the inequality -- reduce some of the inequality by, for instance, curtailing monopoly power, curtailing predatory lending, curtailing abusive credit card practices, curtailing the abuses of CEO pay. All of those kinds of things, what I generically call "rent seeking," are things that distort and destroy our economy.
So in fact, part of the problem of low taxes at the top is that since so much of the income at the very top is a result of rent seeking, when we lower the taxes, we're effectively lowering the taxes on rent seeking, and we're encouraging rent-seeking activities. When we have special provisions for capital gains that allow speculations to be taxed at a lower rate than people who work for a living, we encourage speculation. So that if you look at the design bit of our tax structure, it does create incentives for doing the wrong thing.
LP: When ordinary people see this speculation and unfairness, do you think it disincentivizes them to work harder, to take risks?
JS: Oh, very much so. It has a very enervating effect on our society and our economy. I describe experimental results in in my book where peoples' incentives to work hard are reduced when they believe they are part of an unfair system.
LP: We also hear that deregulation and downsizing government is somehow supposed to make capitalism work better for all of us. Why has that persistent belief failed us?
JS: A lot of these are questions about perception. To the extent that we can see waste, obviously we say that if we could get rid of that waste, we would be a better economy. By definition, waste is waste. The Republican rhetoric has focused on waste in the public sector. But waste, at some level, is an inherent consequence of human fallibility. We're going to make mistakes, and that's going to be true in the public and the private sector. No government program has ever wasted resources on the scale of America's private financial sector in the run-up to the crisis. So the first thing you realize is there is waste everywhere including in the private sector.
Now if you ask people about things there are important to them ... obviously they care a lot about the school their children go to. They worry about too-large classes. They worry about police protection. Those are all things that people value a lot. They value the Internet, which was created by government-funded research. Health care and drugs were are all based on government-funded research. So the bottom line is that government services have proved highly valuable. And this is where the big lie, the big distortion is. By talking about the few instances of inefficiency, they try to direct the attention away from the teachers, the policeman, the fireman, the researchers, the people building the roads to make our society function. And they turn our attention away from the failures in the private sector.
LP: What is the connection between the increase of deregulation and the rise of inequality?
JS: I think there are a couple of things going on simultaneously. The most important aspect for deregulation was in the financial sector. And that deregulation led to this over-bloated financial sector, predatory lending, abusive credit card practices and so forth. That did double function. It lead to more wealth at the top. It took away wealth and income from the bottom. So that really was very bad for American inequality. Not good for American economic growth. So that's one aspect of it.
Deregulation was, in part, the result of an ideology. A lot of weight was given to the business community and the people of the top. Corporations and the one percent. It reflected the increasing influence of money in politics. That itself again led to more inequality. Under Bush, you get bills where the government said that it would not bargain with the drug companies, giving the drug companies over a half trillion dollars over 10 years, lowering progressive income taxes, special provisions for capital gains and dividends. Things in turn which created a more distorted economy and a more unequal society. So some of the forces that gave rise to deregulation gave rise to these other activities that also gave rise to inequality.
LP: Obviously there are lot of costs that this inequality imposes upon us. What, in your view is the biggest cost, particularly to young people?
JS: One aspect of it is the problem about student debt. Market forces are global. America's inequality is distinctive because of the way we shape those market forces and a good example are our bankruptcy laws which are the kind of laws that regulate our economy. Our bankruptcy law gave priority to the banks, to derivatives, to risky products and AIG and so forth. But when you do that, you expand risk-taking by the banks. You encourage the banks to go into risk, into gambling, rather than into lending.
At the other extreme, we passed a change in the bankruptcy code. There's a provision that students in bankruptcy cannot discharge their debt -- even if the school doesn't provide what was promised. Then you combine that with this austerity going on today, where we're forcing many of the states to raise their tuition enormously. So what you have is the situation in which the students who want access to education have no choice but to borrow. Their parents' incomes are doing very badly, and yet if they borrow, there's no way, no matter what they do, to get out from under this debt. Even if their education doesn't pay off. That's compounded by the fact that we have this very high unemployment, and particularly high youth unemployment. And data show very clearly that if a young person graduates from college in a period in which there's high unemployment, the income prospect for your entire life is going to be greatly diminished.
LP: You've talked about the corruption in our political system. What is our best hope in the political realm of reversing this trend in economic inequality?
JS: On the positive side, let me just say that there are a number of reasons for hope. One of them is that if we look at countries like Brazil that seemed to be over the precipice, people saw where it was going and the country came together and did things like education under Cardoso. And hunger and nutrition and health programs. You can already see in the data that inequality has been coming down. The United States faced high levels of inequality in the Gilded Age, in the period in the Roaring '20s. But it backed off. The social legislation of the '30s reversed the trend. So there is hope that societies that are moving in this direction that we've been moving will see the light and change.
And there's lots that you can do. In my book, I described this very comprehensive economic agenda. It's not hard. And you don't have to do everything. What I try to put forward are two hypotheses of how that might happen. In one of them, what I call the "1 percent" will finally realize that it's in their enlightened self interest, rightly understood, to care about the rest of society. You cannot do well at the top of the pyramid unless the base of the pyramid is strong. And the other one is that the 99 percent realize that they've been sold a bill of goods. And they realize that some of these ideas that we've been talking about -- trickle-down economics that destroy the interests of the poor, the middle class -- are just wrong. They come to realize that the United States is not the land of opportunity, that the United States has higher level of inequality of any of the other advanced industrial countries. As they come to realize this, then maybe they'll wake up and say, why is that?
LP: And if we wake up, if we understand it, how do we get our politicians to listen to us? What can we do to fix our political system?
JS: Well, you know, just as in the case of the economic agenda, I don't think there is any single magic bullet that is going to make a big difference -- one that will be definitive. There are lots of things. Economic inequality has many dimensions and has manifested in many levels of our complex political system. I guess I have to believe that the single thing that probably distorts our democracy the most is campaign finance. So that would be a place to start. Public funding of all campaigns would probably take away a lot of the power of money.
So in one way, you have to ask the fundamental question, how is it that we've become a country that's more accurately described as one dollar, one vote, than one person, one vote? And one has to say it has something to do with that power of money in the political process. There are other changes in legislation that would make a great deal of difference. We have a system where you need a lot of money to get out the vote. So if you went to the Australian route, and said you have to vote, that would also have an impact.
LP: I want to paint a picture, particularly for the young people. What might life actually look for them 20 years down the road, 30 years down the road, if we can reverse this trend? And what might life look like if we don't?
JS: Let me step back and say that economists always like to think about the counter-facts or what life would be if we go down one course versus another. We're not gonna to be entering the Garden of Eden. But if we go down the route that we're going, we're going to a world where people live in gated communities. We already have by far the largest fraction of our population locked up in prison. We will have an increasingly insecure society. Americans will be facing insecurity, of economic insecurity, healthcare insecurity, a sense of physical insecurity. We will be worrying politically about the role of extremism. Extremism on the right, extremism on the left. So that's the kind of picture that I can see as going down towards. I see so many other countries that have these divided societies going down this directions.
The other one is a society where most Americans are actually better off. I mean, the reality is that Americans are wonderfully optimistic. Even when things are not going very well, they'll smile and say well, you know, we're just having a temporary setback. A 20-year, zero-increase in wealth is not a small setback, and so I think the alternative is that they can see a world in which our increasing wealth is more equitably shared, and that will be a world where they will have more security, more wealth, more time to spend doing what they really care about. Some individuals will be absorbed in their work, other individuals will have sufficient income that they'll be able to have a hobby. A society in which everybody will be able to exercise their creativity in their own way.
LP: Has there been any reaction to your book that you didn't anticipate as you were writing?
JS: I guess the thing that was most moving in a number of the talks that I've given is the large number of young people that have come to the microphone and asked questions where you can sense their sense of despair, their sense of frustration at being saddled by student loans, their sense of job prospects being not very good. A couple of them really articulated a sense of unfairness. One kid said "To get a job, you have to have an internship. I don't have the connections. I don't have the money to live on to accept one of these low-paying internships."
And then another one said "You know, to get a job now, you need a master's degree. I can't afford it. I already have too much student debt." And these were, you know, intelligent kids, who obviously played by the rules, done everything right, worked hard at school. But they were hitting the kind of frustration that you shouldn't be getting from young people. To me, that was really heart-rending. And it came from not just one kid. Not in just one talk.
LP: Do you sense that they have energy for action? Political action or participation in social movements?
JS: I don't see them enervated. These are kids who have not dropped out. They really have a thirst. They want to know what could we do. But I didn't get the sense that they felt very confident that either the political system or protest movements work. So they were expressing a sense of frustration, despair, that, you know, "Occupy Wall Street didn't work, the political system hasn't been reformed, the economy's not functioning, we're saddled with these debts, job prospects are bleak. And, we don't have the money like a rich kid to stay in school. What do we do?"
LP: And what's your answer to them?
JS: Well, all I can say is that I just felt enormously empathetic with them. And I think the only hope at this point is to try to get political activism, including protests like Occupy Wall Street. But also engaging in the political movements. Or trying to make the protest movements more linked to our political process.
LP: When you were saying that young people felt a sense that Occupy Wall Street didn't work, do you think that's really true?
JS: I think it did move the conversation. What is clear is that it hasn't yet reached fruition. It did move the conversation, but certainly, in the context of one of the political parties, things haven't really changed where they're going. It may have succeeded in getting President Obama to talk a little bit more forthrightly about the problems of inequality in our society. And in that sense, it has made, I think, Americans more receptive to the fact that economic inequality is one of the major problems we're facing today.
Thursday, June 21, 2012
Dimon Lambastes Loans and Expresses His Devotion to Derivatives
By William K. Black
The ongoing U.S. crisis was driven largely by financial derivatives. Nine of America’s systemically dangerous institutions (SDIs) failed or had to be bailed out – Bear Stearns, Lehman, Merrill Lynch, Fannie, Freddie, AIG, Countrywide, Wachovia, and Washington Mutual (WaMu). The SDI failures were primarily due to losses caused or aided by the sale and purchase of enormous amounts of fraudulent derivatives, and deregulation, desupervision, and de facto decriminalization proved exceptionally criminogenic. The Commodities Futures Modernization Act of 2000 and the Gramm, Leach, Bliley Act of 1999, respectively, made credit default swaps (CDS) into a regulatory black hole and repealed the Glass-Steagall Act’s prohibition against banks mixing commercial and investment banking.
The Dodd-Frank bill should have repealed the two deregulatory acts passed near the end of Clinton’s term with broad bipartisan support, but the Obama administration never tried to go back to the legal governance system for finance that worked brilliantly for nearly a half-century and Jamie Dimon and JPMorgan led the lobbying blitz that ensured that the Dodd-Frank Act would have the taste, depth, and substance of light beer made by an enormous commercial American brewery. The Volcker rule was intended to partially restore the Glass-Steagall Act by restricting banks’ proprietary derivatives investments to hedging. The rationale was that there is no public policy basis for providing federal subsidies to banks to speculate in financial derivatives. That public policy argument against subsidizing dangerous bets by banks in derivatives is compelling and cuts across all political spectrums. Among banks, only the SDIs are massive users and issuers of financial derivatives. The largest SDIs love financial derivatives. Merrill Lynch failed because it was the largest purchaser of its own “green slime” derivatives, particularly collateralized debt obligations (CDOs) “backed” largely by endemically fraudulent liar’s loans. Such purchases were guaranteed to swiftly make Merrill’s investment officers wealthy and destroy the firm. My most recent columns have quoted Dimon’s dictum about accounting control fraud:
“Low-quality revenue is easy to produce, particularly in financial services. Poorly underwritten loans represent income today and losses tomorrow.”
Dimon’s dictum is equally true about the purchase of derivatives and the sale of CDS “protection.” AIG’s managers in charge of selling CDS protection took advantage of a “sure thing.” They booked income immediately and posted no reserves against the credit risk they were taking. They grew massively and employed extreme leverage. Those tactics maximize reported (fictional) income and modern executive compensation. The catastrophic losses come years later and are borne by others (the government, creditors, and shareholders). The officers become wealthy through the accounting scam.
The Senators who questioned Dimon last week knew that JPMorgan held more derivatives than any other entity and had just suffered serious, growing losses through proprietary investments in derivatives that JPMorgan claimed to be a “hedge” even though the investments acted to magnify rather than reduce risk. (JPMorgan’s insistence upon calling an anti-hedge a hedge led me to dub their practice “hedginess.”) The Senators also knew that Dimon directed the lobbying effort designed to prevent the adoption of the Volcker rule in the Dodd-Frank Act and, when that effort failed, he directed the lobbying effort designed to eviscerate the rule.
Given all this, the thing Dimon feared in his Senate and House testimony was being pinned down under oath about the supposed hedge. Fortunately (from his perspective), he was the CEO of America’s largest bank and he was in front of the modern U.S. Congress. His greatest danger was dying of an overdose of fawning.
The questioning was so embarrassingly weak that no one seems to have noticed the “watch my left hand closely” sleight of hand routine that Dimon pulled on derivatives. In response to a comment by Senator Shelby, the ranking Republican on the Banking Committee, Dimon said: “The biggest risk we take is credit – loans.” He used a similar line with Senator Bob Corker (R. Tenn): “The biggest risk a bank takes is making loans” “Loans are our largest risk.” By contrast, he claimed that derivatives were essential to protect JPMorgan from systemic risk.
In a few sentences, Dimon sought to reverse the concept underlying the Volcker rule. Dimon’s axiom becomes: loans are the problem and derivatives are the solution. The entire role of derivatives in driving the ongoing U.S. crisis – including the massive growth in fraudulent mortgage loans designed to feed the fraudulent CDOs – disappears. The Volcker rule is made to sound irrational. The axiom is as clever as it is false. It assumes the answer. Derivatives speculation by banks is not hedging. It does not reduce risk. It can massively increase losses. Indeed, there are few things more dangerous than believing that a position is a hedge when it actually operates to increase losses. The false belief that a risk exposure is hedged leads to complacency that can allow losses to grow dramatically.
But none of this captures the greater risk of fraud through derivatives. JPMorgan speculates in derivatives through, for example, the sale of CDS protection. Selling CDS protection (like purchasing a CDO) involves the bank taking on a credit risk that can be exceptionally large. The banks’ officers have perverse incentives to engage in behavior that Dimon’s dictum on control fraud describes. “Low-quality revenue is easy to produce, particularly in financial services. Poorly underwritten loans represent income today and losses tomorrow.” Poorly underwritten derivatives operate in the same fashion, but with accounting rules that are even more fraud-friendly than deliberately making bad loans and with far less transparency than is true of loans. The fact that Dimon refused to tell the Congress the nature of JPMorgan’s derivatives position is a vivid demonstration of how much more opaque derivatives remain than loans.
The ongoing U.S. crisis was driven largely by financial derivatives. Nine of America’s systemically dangerous institutions (SDIs) failed or had to be bailed out – Bear Stearns, Lehman, Merrill Lynch, Fannie, Freddie, AIG, Countrywide, Wachovia, and Washington Mutual (WaMu). The SDI failures were primarily due to losses caused or aided by the sale and purchase of enormous amounts of fraudulent derivatives, and deregulation, desupervision, and de facto decriminalization proved exceptionally criminogenic. The Commodities Futures Modernization Act of 2000 and the Gramm, Leach, Bliley Act of 1999, respectively, made credit default swaps (CDS) into a regulatory black hole and repealed the Glass-Steagall Act’s prohibition against banks mixing commercial and investment banking.
The Dodd-Frank bill should have repealed the two deregulatory acts passed near the end of Clinton’s term with broad bipartisan support, but the Obama administration never tried to go back to the legal governance system for finance that worked brilliantly for nearly a half-century and Jamie Dimon and JPMorgan led the lobbying blitz that ensured that the Dodd-Frank Act would have the taste, depth, and substance of light beer made by an enormous commercial American brewery. The Volcker rule was intended to partially restore the Glass-Steagall Act by restricting banks’ proprietary derivatives investments to hedging. The rationale was that there is no public policy basis for providing federal subsidies to banks to speculate in financial derivatives. That public policy argument against subsidizing dangerous bets by banks in derivatives is compelling and cuts across all political spectrums. Among banks, only the SDIs are massive users and issuers of financial derivatives. The largest SDIs love financial derivatives. Merrill Lynch failed because it was the largest purchaser of its own “green slime” derivatives, particularly collateralized debt obligations (CDOs) “backed” largely by endemically fraudulent liar’s loans. Such purchases were guaranteed to swiftly make Merrill’s investment officers wealthy and destroy the firm. My most recent columns have quoted Dimon’s dictum about accounting control fraud:
“Low-quality revenue is easy to produce, particularly in financial services. Poorly underwritten loans represent income today and losses tomorrow.”
Dimon’s dictum is equally true about the purchase of derivatives and the sale of CDS “protection.” AIG’s managers in charge of selling CDS protection took advantage of a “sure thing.” They booked income immediately and posted no reserves against the credit risk they were taking. They grew massively and employed extreme leverage. Those tactics maximize reported (fictional) income and modern executive compensation. The catastrophic losses come years later and are borne by others (the government, creditors, and shareholders). The officers become wealthy through the accounting scam.
The Senators who questioned Dimon last week knew that JPMorgan held more derivatives than any other entity and had just suffered serious, growing losses through proprietary investments in derivatives that JPMorgan claimed to be a “hedge” even though the investments acted to magnify rather than reduce risk. (JPMorgan’s insistence upon calling an anti-hedge a hedge led me to dub their practice “hedginess.”) The Senators also knew that Dimon directed the lobbying effort designed to prevent the adoption of the Volcker rule in the Dodd-Frank Act and, when that effort failed, he directed the lobbying effort designed to eviscerate the rule.
Given all this, the thing Dimon feared in his Senate and House testimony was being pinned down under oath about the supposed hedge. Fortunately (from his perspective), he was the CEO of America’s largest bank and he was in front of the modern U.S. Congress. His greatest danger was dying of an overdose of fawning.
The questioning was so embarrassingly weak that no one seems to have noticed the “watch my left hand closely” sleight of hand routine that Dimon pulled on derivatives. In response to a comment by Senator Shelby, the ranking Republican on the Banking Committee, Dimon said: “The biggest risk we take is credit – loans.” He used a similar line with Senator Bob Corker (R. Tenn): “The biggest risk a bank takes is making loans” “Loans are our largest risk.” By contrast, he claimed that derivatives were essential to protect JPMorgan from systemic risk.
In a few sentences, Dimon sought to reverse the concept underlying the Volcker rule. Dimon’s axiom becomes: loans are the problem and derivatives are the solution. The entire role of derivatives in driving the ongoing U.S. crisis – including the massive growth in fraudulent mortgage loans designed to feed the fraudulent CDOs – disappears. The Volcker rule is made to sound irrational. The axiom is as clever as it is false. It assumes the answer. Derivatives speculation by banks is not hedging. It does not reduce risk. It can massively increase losses. Indeed, there are few things more dangerous than believing that a position is a hedge when it actually operates to increase losses. The false belief that a risk exposure is hedged leads to complacency that can allow losses to grow dramatically.
But none of this captures the greater risk of fraud through derivatives. JPMorgan speculates in derivatives through, for example, the sale of CDS protection. Selling CDS protection (like purchasing a CDO) involves the bank taking on a credit risk that can be exceptionally large. The banks’ officers have perverse incentives to engage in behavior that Dimon’s dictum on control fraud describes. “Low-quality revenue is easy to produce, particularly in financial services. Poorly underwritten loans represent income today and losses tomorrow.” Poorly underwritten derivatives operate in the same fashion, but with accounting rules that are even more fraud-friendly than deliberately making bad loans and with far less transparency than is true of loans. The fact that Dimon refused to tell the Congress the nature of JPMorgan’s derivatives position is a vivid demonstration of how much more opaque derivatives remain than loans.
The Biggest Myth Preventing an Economic Recovery
by WashingtonsBlog
There are many widespread myths preventing an economic recovery, including the following myths:
■Military spending stimulates the economy
■The banks are acting more conservatively now than before the financial crisis
■We’ve got to prop up the big banks
■We’ve got to protect the bondholders against suffering big losses
■The government has prosecuted the financial fraud which it has discovered, but it’s hard to make out a case against most of Wall Street’s acts
■The economy always returns to equilibrium and stability by itself
Obama’s belief that unemployment is good for the economy, and Greenspan’s belief that too little debt is bad for the country are also ridiculous.
But the most dangerous myth – because a lot of economic policy is based upon it, and because so few know that it is false – is the myth about how banks make loans.
The Myth that Private Debt Doesn’t Matter
Before we can address the myth about how banks make loans – and as a way to understand the deadly effect of that misconception, we need to talk about debt.
As economics professor Steve Keen documents in his must-read book, Debunking Economics: The Naked Emperor Dethroned, mainstream economists – from both the left and the right – don’t even take debt into consideration in their models of what makes for healthy economies.
As Keen noted in September:
The vast majority of economists were taken completely by surprise by this crisis—including not just … the ubiquitous “market economists” that pepper the evening news, but the big fish of academic, professional and regulatory economics as well.
***
Why did conventional economists not see this crisis coming, while I and a handful of non-orthodox economists did [?] Because we focus upon the role of private debt, while they, for three main reasons, ignore it:
***
They believed that the level of private debt—and therefore also its rate of change—had no major macroeconomic significance:
***
Finally, the most remarkable reason of all is that debt, money and the financial system itself play no role in conventional neoclassical economic models. Many non-economists expect economists to be experts on money, but the belief that money is merely a “veil over barter”—and that therefore the economy can be modeled without taking into account money and how it is created—is fundamental to neoclassical economics. Only economic dissidents from other schools of thought … take money seriously, and only a handful of them—including myself (Steve Keen, 2010; http://www.economics-ejournal.org/economics/journalarticles/2010-31)—formally model money creation in their macroeconomics.
Even the most “avant-garde” of neoclassical economists … have only just begun to consider the role that debt might play in the economy ….
In other words, most economists think that debt – and our money system – don’t matter.
(Don’t freak out … this essay does not argue for ruthless austerity for Mom and Pop on Main Street. Virtually all of the economists we quote stress that the bondholders bad debt must be written down. And this post also focuses on private – rather than public – debt.)
For example, The economists who have the most influence over government policy – such as Ben Bernanke and Paul Krugman – think that the amount of private debt is totally irrelevant to the health of the economy:
Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects… (Bernanke 2000, p. 24)
***
Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth — one person’s liability is another person’s asset…
In what follows, we begin by setting out a flexible-price endowment model in which “impatient” agents borrow from “patient” agents, but are subject to a debt limit. If this debt limit is, for some reason, suddenly reduced, the impatient agents are forced to cut spending… (Krugman and Eggertsson 2010, p. 3)
***
People think of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.
That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. (Krugman 2011)
Specifically, Bernanke and Krugman assume that huge levels of household debt don’t hurt the economy because more debt among households just means that savers have loaned them money … i.e. that it is a net wash to the economy.
To make this assumption, they rely on the myth that banks can only loan as much money out as they have in deposits. In other words, they assume that if bank customer John Doe has $100 in the bank, then the bank can loan that $100 to someone else.
But as Keen notes, banks actually loan out money whether or not they have enough in deposits … and then borrow the shortfall from the Fed or other sources.
Keen therefore says that it is not a wash … and that high levels of private debt are the cause of the current economic crisis.
I wrote to L. Randall Wray to get his view on who is right. Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri–Kansas City. Wray is one of the country’s top experts on money creation.
Wray is the author of Money and Credit in Capitalist Economies, 1990, and Understanding Modern Money: The Key to Full Employment and Price Stability, 1998. He is also coeditor of, and a contributor to, Money, Financial Instability, and Stabilization Policy, 2006, and Keynes for the 21st Century: The Continuing Relevance of The General Theory, 2008.
I asked Wray:
As you might have heard – Paul Krugman argues that banks only loan out based upon their deposits, while Steve Keen argues that loans are created through double entry bookkeeping, so that money is created endogenously [i.e. banks create their own money].
For example, here is Scott Fullwiler’s (Associate Professor of Economics and James A. Leach Chair in Banking and Monetary Economics at Wartburg College) take on the debate: http://www.nakedcapitalism.com/2012/04/scott-fullwiler-krugmans-flashing-neon-sign.html Or summary
here: http://unlearningeconomics.wordpress.com/2012/04/03/the-keenkrugman-debate-a-summary/
As a leading expert on modern monetary theory, who do you think is right? Do banks need deposits before they can lend … or do they lend regardless of deposits, and only bounded by reserve and capital requirements (or access to Fed monies)?
Wray responded:
Bank deposits are bank IOUs; an IOU can only come from the issuer. Where do your IOUs come from? Do you borrow them? NO. [Professor] Scott [Fullwiler] is right, Krugman does not know what he is talking about.
Indeed, economics professor and money expert Fullwiler says that Krugman should wear a flashing neon sign saying “I don’t know what I’m talking about”, and explains:
As is well known, and by the logic of double-entry accounting, the bank does make a loan out of thin air—no prior deposits or reserves necessary.
***
[Krugman writes:]
And currency is in limited supply — with the limit set by Fed decisions.
This statement is simply mindboggling. It’s so wrong I don’t know where to begin. The Fed NEVER limits the supply of currency. Never. Ever. To do otherwise would be to violate its mandate in the Federal Reserve Act to provide for an elastic currency and maintain stability of the payments system.
Economics professor Michael Hudson also slams Krugman for having a blindspot on debt:
Mr. Krugman’s failure to see today’s economic problem as one of debt deflation reflects his failure (suffered by most economists, to be sure) to recognize the need for debt writedowns, for restructuring the banking and financial system, and for shifting taxes off labor back onto property, economic rent and asset-price (“capital”) gains. The effect of his narrow set of recommendations is to defend the status quo – and for my money, despite his reputation as a liberal, that makes Mr. Krugman a conservative. I see little in his logic that would oppose Rubinomics, which has remained the Democratic Party’s program under the Obama administration.
***
Mr. Krugman got lost in the black hole of banking, finance and international trade theory that has engulfed so many neoclassical and old-style Keynesian economists. Last month Mr. Krugman insisted that banks do not create credit, except by borrowing reserves that (in his view) merely shifts lending savings from wealthy people to those with a higher propensity to consume. Criticizing Steve Keen (who has just published a second edition of his excellent Debunking Economics to explain the dynamics of endogenous money creation), he wrote:
Keen then goes on to assert that lending is, by definition (at least as I understand it), an addition to aggregate demand. I guess I don’t get that at all. If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand.Keen says that it’s because once you include banks, lending increases the money supply. OK, but why does that matter? He seems to assume that aggregate demand can’t increase unless the money supply rises, but that’s only true if the velocity of money is fixed;
But “velocity” is just a dummy variable to “balance” any given equation – a tautology, not an analytic tool. As a neoclassical economist, Mr. Krugman is unwilling to acknowledge that banks not only create credit; in doing so, they create debt. That is the essence of balance sheet accounting. But … Krugman offers the mythology of banks that can only lend out money taken in from depositors (as though these banks were good old-fashioned savings banks or S&Ls, not what Mr. Keen calls “endogenous money creators”). Banks create deposits electronically in the process of making loans.
***
Said Krugman:
First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.***
There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect.
***
The problem with Mr. Krugman’s analysis is that bank debt creation plays no analytic role in Mr. Krugman’s proposals to rescue the economy. It is as if the economy operates without wealth or debt, simply on the basis of spending power flowing into the economy from the government, and being spent on consumer goods, investment goods and taxes – not on debt service, pension fund set-asides or asset price inflation. If the government will spend enough – run up a large enough deficit to pump money into the spending stream, Keynesian-style – the economy can revive by enough to “earn its way out of debt.” The assumption is that the government will revive the economy on a broad enough scale to enable the individuals who owe the mortgages, student loans and other debts – and presumably even the states and localities that have fallen behind in their pension plan funding – to “catch up.”
Without recognizing the role of debt and taking into account the magnitude of negative equity and earnings shortfalls, one cannot see that what is preventing American industry from exporting more is the heavy debt overhead that diverts income to pay the Finance, Insurance and Real Estate (FIRE) sector. How can U.S. labor compete with foreign labor when employees and their employers are obliged to pay such high mortgage debt for its housing, such high student debt for its education, such high medical insurance and Social Security (FICA withholding), such high credit-card debt – all this even before spending on goods and services?
In fact, how can wage earners even afford to buy what they produce?
Banks DO, In Fact, Create Money Out of Thin Air
If you’re still not convinced that banks create money out of thin air, without regard to whether or not they have deposits on hand, please note that the Fed has said as much.
For example, a 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics” said:
[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.
Moreover:
(1) William C. Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, said in a speech in July 2009:
Based on how monetary policy has been conducted for several decades, banks have always had the ability to expand credit whenever they like. They don’t need a pile of “dry tinder” in the form of excess reserves to do so. That is because the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference.
(2) On February 10, 2010, Ben Bernanke proposed the elimination of all reserve requirements
The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.
Under the current fractional reserve banking system, banks can loan out many times reserves. But even that system is being turned into a virtually infinite printing press for banks.
Germany’s central bank – the Deutsche Bundesbank (German for German Federal Bank) – has also admitted in writing that banks create credit out of thin air.
And there’s an overwhelming amount of additional proof:
As PhD economist Steve Keen pointed out recently, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true:
The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.
The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.
Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.
Kydland and Prescott observed at the end of their paper that:
Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.
In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.
Keen explained in an interview Friday that 25 years of research shows that creation of debt by banks precedes creation of government money, and that debt money is created first and precedes creation of credit money.
As Mish has previously noted:
Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.
This angle of the banking system has actually been discussed for many years by leading experts:
“The process by which banks create money is so simple that the mind is repelled.”
- Economist John Kenneth Galbraith
“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.“
- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report
“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”
-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.
“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.”
- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.
I’ve also noted:
In First National Bank v. Daly (often referred to as the “Credit River” case) the court found that the bank created money “out of thin air”:
[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.
The court also held:
The money and credit first came into existence when they [the bank] created it.
(Here’s the case file).
Justice courts are just local courts, and not as powerful or prestigious as state supreme courts, for example. And it was not a judge, but a justice of the peace who made the decision.
But what is important is that the president of the First National Bank of Montgomery apparently admitted that his bank created money by simply making an entry in its book …
Moreover, although it is counter-intuitive, virtually all money is actually created as debt. For example, in a hearing held on September 30, 1941 in the House Committee on Banking and Currency, then-Chairman of the Federal Reserve (Mariner S. Eccles) said:
That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.
And Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, said:
If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.
Indeed, even Paul Krugman admits that “banks can create inside money”. Inside money is “debt that is used as money”.
Why Is The Myth About Banks So Dangerous?
Even if banks don’t really loan based on their deposits and reserves, who cares? Why is this such a dangerous myth?
Because, if banks don’t make loans based on available deposits or reserves, that means:
(1) This was never a liquidity crisis, but rather a solvency crisis. In other words, it was not a lack of available liquid funds which got the banks in trouble, it was the fact that they speculated and committed fraud, so that their liabilities far exceeded their assets. The government has been fighting the wrong battle, and has made the economic situation worse.
(2) The giant banks are not needed, as the federal, state or local governments or small local banks and credit unions can create the credit instead, if the near-monopoly power the too big to fails are enjoying is taken away, and others are allowed to fill the vacuum.
Indeed, the big banks do very little traditional banking. Most of their business is from financial speculation. For example, less than 10% of Bank of America’s assets come from traditional banking deposits.
Time Magazine gave some historical perspective in 1993:
What would happen to the U.S. economy if all its commercial banks suddenly closed their doors? Throughout most of American history, the answer would have been a disaster of epic proportions, akin to the Depression wrought by the chain-reaction bank failures in the early 1930s. But [today] the startling answer is that a shutdown by banks might be far from cataclysmic.
***
Who really needs banks these days? Hardly anyone, it turns out. While banks once dominated business lending, today nearly 80% of all such loans come from nonbank lenders like life insurers, brokerage firms and finance companies. Banks used to be the only source of money in town. Now businesses and individuals can write checks on their insurance companies, get a loan from a pension fund, and deposit paychecks in a money-market account with a brokerage firm. “It is possible for banks to die and still have a vibrant economy,” says Edward Furash, a Washington banks consultant.
So we the government has been barking up the wrong tree by propping up the big banks.
Moreover, as discussed above, the fact that banks can create money means that the level of private debt does matter … and economists like Bernanke and Krugman who encourage massive levels of private debt are hurting the economy.
As professor Keen explains:
In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt, with the change in debt spending new money into existence in the economy. This is then spent not only goods and services, but on financial assets as well—shares and property. Changes in the level of debt therefore have direct and potentially enormous impacts on the macroeconomy and asset markets, as the GFC—which was predicted only by a handful of credit-aware economists (Bezemer 2009)—made abundantly clear.
If the change in debt is roughly equivalent to the growth in income—as applied in Australia from 1945 to 1965, when the private debt to GDP ratio fluctuated around 25 per cent (see Figure 1)—then nothing is amiss: the increase in debt mainly finances investment, investment causes incomes to grow, and the economy moves forward in a virtuous feedback cycle. But when debt rises faster than income, and finances not just investment but also speculation on asset prices, the virtuous cycle gives way to a vicious positive feedback process: asset prices rise when debt rises faster than income, and this encourages more borrowing still.
The result is a superficial economic boom driven by a debt-financed bubble in asset prices. To sustain a rise in asset prices relative to consumer prices, debt has to grow more rapidly than income—in other words, if asset prices are to rise faster than consumer prices, then rather than merely rising, debt has to accelerate. This in turn guarantees that the asset price bubble will burst at some point, because debt can’t accelerate forever. When debt growth slows, a boom can turn into a slump even if the rate of growth of GDP remains constant.
This process is easily illustrated in a numerical example. Consider an economy with a GDP of $1 trillion that is growing at 10% per annum, with real growth of 5% and inflation of 5%, and in which private debt is $1.25 trillion and growing at 20% p.a. Total spending on both goods & services and financial assets is therefore $1.25 trillion: $1 trillion is financed by income, and $250 billion is financed by the 20% increase in debt.
In the following year, if the growth of debt simply slows down to the same rate at which nominal GDP is growing (without affecting the rate of economic growth), then the growth in debt will be $150 billion (10% of the $1.5 trillion level reached at the end of the previous year). Total spending will therefore be exactly the same as the year before: $1.25 trillion, consisting of $1.1 trillion in GDP plus a $150 billion growth in debt. However, since inflation is running at 5%, this amounts to a 5% fall in the real level of economic activity—which would be spread across both commodity and asset markets.
If instead the growth of debt stopped, then total spending the next year will be $1.1 trillion, a 15% fall from the level of the previous year in nominal terms, and 20% in real terms. This would cause a massive slump in demand for goods & services, assets, or both, even without a slowdown in the rate of growth of GDP.
This hypothetical example is not far removed from the actual experience of the GFC. As the US experience illustrates most clearly, the switch from rising to falling private debt ushered in the biggest economic downturn since the Great Depression, a prolonged period of high unemployment, and sharp falls in asset markets—all of which are plotted in Figure 3.
Figure 3
This is why the shift from the Age of Leverage to the Age of Deleveraging was so dramatic, and yet so unforeseen by conventional economists: it was caused by a huge reduction in aggregate demand from a factor they ignore. This debt-induced reduction in aggregate demand will persist as long as private debt levels are falling—as they still are in the USA, though at a much reduced rate from the peak rate of fall in early 2010.
In 2008, the Bank for International Settlements (BIS) – often described as the central bank for central banks – said that failing to force companies to write off bad debts “will only make things worse”.
Indeed, Bernanke, Krugman and other mainstream economists from the left and the right who encourage more private debt are only creating a debt trap … where people take on new debt to try to pay for the old debt, and end up in a worse situation than they started:
http://www.washingtonsblog.com/2012/06/the-biggest-myth-preventing-an-economic-recovery.html
There are many widespread myths preventing an economic recovery, including the following myths:
■Military spending stimulates the economy
■The banks are acting more conservatively now than before the financial crisis
■We’ve got to prop up the big banks
■We’ve got to protect the bondholders against suffering big losses
■The government has prosecuted the financial fraud which it has discovered, but it’s hard to make out a case against most of Wall Street’s acts
■The economy always returns to equilibrium and stability by itself
Obama’s belief that unemployment is good for the economy, and Greenspan’s belief that too little debt is bad for the country are also ridiculous.
But the most dangerous myth – because a lot of economic policy is based upon it, and because so few know that it is false – is the myth about how banks make loans.
The Myth that Private Debt Doesn’t Matter
Before we can address the myth about how banks make loans – and as a way to understand the deadly effect of that misconception, we need to talk about debt.
As economics professor Steve Keen documents in his must-read book, Debunking Economics: The Naked Emperor Dethroned, mainstream economists – from both the left and the right – don’t even take debt into consideration in their models of what makes for healthy economies.
As Keen noted in September:
The vast majority of economists were taken completely by surprise by this crisis—including not just … the ubiquitous “market economists” that pepper the evening news, but the big fish of academic, professional and regulatory economics as well.
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Why did conventional economists not see this crisis coming, while I and a handful of non-orthodox economists did [?] Because we focus upon the role of private debt, while they, for three main reasons, ignore it:
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They believed that the level of private debt—and therefore also its rate of change—had no major macroeconomic significance:
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Finally, the most remarkable reason of all is that debt, money and the financial system itself play no role in conventional neoclassical economic models. Many non-economists expect economists to be experts on money, but the belief that money is merely a “veil over barter”—and that therefore the economy can be modeled without taking into account money and how it is created—is fundamental to neoclassical economics. Only economic dissidents from other schools of thought … take money seriously, and only a handful of them—including myself (Steve Keen, 2010; http://www.economics-ejournal.org/economics/journalarticles/2010-31)—formally model money creation in their macroeconomics.
Even the most “avant-garde” of neoclassical economists … have only just begun to consider the role that debt might play in the economy ….
In other words, most economists think that debt – and our money system – don’t matter.
(Don’t freak out … this essay does not argue for ruthless austerity for Mom and Pop on Main Street. Virtually all of the economists we quote stress that the bondholders bad debt must be written down. And this post also focuses on private – rather than public – debt.)
For example, The economists who have the most influence over government policy – such as Ben Bernanke and Paul Krugman – think that the amount of private debt is totally irrelevant to the health of the economy:
Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects… (Bernanke 2000, p. 24)
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Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth — one person’s liability is another person’s asset…
In what follows, we begin by setting out a flexible-price endowment model in which “impatient” agents borrow from “patient” agents, but are subject to a debt limit. If this debt limit is, for some reason, suddenly reduced, the impatient agents are forced to cut spending… (Krugman and Eggertsson 2010, p. 3)
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People think of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.
That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. (Krugman 2011)
Specifically, Bernanke and Krugman assume that huge levels of household debt don’t hurt the economy because more debt among households just means that savers have loaned them money … i.e. that it is a net wash to the economy.
To make this assumption, they rely on the myth that banks can only loan as much money out as they have in deposits. In other words, they assume that if bank customer John Doe has $100 in the bank, then the bank can loan that $100 to someone else.
But as Keen notes, banks actually loan out money whether or not they have enough in deposits … and then borrow the shortfall from the Fed or other sources.
Keen therefore says that it is not a wash … and that high levels of private debt are the cause of the current economic crisis.
I wrote to L. Randall Wray to get his view on who is right. Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri–Kansas City. Wray is one of the country’s top experts on money creation.
Wray is the author of Money and Credit in Capitalist Economies, 1990, and Understanding Modern Money: The Key to Full Employment and Price Stability, 1998. He is also coeditor of, and a contributor to, Money, Financial Instability, and Stabilization Policy, 2006, and Keynes for the 21st Century: The Continuing Relevance of The General Theory, 2008.
I asked Wray:
As you might have heard – Paul Krugman argues that banks only loan out based upon their deposits, while Steve Keen argues that loans are created through double entry bookkeeping, so that money is created endogenously [i.e. banks create their own money].
For example, here is Scott Fullwiler’s (Associate Professor of Economics and James A. Leach Chair in Banking and Monetary Economics at Wartburg College) take on the debate: http://www.nakedcapitalism.com/2012/04/scott-fullwiler-krugmans-flashing-neon-sign.html Or summary
here: http://unlearningeconomics.wordpress.com/2012/04/03/the-keenkrugman-debate-a-summary/
As a leading expert on modern monetary theory, who do you think is right? Do banks need deposits before they can lend … or do they lend regardless of deposits, and only bounded by reserve and capital requirements (or access to Fed monies)?
Wray responded:
Bank deposits are bank IOUs; an IOU can only come from the issuer. Where do your IOUs come from? Do you borrow them? NO. [Professor] Scott [Fullwiler] is right, Krugman does not know what he is talking about.
Indeed, economics professor and money expert Fullwiler says that Krugman should wear a flashing neon sign saying “I don’t know what I’m talking about”, and explains:
As is well known, and by the logic of double-entry accounting, the bank does make a loan out of thin air—no prior deposits or reserves necessary.
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[Krugman writes:]
And currency is in limited supply — with the limit set by Fed decisions.
This statement is simply mindboggling. It’s so wrong I don’t know where to begin. The Fed NEVER limits the supply of currency. Never. Ever. To do otherwise would be to violate its mandate in the Federal Reserve Act to provide for an elastic currency and maintain stability of the payments system.
Economics professor Michael Hudson also slams Krugman for having a blindspot on debt:
Mr. Krugman’s failure to see today’s economic problem as one of debt deflation reflects his failure (suffered by most economists, to be sure) to recognize the need for debt writedowns, for restructuring the banking and financial system, and for shifting taxes off labor back onto property, economic rent and asset-price (“capital”) gains. The effect of his narrow set of recommendations is to defend the status quo – and for my money, despite his reputation as a liberal, that makes Mr. Krugman a conservative. I see little in his logic that would oppose Rubinomics, which has remained the Democratic Party’s program under the Obama administration.
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Mr. Krugman got lost in the black hole of banking, finance and international trade theory that has engulfed so many neoclassical and old-style Keynesian economists. Last month Mr. Krugman insisted that banks do not create credit, except by borrowing reserves that (in his view) merely shifts lending savings from wealthy people to those with a higher propensity to consume. Criticizing Steve Keen (who has just published a second edition of his excellent Debunking Economics to explain the dynamics of endogenous money creation), he wrote:
Keen then goes on to assert that lending is, by definition (at least as I understand it), an addition to aggregate demand. I guess I don’t get that at all. If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand. Yes, in some (many) cases lending is associated with higher demand, because resources are being transferred to people with a higher propensity to spend; but Keen seems to be saying something else, and I’m not sure what. I think it has something to do with the notion that creating money = creating demand, but again that isn’t right in any model I understand.Keen says that it’s because once you include banks, lending increases the money supply. OK, but why does that matter? He seems to assume that aggregate demand can’t increase unless the money supply rises, but that’s only true if the velocity of money is fixed;
But “velocity” is just a dummy variable to “balance” any given equation – a tautology, not an analytic tool. As a neoclassical economist, Mr. Krugman is unwilling to acknowledge that banks not only create credit; in doing so, they create debt. That is the essence of balance sheet accounting. But … Krugman offers the mythology of banks that can only lend out money taken in from depositors (as though these banks were good old-fashioned savings banks or S&Ls, not what Mr. Keen calls “endogenous money creators”). Banks create deposits electronically in the process of making loans.
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Said Krugman:
First of all, any individual bank does, in fact, have to lend out the money it receives in deposits. Bank loan officers can’t just issue checks out of thin air; like employees of any financial intermediary, they must buy assets with funds they have on hand.***
There are vehement denials of the proposition that banks’ lending is limited by their deposits, or that the monetary base plays any important role; banks, we’re told, hold hardly any reserves (which is true), so the Fed’s creation or destruction of reserves has no effect.
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The problem with Mr. Krugman’s analysis is that bank debt creation plays no analytic role in Mr. Krugman’s proposals to rescue the economy. It is as if the economy operates without wealth or debt, simply on the basis of spending power flowing into the economy from the government, and being spent on consumer goods, investment goods and taxes – not on debt service, pension fund set-asides or asset price inflation. If the government will spend enough – run up a large enough deficit to pump money into the spending stream, Keynesian-style – the economy can revive by enough to “earn its way out of debt.” The assumption is that the government will revive the economy on a broad enough scale to enable the individuals who owe the mortgages, student loans and other debts – and presumably even the states and localities that have fallen behind in their pension plan funding – to “catch up.”
Without recognizing the role of debt and taking into account the magnitude of negative equity and earnings shortfalls, one cannot see that what is preventing American industry from exporting more is the heavy debt overhead that diverts income to pay the Finance, Insurance and Real Estate (FIRE) sector. How can U.S. labor compete with foreign labor when employees and their employers are obliged to pay such high mortgage debt for its housing, such high student debt for its education, such high medical insurance and Social Security (FICA withholding), such high credit-card debt – all this even before spending on goods and services?
In fact, how can wage earners even afford to buy what they produce?
Banks DO, In Fact, Create Money Out of Thin Air
If you’re still not convinced that banks create money out of thin air, without regard to whether or not they have deposits on hand, please note that the Fed has said as much.
For example, a 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics” said:
[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.
Moreover:
(1) William C. Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, said in a speech in July 2009:
Based on how monetary policy has been conducted for several decades, banks have always had the ability to expand credit whenever they like. They don’t need a pile of “dry tinder” in the form of excess reserves to do so. That is because the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference.
(2) On February 10, 2010, Ben Bernanke proposed the elimination of all reserve requirements
The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.
Under the current fractional reserve banking system, banks can loan out many times reserves. But even that system is being turned into a virtually infinite printing press for banks.
Germany’s central bank – the Deutsche Bundesbank (German for German Federal Bank) – has also admitted in writing that banks create credit out of thin air.
And there’s an overwhelming amount of additional proof:
As PhD economist Steve Keen pointed out recently, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true:
The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.
The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.
Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.
Kydland and Prescott observed at the end of their paper that:
Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.
In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.
Keen explained in an interview Friday that 25 years of research shows that creation of debt by banks precedes creation of government money, and that debt money is created first and precedes creation of credit money.
As Mish has previously noted:
Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.
This angle of the banking system has actually been discussed for many years by leading experts:
“The process by which banks create money is so simple that the mind is repelled.”
- Economist John Kenneth Galbraith
“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.“
- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report
“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”
-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)
“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”
- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.
“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.”
- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.
I’ve also noted:
In First National Bank v. Daly (often referred to as the “Credit River” case) the court found that the bank created money “out of thin air”:
[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.
The court also held:
The money and credit first came into existence when they [the bank] created it.
(Here’s the case file).
Justice courts are just local courts, and not as powerful or prestigious as state supreme courts, for example. And it was not a judge, but a justice of the peace who made the decision.
But what is important is that the president of the First National Bank of Montgomery apparently admitted that his bank created money by simply making an entry in its book …
Moreover, although it is counter-intuitive, virtually all money is actually created as debt. For example, in a hearing held on September 30, 1941 in the House Committee on Banking and Currency, then-Chairman of the Federal Reserve (Mariner S. Eccles) said:
That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.
And Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, said:
If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.
Indeed, even Paul Krugman admits that “banks can create inside money”. Inside money is “debt that is used as money”.
Why Is The Myth About Banks So Dangerous?
Even if banks don’t really loan based on their deposits and reserves, who cares? Why is this such a dangerous myth?
Because, if banks don’t make loans based on available deposits or reserves, that means:
(1) This was never a liquidity crisis, but rather a solvency crisis. In other words, it was not a lack of available liquid funds which got the banks in trouble, it was the fact that they speculated and committed fraud, so that their liabilities far exceeded their assets. The government has been fighting the wrong battle, and has made the economic situation worse.
(2) The giant banks are not needed, as the federal, state or local governments or small local banks and credit unions can create the credit instead, if the near-monopoly power the too big to fails are enjoying is taken away, and others are allowed to fill the vacuum.
Indeed, the big banks do very little traditional banking. Most of their business is from financial speculation. For example, less than 10% of Bank of America’s assets come from traditional banking deposits.
Time Magazine gave some historical perspective in 1993:
What would happen to the U.S. economy if all its commercial banks suddenly closed their doors? Throughout most of American history, the answer would have been a disaster of epic proportions, akin to the Depression wrought by the chain-reaction bank failures in the early 1930s. But [today] the startling answer is that a shutdown by banks might be far from cataclysmic.
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Who really needs banks these days? Hardly anyone, it turns out. While banks once dominated business lending, today nearly 80% of all such loans come from nonbank lenders like life insurers, brokerage firms and finance companies. Banks used to be the only source of money in town. Now businesses and individuals can write checks on their insurance companies, get a loan from a pension fund, and deposit paychecks in a money-market account with a brokerage firm. “It is possible for banks to die and still have a vibrant economy,” says Edward Furash, a Washington banks consultant.
So we the government has been barking up the wrong tree by propping up the big banks.
Moreover, as discussed above, the fact that banks can create money means that the level of private debt does matter … and economists like Bernanke and Krugman who encourage massive levels of private debt are hurting the economy.
As professor Keen explains:
In a credit-based economy, aggregate demand is therefore the sum of income plus the change in debt, with the change in debt spending new money into existence in the economy. This is then spent not only goods and services, but on financial assets as well—shares and property. Changes in the level of debt therefore have direct and potentially enormous impacts on the macroeconomy and asset markets, as the GFC—which was predicted only by a handful of credit-aware economists (Bezemer 2009)—made abundantly clear.
If the change in debt is roughly equivalent to the growth in income—as applied in Australia from 1945 to 1965, when the private debt to GDP ratio fluctuated around 25 per cent (see Figure 1)—then nothing is amiss: the increase in debt mainly finances investment, investment causes incomes to grow, and the economy moves forward in a virtuous feedback cycle. But when debt rises faster than income, and finances not just investment but also speculation on asset prices, the virtuous cycle gives way to a vicious positive feedback process: asset prices rise when debt rises faster than income, and this encourages more borrowing still.
The result is a superficial economic boom driven by a debt-financed bubble in asset prices. To sustain a rise in asset prices relative to consumer prices, debt has to grow more rapidly than income—in other words, if asset prices are to rise faster than consumer prices, then rather than merely rising, debt has to accelerate. This in turn guarantees that the asset price bubble will burst at some point, because debt can’t accelerate forever. When debt growth slows, a boom can turn into a slump even if the rate of growth of GDP remains constant.
This process is easily illustrated in a numerical example. Consider an economy with a GDP of $1 trillion that is growing at 10% per annum, with real growth of 5% and inflation of 5%, and in which private debt is $1.25 trillion and growing at 20% p.a. Total spending on both goods & services and financial assets is therefore $1.25 trillion: $1 trillion is financed by income, and $250 billion is financed by the 20% increase in debt.
In the following year, if the growth of debt simply slows down to the same rate at which nominal GDP is growing (without affecting the rate of economic growth), then the growth in debt will be $150 billion (10% of the $1.5 trillion level reached at the end of the previous year). Total spending will therefore be exactly the same as the year before: $1.25 trillion, consisting of $1.1 trillion in GDP plus a $150 billion growth in debt. However, since inflation is running at 5%, this amounts to a 5% fall in the real level of economic activity—which would be spread across both commodity and asset markets.
If instead the growth of debt stopped, then total spending the next year will be $1.1 trillion, a 15% fall from the level of the previous year in nominal terms, and 20% in real terms. This would cause a massive slump in demand for goods & services, assets, or both, even without a slowdown in the rate of growth of GDP.
This hypothetical example is not far removed from the actual experience of the GFC. As the US experience illustrates most clearly, the switch from rising to falling private debt ushered in the biggest economic downturn since the Great Depression, a prolonged period of high unemployment, and sharp falls in asset markets—all of which are plotted in Figure 3.
Figure 3
In 2008, the Bank for International Settlements (BIS) – often described as the central bank for central banks – said that failing to force companies to write off bad debts “will only make things worse”.
Indeed, Bernanke, Krugman and other mainstream economists from the left and the right who encourage more private debt are only creating a debt trap … where people take on new debt to try to pay for the old debt, and end up in a worse situation than they started:
http://www.washingtonsblog.com/2012/06/the-biggest-myth-preventing-an-economic-recovery.html
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