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Sunday, February 15, 2009

Illicit Interest Arbitrage

There's one specific type of financial crime called "Illicit Interest Arbitrage". It's the bread-and-butter of the financial industry.

Illicit Arbitrage is any situation where you can buy at the bid and sell at the offer, without taking any risk. There is legitimate arbitrage, where the arbitrageur is taking on a degree of risk. There is also electronic arbitrage, where the arbitrageur makes his profit by being a fraction of a second faster than everyone else, exploiting small price differences.

Banks have a unique perk that nobody else gets. The can borrow from the Federal Reserve at the Fed Funds Rate, currently 0%-0.25%. There are net capital requirements, but essentially banks can borrow as much as they want at the Fed Funds Rate. This is a massive subsidy to the financial industry, paid by everyone else as inflation. Banks can borrow at the bid of 0% and lend at the offer, which is always a few percentage points higher than the Fed Funds Rate.

Everyone other than a bank who wishes to borrow must borrow from a bank. Non-banks aren't allowed to borrow directly from the Federal Reserve at the Fed Funds Rate. This allows banks to tack on fees and charges. They can borrow at the bid rate of 0% and lend at the offer rate. They collect this spread, without performing any work.

Why doesn't the spread collapse to zero? Why aren't all loans offered at the Fed Funds Rate? The reason is government regulation. The government regulates how much leverage can be used for each type of loan. This affects the relative price of each type of loan. Plus, when the debtor is considered "uncreditworthy", banks will charge more, and government regulations allow less leverage to be used when loaning to less creditworthy debtors.

Banks get a unique perk that nobody else gets. Banks may borrow at the Fed Funds Rate. A bank borrows at the Fed Funds Rate and purchases bonds or tangible assets. In this manner, large banks make a practically guaranteed riskless profit. Due to the Compound Interest Paradox, there is a periodic bust and credit crisis. Small banks and small businesses may be ruined during the bust cycle. Individuals and small businesses are tempted into loading up on debt during the boom. Large banks and large corporations are "too big to fail" and almost always qualify for a bailout. Even if a CEO mismanages a large bank, he suffers no negative personal consequences. He gets to keep his huge salary and bonuses. Due to his connections, a CEO can always find another cushy job.

The USA follows a form of reverse socialism. When the average person makes a bad investment decision, he loses everything. When politically connected insiders make bad investment decisions, they qualify for a bailout and can easily find a new job.

The US monetary system is biased against individuals and small business owners, and is biased in favor of politically connected insiders.


fritz said...

I wonder how it was made illegal to use silver and gold as money. That would be a great starting point for agorism. Maybe we could use tally sticks, or wompum. Anything but federal reserve notes. Next would be some small private banks. That would be a nice start.


robert30062 said...

I really like Fritz's blogger picture, ole' Robert Edward. :) I just stopped by to say hi. I have some thoughts on logistics that I think we really need to address. We are pretty good at conceptualizing what good and bad but there isn't that much emphasis on how we get to where we want to be. We need to come up with institutionalized methods of freeing people of their pro-state brainwashing with specific things to say. Starting with perhaps "Tactic 1" or something. I think that starting groups including other activities could be a great way to bring people together toward agorism, maybe something involving sports or gaming. What do you think FSK, Fritz? As always though, f**k the Fed!!


fritz said...

Good idea Robert. But I think right now the most important thing is just plain old exposure. And of course developing your own personal network of free trading partners.
Most people won't buck the system right now because they have a place to live ,a job, and some food,and money for a few toys and entertainment. Most folks believe its better to go with the devil you know instead of tempting the devil you don't. you know,better safe than sorry.

Most important right now would be to educate people. Mainly of their rights as free people,the evils of state control,and the pros about the free market.

And practice trade using anything but federal reserve notes when ever possible.

I have often thought...instead of all this talk lets start action....But I can't think of a strategy for a phase 1 movement(except education) I tell you what, I will put that in my mind as a working task. And see what I come up with in my dream state. I get great ideas from the dream world. You do the same thing Robert, and we will meet back here with some ideas for possible plans for early stage development.

think in and out of the box, and in terms of peaceful actions to be taken.


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