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Wednesday, October 28, 2009

Financial System "Reform"

I was watching the Communism Channel, and they were all excited about Ben Bernanke and President Obama and Congress saying "We need to overhaul the financial industry regulations."

They also were saying "We need to limit CEO pay at all banks that received Federal bailout money."

Here's a quick quiz to see if you're paying attention. If you know the correct answer to this question, then you know more about economics than every Nobel Communism Prize winner!

Q: Which banks have received Federal bailout money?


Q: Which banks have received Federal bailout money?

A: All banks, all the time.

The comedians were saying "The financial industry is about 15%-20% of the S&P 500 by market capitalization. That's increased back to 'normal' levels." My reaction was "OMFG! The financial industry is leeching 15%-20% of all economic activity!"

Banksters don't earn their profits due to their l33t business skills. The profits of the banksters are economic rent. They are exploiting defects in the monetary system, rather than providing a useful good or service.

The banksters aren't brilliant risk-takers. When they gamble and are wrong, they get a bailout. When they gamble and are right, they get to keep the profits. The banksters are gambling with other people's money. If their gambles fail, they can declare bankruptcy and default. Via the concept of "too big to fail", they qualify for a bailout.

The Fed Funds Rate is currently 0%-0.25% while true inflation is 20%-30% or more. This is a humongous bailout to the banksters. Everyone else pays the cost via inflation. Almost all the time, the Fed Funds Rate is much less than true inflation. This is a continuous bailout to the banksters, even if no Federal bailout money is explicitly allocated.

The Federal Reserve has monopoly control of the monetary system. Federal Reserve insiders have the power to print as much money as desired and lend/give it to insiders. If you lend someone money at 0.25% interest, that's really a gift when true inflation is 20%-30% or more. The loan can be repaid with devalued money, making it a gift. An insider borrows at cheap rates, buys tangible assets, waits for inflation, then sells them and repays the loan with devalued money.

The Federal Reserve insiders wield tremendous economic power. Federal Reserve insiders may lend more money to some banks than other banks. They literally have the power to decide which banks go bankrupt, and which banks get bailed out. When the Federal Reserve lends money to a bank at cheap interest rates, there is no obligation to publicly disclose which banks got how much money. This is one of the things Ron Paul wants disclosed in his "Audit the Fed!" law.

Suppose that the CEO of a corporation sells a bond at 6% interest. The bank borrows at the Fed Funds Rate (currently 0%-0.25%) and lends the money to the corporation at 6%. The spread of 5.75% is illicit interest arbitrage for the bank. The bank uses leverage of 10x, 30x, or more, making this trade very profitable. If the CEO wants to borrow, he must go through the middleman of a bank. Only the banksters may borrow directly from the Federal Reserve at the Fed Funds Rate. The banksters earn a profit, but they do no real work; they're lending brand new money printed out of thin air.

Both the Fed Funds Rate and the 6% that the CEO pays are a negative real interest rate. This makes it very easy for the CEO to repay his loan. The banksters don't really have to evaluate risk. The loan rate is less than true inflation, which means that the borrower should have an easy time repaying it.

If I could sell a bond at 6% interest for 10 years, with payment not due for 10 years, then I could buy gold and be practically guaranteed to profit. I can't do this, because if I borrow to buy gold it's on margin. If the price of gold declines due to a temporary money supply shrinkage, I'll get a margin call and lose everything. Further, I have to pay a lot more than 6% if I want to borrow to buy gold.

It's in the rational self-interest of the CEO to borrow the money. The CEO borrows at 6% and builds a factory. True inflation is 20%-30%. The value of the factory will increase by 10%-15% per year, even if the return underperforms true inflation. The CEO profited, because he borrowed at 6% and bought a factory that increases in value by 10%-15% per year or more. The return of the factory was less than true inflation, but it's in the rational self-interest of the CEO to borrow and build the factory.

The incentive is for the bankster to load up on as much leverage as he can. The incentive is for the CEO to borrow as much as he can, because real interest rates are negative. Negative real interest rates encourage people to borrow as much as they can. It's just like government-subsidized oil prices would encourage people to use as much gasoline as they can.

Suppose there were no Federal Reserve interest rate subsidy. If interest rates were 25% and inflation were 20%, then it would only make sense to borrow for something useful. It would only make sense to borrow if the real return on the investment were 5%. With negative real interest rates, it was profitable for the CEO to borrow and build a factory, even though the real return on his investment was -5%. If interest rates are -15% and the return on investment is -5%, then you should borrow and build, profiting 10%. In this manner, negative real interest rates encourage the destruction of capital and wasteful spending.

A pro-State troll says "Fiat money is good! The CEO got to build a factory!" The fallacy is that the factory was built at the expense of something else. A factory was built at a loss of 5%. Instead, something else was not built. The CEO got a free factory, but I have trouble raising money to start my own business. My savings are stolen via inflation.

Only the CEO of a large bank may borrow at such favorable rates. If I wanted to borrow to invest in my blogging business, I can't. Google can borrow billions of dollars to buyout YouTube, but I have a hard time raising capital to start my own software business.

My savings are stolen via inflation, making it hard for me to raise capital to start my own business. It's hard for me to start a business via reinvested savings, because my savings are stolen via inflation. The nominal value of my stock market investments has declined by nearly 50% over the past few years. When you add in true inflation, a huge chunk of my savings were stolen. I had to actually work to acquire that wealth. This wealth didn't vanish into thin air. It wound up in the pockets of the banksters. The net effect is that some of my past labor was stolen from me.

When the banksters write a loan, they literally print brand new money and loan it to you. When the Federal government prints new money to bail out the banksters, that was also newly printed money. Technically, the Federal government does not print money. The Federal government printed Treasury Bonds, which were sold to the financial industry via the Federal Reserve. Then, the proceeds of those bond sales were used to bail out the banksters. The banksters profit both from the Treasury Bond sale and from the bailout.

Negative real interest rates are a Federal subsidy to the banking industry. Even with no explicit bailout, the banksters receive a continual government subsidy, due to their ability to borrow at artificially cheap rates. I can't borrow directly from the Federal Reserve at the Fed Funds Rate. If I want to borrow, I have to go through the middleman of a bank. If I want to borrow, I have to pay much higher rates than the banksters or CEOs, or I can't borrow at all. Via inflation, my savings are stolen and given to the banksters and CEOs.

Via adjusting the Fed Funds Rate, the Federal Reserve bails out banks even if there's no explicit Federal government bailout.

Let's consider an example. During the inflationary boom, suppose the Fed Funds Rate is 4% and mortgage rates are 6%. Banks use leverage of 30x or more. Banks borrow at 4%, lend at 6%, and with 30x leverage make a profit of 60%.

Suppose there's a mild recession. The default loss rate on loans is 3%. Instead of borrowing at 4% and lending at 6%, now the banksters are borrowing at 4% and lending at 3% (adjusted for defaults). Now, they are going bankrupt in a hurry. The Federal Reserve bails them out by lowering the Fed Funds Rate to 1%. Now, they're borrowing at 1% and lending at 3%. The profit equation is restored. Eventually, there's sufficient inflation that the mortgages are solvent again. The Fed Fund Rate is re-raised to 4%, setting up the next recession.

In a mild recession, some small banks, small corporations, and small businesses will go bankrupt. When the banksters foreclose, they take possession of real assets. Instead of immediately selling, they wait for the next inflationary boom to sell these assets at a profit.

Via Level 3 accounting, the banksters don't have to mark-to-market their devalued assets. If I borrow on margin to buy stock, then I get a margin call when the stock price goes down. When the banksters use excessive leverage, they aren't forced into bankruptcy when prices decline due to a recession/depression.

Suppose there's a severe recession/depression. The default loss rate on loans is 20%. Instead of borrowing at 4% and lending at 6%, now the banksters are borrowing at 4% and lending at -16% (adjusted for defaults). Now, they are going bankrupt in a real hurry.

There is a problem. The Federal Reserve can't lower nominal interest rates below 0%.

The solution is to bailout the banksters. Small banks and small corporations are allowed to fail. Individuals lose their homes and their jobs. Insiders get a bailout. The net effect of the recession is concentration of power in the hands of insiders.

What would happen if there were no bailout? The financial system would collapse in hyperdeflation. Completely insolvent, large banks could no longer issue new loans. Via the Compound Interest Paradox, the monetary system would collapse in hyperdeflation. Old loans would still be due, but no new loans would be issued. If the money supply crashes by 50%, it's like the outstanding balance due on all debt contracts were doubled.

Suppose you have a $900k mortgage on a $1M house. The value of your house crashes to $500k. One viewpoint is "The house lost half its value." Another viewpoint is "The value of the house is unchanged, but the amount due on your mortgage doubled. The real value of the house is not affected by the money supply." It's like the banksters said "HAHAHA!! You owe us twice as much on your mortgage now! Sucker!"

Via "rule of law", this illegitimate mortgage contract is enforced. Via State violence, you will be kicked out of your home if you can't pay your mortgage. Via State violence, the banksters get a bailout. The police who kick you out of your home for not paying your mortgage are really a private debt collection agency working for Goldman Sachs.

Reforming a corrupt system is not an alternative. A bailout is the only other possibility.

Suppose that Americans collectively have $2 trillion on deposit in banks. (I have no idea what the correct number is. I'll use $2 trillion.) There are no tangible assets backing that $2 trillion. It's all phony loans and one big pyramid scheme. The only reason that old loans can be repaid is that new loans are continually issued. With fiat money, there are literally *NO* tangible assets backing the money. The only reason your money is valuable is that other people can be conned into accepting it. The only reason fiat money is valuable is that the IRS demands people pay Federal Reserve Points whenever they work. The income tax creates an artificial demand for fiat money, even though it's intrinsically worthless.

If there were no bailout and large banks failed, then the scam would be exposed. People would refuse to keep their savings in banks. Instead, via direct and indirect bailouts, the Federal government and Federal Reserve promise to print enough new money to back bank deposits. The nominal value of your checking account is guaranteed by the State. However, the real purchasing power is stolen over time via inflation. An immediate 100% loss of your savings would be an obvious scam. The steady loss of 2%-3% per month via inflation goes unnoticed.

If police with guns came to your door once a month and demanded 2% of your property, you'd be very offended. With inflation, the same thing happens with no overt violence. There is occasional violence against people who attempt to use gold and silver as money, such as Robert Kahre, the Liberty Dollar, and E-Gold. The vast majority of people don't even think about using gold and silver as money, because State thugs assault anyone who starts using gold and silver as money.

Nominal interest rates can't be lowered below zero. Via deficit spending, the Federal government increases the inflation rate, lowering real interest rates further below zero.

Suppose a bank holds a mortgage for $1M on a house that has a current market value of $500k. The bank is $500k in the hole. Via excessive use of leverage, the bank doesn't just owe $500k; it owes $500k times a 30x or greater leverage ratio. If the bank had $10B in book value it probably had $300B in mortgages. When the mortgages drop in value by 50%, the bank didn't lose $5B. Via leverage, the bank lost $150B.

Suppose that, via deficit spending and bailouts, the Federal government doubles the money supply. Now, the house with a market value of $500k doubles in value to $1M. Instead of being insolvent, the bank is bailed out via inflation. Even if the bank didn't directly receive the stimulus money, the bank benefited from inflation.

Here are all the bailouts the banksters receive. Most of these bailouts occur all the time, even if there is no explicitly allocated Federal bailout money.

  1. Negative real interest rates are a continual subsidy to the banksters. The Fed Funds Rate is currently 0%-0.25% while real inflation is 20%-30% or more. This subsidizes bank profits, even with no explicit bailout.
  2. There was a weird program where banks could borrow at the Fed Funds Rate at 0%-0.25%, and then immediately place their reserves on deposit at the Federal Reserve for 1%. This is the "Banks get interest on excess reserves!" program the Federal Reserve was sponsoring. I never understood this. I'm not sure if this bit is correct.
  3. Nominal interest rates are almost always less than true inflation. This is a continual bailout for the banksters.
  4. Bailout money was specifically allocated to large banks via TARP. When professional comedians talk about "banks who received bailout money", they mean this.
  5. When a non-bank corporation is bailed out, the true beneficiaries are the creditors. When AIG/GM/FRE/FNM were bailed out, the true beneficiary was the creditors. Goldman Sachs purchased a lot of credit default swap insurance from AIG. Technically, AIG was bailed out, but the bailout money was immediately used to pay off Goldman Sachs. What should have happened was AIG was forced into bankruptcy, and then Goldman Sachs should have lost its credit default swap insurance bets. When you buy insurance, "risk of bankruptcy by insurer" is one of the risks you're supposed to account for. The AIG bailout protected executives at Goldman Sachs from their mistake of buying too much insurance from AIG.
  6. Inflationary "stimulus" spending benefits the banksters, even if they personally didn't receive it. By increasing the inflation rate, this further benefits the banksters. Inflation makes it easier for debtors to repay their loans.
  7. The rules of the monetary system guarantee that a certain percentage of all economic activity is profits for banks. It's built into the rules of the monetary system. Banks print the money that everyone else uses to trade and pay income taxes. This forces everyone to use banks as middlemen, directly or indirectly. Even if I have no debt, the only way I can get money is if someone else borrowed it.
  8. One of the biggest items on the Federal government's budget is "interest on the national debt". This wealth doesn't vanish into thin air. It's profit for the banksters. State violence forces people to pay taxes, with part of the profits going to the banksters. This literally makes the IRS a private debt collection agency working for Goldman Sachs.
  9. State violence outlaws competing monetary system. When Federal thugs assault Robert Kahre, E-Gold, or the Liberty Dollar, that subsidizes bank profits. By making it hard for people to invest in gold and silver, State thugs enable banksters to steal their savings via inflation.
  10. In almost every industry, a handful of corporations have a State-backed monopoly/oligopoly. With a State-backed monopoly, executives are at a large corporation are "creditworthy". Their State-granted monopoly is pledged as collateral for the debt. The fact that the economy is parceled out among State-backed monopolies subsidizes bank profits.
It's silly to say "We're capping executive pay at banks that received bailout money." All banks receive bailouts all the time. It's a structural defect intentionally written into the rules of the monetary system. Who wrote the rules of the monetary system? Via lobbying and "captured regulators", the rules of the financial system were written by the banksters!

It's silly to say "We're overhauling the financial industry regulatory system." The problem is caused by regulations in the first place.

The fundamental problem is the Federal Reserve credit monopoly and the corrupt system of fiat debt-based money. All other regulations are attempting to patch a fundamentally corrupt system.

The Federal Reserve caused the Great Depression. Instead of eliminating the Federal Reserve, the Federal Reserve was given more power via the default on the gold standard and the gold confiscation. A bunch of laws were passed regulating the banking industry, but the fundamental problem was not addressed.

In the 70s and 80s, there was the S&L crisis. Banks were borrowing short-term and lending long term. When the Federal Reserve jacked up interest rates to fight inflation, this caused many banks to become insolvent. Instead of eliminating the Federal Reserve, the CDO was invented. (CDO = Collateralized Debt Obligation) The miraculous invention of the CDO guaranteed that there would never again be a problem with banks and mortgages!

In the recent housing bubble, negative real interest rates encouraged banks to speculate on mortgage bonds. CDOs were the "cure" for the S&L crisis, but they were blamed for the recent housing bubble/bust! Via CDO magic, a bunch of lousy mortgages were packaged and sold as AAA bonds.

There was fancy math that justified this bundling of lousy mortgages into AAA bonds. There were faulty assumptions, "Mortgage defaults are uncorrelated!" and "Housing prices always go up!". It's irrelevant that the underlying quantitative analysis was unsound. The banksters got a bailout. Everyone was using the exact same model! The individuals who made lousy assumptions were not punished. If you're the type of person who would say "Wait a minute! These assumptions are wrong!", then your parasitic bosses would fire you.

Making lots of money off mortgages, the banksters lobbied for looser regulations. Instead of requiring a 20% downpayment, only a 5% or 2% or less downpayment was required. Banks were also allowed to use greater and greater leverage. The housing market boomed, encouraging everyone to borrow as much as they could and buy the biggest house they could. The banksters were borrowing at 1% and investing in mortgages yielding 6% while using huge leverage ratios.

All this speculation was fed by the Federal Reserve credit monopoly and negative real interest rates. Without the Federal Reserve interest rate subsidy, speculating on mortgage bonds would not be profitable. As long as there's a Federal Reserve interest rate subsidy, it doesn't matter what other banking regulations are passed. Negative real interest rates encourage speculation, encourage banksters to look for loopholes in the regulations, and encourage banksters to lobby for loopholes in the regulations.

Instead of eliminating the Federal Reserve credit monopoly, a bunch of new banking regulations will be passed. It's silly to talk about "Nationalizing the banking industry is evil!" The banking industry was nationalized in 1913 when the Federal Reserve was created. Actually, laws passed during the US Civil War effectively nationalized the banking industry; the crisis caused by these regulations plus limited liability incorporation allowed the Federal Reserve to be created.

All the "re-regulate the financial industry" talk is one big evil fnord. It's distracting from the real issue, which is "The Federal Reserve credit monopoly is evil."

It's silly to talk about capping CEO pay at banks. The profits of the banksters are pure economic rent. Even if you cap the CEO's pay at $500k when he really wants to pay himself $20M, then he'll just hire 40 of his unqualified idiot friends and pay them $500k each.

Huge CEO pay is immoral, because the CEO isn't usually the person who himself built a successful business. The CEO is paying himself with other people's money. The CEO usually came in as an appointed bureaucrat to lead an already successful business with a State-backed monopoly. A CEO gets his job with good parasite skills, and not the type of skills needed to actually build a successful business.

"Greedy CEOs paying themselves with profits backed by State violence!" is then confused with "Free markets are evil!". If I manage to make $1M/year from my blog, that isn't immoral, because I built it myself with my own work. If a CEO pays himself a huge salary with other people's money, profiting from State violence, then that's immoral.

It's silly to say "If we cap CEO pay, then they'll work elsewhere!" What are the banksters going to do, open a pizza store? The banksters have no useful skills. They are pure parasites. They've conned everyone else into thinking they have useful skills, when they actually know less than nothing. Everything a bank does is a net destruction of value.

All the mainstream media discussion of financial industry reform is one big evil fnord. Boom/bust cycles are scientifically created by a Federal Reserve credit monopoly. It's a structural defect in the monetary system, put there on purpose by the banksters.

If you're offended by bailouts and inflation, agorism is your best option. You should boycott all stupid taxes, stupid laws, and worthless paper money. Don't wait for politicians to give you freedom. If you want freedom, grab it directly yourself.


theftthroughinflation said...

Wow, this is brilliant! Honestly FSK this posting is really a masterpeice!
Most of the debates we have are part of the marginalization tactics. Banking reform debats like you say just marginalize people by having them debate fallacies between each other rather than debate the true cause and effect.
This is similar to politics. Voters spend all sorts of time stressing about things like which candidate claims to support abortion or not! In reality the politicians don't care either way. The marginalization just keeps people from asking "who has the right to decide if I can abort a fetus or not?!".
Well done FSK!

Anonymous said...

Excellent post, FSK. Except for the last line. Everyone should do that, not just everyone else.

rodney said...

Great post FSK

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