Tuesday, January 27, 2009

Let the Banks Die!

Crisis Solved: Give Money to Healthy Banks, Let FDIC's Bair Handle the Dying
Posted Jan 21, 2009 05:59pm EST by Aaron Task

Why should taxpayers have to keep bailing out banks that aren't lending and are black holes?
Why can't Congress just force these banks to write down their bad debt then recapitalize them?

Why doesn't the government create a bank that does not have toxic assets and will fill the void of much needed loans to businesses who need them?

"Lack of political courage [and] ignorance of finance" in Congress are the answers to these and related questions, according to Chris Whalen, managing director and co-founder of Institutional Risk Analytics. "Our friends in Washington who've been receiving a lot of money from Wall Street don't want to put these people out of work."

Whalen, who warned of the crisis long before it was obvious to most, says politicians and policymakers will ultimately be forced to come around to the reality that some of the nation's largest financial institutions are, indeed, insolvent and beyond rescue.

"The numbers will dictate our actions," say Whalen, who recommends the following:

Force banks to write-down bad debts: This will align their asset with their liabilities and prevent those who emerge solvent from hording government monies. "We want a healthy, growing economy, and need new banks providing credit and [help] clean up the mess," he says.

Allow FDIC chair Sheila Bair to do her job: Historically, the FDIC puts insolvent banks into receivership, put their assets into a new corporation which is "clean" (no legacy liabilities) and sells it to a stronger bank. JPMorgan's purchase of Washington Mutual followed this script, for example; Bank of America's purchase of both Countrywide and Merrill did not, which is why Ken Lewis is now stuck with "two rancid, hideous cancers," Whalen says.

Give money to healthy banks: "Give 'em capital on good terms," Whalen says. "But they have to eat all of Sheila [Bair's] cooking; they've got to take [insolvent] banks they can't sell to other investors."

Stop the Fed's support of the OTC credit default swaps market: "When are we going to realize leverage in over-the-counter market is driving most of this crisis," he wonders. Yet they refuse to deal with it because the Fed has been a sponsor of the OTC market in the first place."

The good news is Whalen thinks the crisis could be resolved within a year if politicians find the courage to take these steps. The bad news...well, I don't have to say it, do I?


Common Sense on Banks

Banking bailouts were sold to us as a "necessary evil" because we were told only our existing network of banks could irrigate the economy with cash and so rescue industry. Now we know they can't do that because their legacy absorbs all the resources, it would appear more sensible to let the old banks fail and start a new generation of banks. After all, the best credit risk is the institution that has no debt. So you could say the error wasn't to let Lehman collapse, but not to have allowed all the banks to collapse in order to have a fresh start. And right now the job market has plenty of bankers available to set up and run new institutions. With just a quarter of the $800 billion or so already splashed about you could start a whole new Wall St. It's not a matter of saying "no more banking system" but "no more fatally compromised old banking system burdened with structural insolvency." (Ban)king is dead. long live (ban)king.

The term "bad bank" is being tossed around Washington dinner tables this week, a sign that the situation facing the largest banks is reaching a boiling point. It is amazing to us to see how little people understand the choices facing us with the big banks, how narrow those choices truly are and how the numbers in terms of losses are so BIG that they will ultimately force us to do the right thing. A couple of points:

First, IRA's estimate for accumulated bank charge offs for 2009 is in the neighborhood of $1 trillion vs. $1.5 trillion in Tier 1 Risk Based Capital at all US banks today. Good news, though, is that 2/3 to 2/4 of that loss number comes from the top four - Citigroup (C), Bank of America (BAC), JPMorganChase (JPM) and Wells Fargo (WFC), in that order of risk profile.

Since most of the toxicity in the banking system is concentrated among the larger banks, perhaps we can rebuild the industry using the next round of TARP funds to bulk up these relatively smaller banks and thereby end up with 10-15 larger super regionals in the $300-$500 billion asset range. There may even be banks of this size still doing business under the current names of C, JPM, BAC, etc, but these new banks will have new owners and creditors.

Second, the Good Bank/Bad Bank debate is really a political battle between the large banks listed above plus Goldman Sachs (GS) and Morgan Stanley (MS) et al among the Sell Side survivors in NYC vs. the rest of the industry and the US economy. In preparing their plans for review by the White House, we hear that the Fed and OCC are supporting further bailouts for the larger banks, while the rest of the industry is being resolved and recapitalized a la Washington Mutual and Lehman Brothers.

Perhaps we ought to feed the "good bank" parts of the "too big to fail" crowd, a crowd prone to leverage and bad risk management, to the smaller and plain vanilla bankers that comprise the nominal majority of the industry. This would solve many things including reducing the lobbying power that Wall Street has in Washington. Come to think of it, President Obama should think about banning lobbying by any company participating in the TARP.

Remember that the entire banking industry stands in front of the taxpayers in terms of loss absorption at the FDIC, so you can understand why the smaller banks in the industry are SERIOUSLY PISSED OFF at the large banks and their minions in the Obama Administration like Tim Geithner and Robert Rubin. Oh, and don't forget Chairman Ben Bernanke and the entire Fed board of governors. These leading officials are increasingly talking the side of the large banks in the battle over limited financial resources, a fact that is causing the community bankers to rise in anger. Stay tuned.

The better course for the economy outside NYC is to resolve these large institutions over the course of 2009 and beyond, first by diluting the equity (common and preferred) and effecting a conservatorship a la Fannie/Freddie. This eliminates the issue for the markets. A formal open bank assistance might be a default under the ISDA contract template, something the Fed's conflicted Mandarins would not initially accept, but when the charge-offs at C rise above total risk based capital and keep rising, perhaps minds in DC will begin to change. Then we can haircut the Big Four Bank debt in a negotiated deal pre-receivership, and sell the non M2M bank assets and liabilities to stronger hands. This is the traditional American way of dealing with insolvency in the absence of political meddling by the Fed and the Congress. Let Sheila Bair and the FDIC do the job and we can make the economy rebound with surprising speed. It only takes political courage. We have the money.


Monday, January 26, 2009

Types of Objections

The objections to Jubilee, though they take many forms, in various degrees of eloquence, can be classified into a small number of essential points:

It is unnecessary
It would destroy the economy
It has failed in the past
It would reward the wicked and punish the good
It would not be legal

In snippets below are various real comments made concerning a modern Jubilee:

Dangerous (Would destroy all Money and the Economy):
Money theory -- ALL money is debt, and vice versa. My money in the bank is a debt to whoever they loaned it to. So absolve the mortgage holder of his debt, and the savings account holder loses also. There would be no money left. We would end up in a Mad max style post monetary system. Only gold and real assets would have value.

Savings will see them canceled too? There are far more savers than borrowers.

If all debts were cancelled then all savings deposited with lenders like banks and building societies would also have to be cancelled. Not just eroded in internal value through negative real interest rates, or reduced in external value through the depreciation of sterling, but completely cancelled.

So, I've done "the right thing" over many years by carefully paying off all my debts and building up savings to safeguard my future; and yet eg Nationwide would tell me that as almost all of its assets - all the mortgage loans on its books - have been wiped out by order of the government, so most of its liabilities - including all the savings that I deposited with them - must also be wiped out by order of the government.

The problem with a debt jubilee is that everybody with a bank account (or just holding paper money under the mattress) is a creditor of the system.

Unless you are a shareholder? Such an easy phrase for a champagne socialist to write - but untold misery for thousands of honest, hard-working people who tried to put a little money aside for their old age.

Please explain this to me. You put some money into the bank, and they lend it to X, Y and Z. The debts of X, Y and Z are then canceled in the Jubilee. How do you get your money back?

Right now, companies don't have the capacity to forgive dept. It would cause a massive loss of income and resultant bankruptcy or closure.

In addition to cancelling the debt, you would also have to shut down all of the existing banks and insurance policies, the car companies and anyone else whose balance sheet means they hold lots of debt. In addition to cancelling debt, we would also cancel all pensions, retirement plans and obligations such as annuities that are held by individuals.

Please explain how a unilateral elimination of debt would not cause a complete collapse of our financial markets and ergo our economy.

The supply of money (M-1) is largely comprised of debt securities. This is to say that the same dollar is frequently recycled through the economy through the process of lending. For example, a worker deposits his payroll in a bank, which lends his deposit (after reserve requirements) to a business, which spends it on inventory or payroll, and the spent money is redeposited with another bank etc. The electronic deposits of a bank are liabilities, are not covered by their reserve requirements, and certainly not covered by the greenbacks in circulation. Additionally, the Treasury creates money by borrowing from investors through the sale of treasury securities. Cancelling all these debts would result in a catastrophic collapse of the financial markets. With out a liquid medium of exchange, the entire economy would also collapse.

Moral Hazard (punishing the good, rewarding the bad):
But if it is ever going to be done I hope that I pick up early warnings about it, so that I have time to borrow up to the hilt and buy tangible assets. That's what has happened in the past when governments have decided to cancel debts - eg under Solon in ancient Athens:

You know, punish the types who don't
succeed, give everything to those who are the winners. So why should we
cancel debt (using those terms). The honest lenders will lose big time.

Makes me feel a right idiot now. All I had to do is take on all the debt the finance crooks were prepared to throw at me - and then sit tight for the "Day of Debt Jubilee" instead of the respectable poverty I've forced myself and my family to live in. Never mind - lesson well learned for the next big credit crunch - if not in time for me, then at least for my children and grandchildren.

I agree, on condition that there is a simultaneous asset jubilee: all the spivs who overborrowed and snapped up properties can have their debts annulled, and simultaneously have their properties move into state ownership, without any recompense. The state can then sell them to help minimize the enormous bill to the taxpayer. Those who were prudent should be the only ones able to put down a deposit, and should therefore receive their belated reward for living within their means, i.e. not stealing from others.

I'm serious. Nobody who has contributed to the fiasco of the last ten years should be rewarded with any concrete assets. I am sick to death of seeing parasites profit from their greed, having other people do all the real work.

Failed in past:
Well first of all it isn't her idea and it has been done already. John Maynard Keynes repeatedly called for a general cancellation of the war debts and reparations arising from WWI. Although it was not called a jubilee, debt cancellation occurred after 1931, beginning with President Herbert Hoover's one-year moratorium on both war debts and reparations.

Solon in ancient Athens…

Revolutionary Russia…

It would not be legal:
No, an act of congress would not do. Debts are contracts which are governed by state laws. Article I Section 10 of the U.S. Constitution specifically prohibits state governments from interfering with contractual obligations.

A relatively small fraction of total debts - maybe five, or at most ten, per cent - are such bad debts that there will be no alternative to writing them off. That will be sufficiently damaging in itself, without extending the idea to all debts.

Modern Jubilee Discussions Beginning on the Internet

I have actually found a couple discussions of the merits of a modern Jubilee Year on the web.

The idea got major publicity through an article in the British press, by a keen economic commentator writing for the Telegraph, Ambrose Evans Pritchard.
Reading the British press is about the only place you can find hard hitting and honest discussions of the economy. The American press is clearly covering up discussion of what is going on, as well as how bad it is getting in other countries.

The other discussion I found is on an Amazon politics forum.


It is good to see the idea being discussed. Unfortunately, most people are initially very negative towards the idea, and there has been little attempt to systematically explain how and why it would work.

I am mining the comments sections of those two articles for common objections, which I can then address systematically. We who go forth with the gospel of Jubilee need to be well-prepared for the inevitable common questions and objections. I have already started to address some objections in a previous post (Addressing Objections to Jubilee) and will expand those arguments in upcoming posts.

Accordingly, the appearance and focus of this blog will be changing. When I started this blog last fall, much of the press was still publishing happy face optimism trying to cover up the severity of the crisis. That has changed drastically in the past month. Everyone, even in the popular press like MSNBC, is openly discussing the possibility of this being as bad as the Great Depression. The establishment is now openly admitting that the turnaround will be years away, although they often throw out 3 or 4 years as a timeline, which is painfully overoptimistic.

Since the bad news is now firmly established, I will be focusing more on the nuts of bolts of how the Jubilee needs to be carried out, and why it will work. As the magnitude of this GD2 continues to set in and deepen, open calls for a modern Jubilee Year will become louder, and will begin to make a lot more sense to a lot more people, but they need the theoretical ammunition to drive their point home.

Brink of Debt Disaster

Here is a great quantitative description of the sheer massive size and irresistable weight of debt we are facing. Communicating the enormity of the problem is the first and crucial step in telling people about a modern Jubilee Year. Until someone realizes that our debt cannot be paid off, their programmed minds will resist the radicalness of the Jubilee Year. Once someone realizes the magnitude of the debt problem, Jubilee becomes perfectly common sensical.

The United States and the United Kingdom stand on the brink of the largest debt crisis in history.

While both governments experiment with quantitative easing, bad banks to absorb non-performing loans, and state guarantees to restart bank lending, the only real way out is some combination of widespread corporate default, debt write-downs and inflation to reduce the burden of debt to more manageable levels. Everything else is window-dressing.

From the 1970s onward, the economy has undergone two profound structural shifts. First, the economy as a whole has become much more indebted. Output rose eight times between 1975 and 2007. But the total volume of debt rose a staggering 20 times, more than twice as fast. The total debt-to-GDP ratio surged from 155 percent to 355 percent. Second, almost all this extra debt has come from the private sector [as the following chart shows].

read more:

How to do a modern Jubilee - one simple proposal

It was amazing to find this article. Written by a college student, over one year ago, laying out a precise plan for our modern Jubilee Year!

SOLUTION: President Bush, I beseech you, declare 2007 the Year of Jubilee in keeping with our Judeo-Christian heritage-- and reap the reward of passing the Oval Office to the next generation of Republicans.

Taking our que from Citigroup, we can name this bold declaration the “People’s Recapitalization Plan.”

Here’s how your 3-point plan can easily unfold:

1. Fed Chairman Ben calls-in all M1, include every form of US currency. No questions asked; however, by Midnight, April 15, 2008, if the currency has not been deposited and accounted for, it will no longer be money. Sorry.

2. Immediately convert the US Economy into an all-electronic-funds-transfer economy. The entire operation can be outsourced to MasterCard, American Express and Visa. If a person needs a debit card, one will be provided for him. Combine this effort with the requirements of the Real ID Act of 2005-- kill two non-documented workers with one transaction, so to speak.

3. All debts currently owed by an American citizen are forgiven. Now, Mr. President, this is the key to the success of the People’s Recapitalization Plan. If we adopt the premise that consumer spending is crucial to world trade and economic growth, you can immediately issue this proclamation:

I, President George W. Bush, in keeping with the American Judeo-Christian heritage, do hereby proclaim 2007 a Year of Jubilee. Accordingly, all American citizens are hereby pardoned of all financial debt, secured and unsecured. Whatever local, state or federal taxes, interest and penalties are forgiven. All property liens or consumer loans, private or public, are forgiven. Go and spend no more; well, spend wisely.

Frankly, Mr. President, this may possibly be the only road to economic recovery. Young people will again buy homes, clothes, toys and Toyotas. Teeth will be repaired; dentures purchased; eye glasses acquired. Shopping will commence.

By Resurrection Morning, the whole of the American public will praise the president’s name. Imagine the goods and services that will be purchased around the world. If Citigroup and Countrywide get a fresh start, surely the American people deserve one Jubilee in their lifetime.

Mr. President, declare 2007 a Year of Jubilee and, by so doing, tell everyone, “Just keep the Change.” This will be much less painful than dividing Jerusalem.

I’m Nancy Lee Wolfe and I approve this message.

January 17th, 2008

Dollar Collapse for Later 2009

It was refreshing to read this article, confirming my analysis of big inflation coming in the latter half of this year. Purchase you capital now, before it gets too expensive.

Dollar Collapse Still Looking Good for later 2009

As the British pound continues to sink, its travails are a cautionary tale for the U.S. dollar.

The U.S. and the U.K. face very similar predicaments, from a deepening recession to a damaged financial system. Both are orchestrating massive bank bailouts and attempting to assist struggling homeowners. Both are ramping up government spending even as they rely on financing from overseas investors. And both countries have central banks that have slashed interest rates and opened the door to unconventional ways of stimulating the economy.

Yet their currencies have headed in opposite directions. On Wednesday, the British pound tumbled to a 23-year low against the dollar, briefly buying just $1.362, down from over $2 only six months ago. The pound also hit a new all-time low versus the Japanese yen. It got a minor boost in late afternoon trading, following a report that finance ministers from major industrialized nations will discuss the currency's weakness when they meet next month.

By contrast, the dollar managed to strengthen against a host of currencies as the financial crisis intensified last fall. It has also surged ahead in recent days, particularly versus the pound and the euro.

Unlike the pound, the dollar is being buttressed by its unique status as the world's reserve currency and the vehicle for transactions in U.S. financial markets, including Treasury bonds. That means investors often seek out the dollar as fears rise, sometimes in spite of their concerns about the U.S. economy.

"The dollar is still benefiting by default" as investors run from riskier bets, says Lisa Scott-Smith of Millennium Global Investments, a London currency manager. "The pound isn't a natural reserve currency in the way that the dollar would be."

The euro also has flagged in recent weeks, as concerns have risen over the creditworthiness of some of the more indebted countries that use the currency. But it has suffered less than the pound, a sign that investors may be gravitating toward the largest, most highly traded currencies as nearly all economies stumble.

Meanwhile, there's little light ahead for the beleaguered pound, say some currency experts. The economic news is "horrendous," says Neil Mellor, a London-based currency strategist at the Bank of New York Mellon. "There is very good reason for panic at the moment."

In one worrisome sign, investors not only dumped the pound earlier this week, but also shed U.K. stocks and government bonds, sending their yields up. Such a combination, if sustained, would raise the fear that investors are exiting from a host of U.K. assets, creating a vicious cycle that is difficult to arrest.

That's also the scenario that some worry might await the dollar and U.S. bond yields, should appetite from overseas investors wane.

These days, policy makers are inclined to let their currencies weaken "until such a time as other asset markets flag that enough is enough," says Alan Ruskin, chief international strategist at RBS Greenwich Capital. Given that the moves in British government bond yields aren't yet extreme by recent standards, "I don't think we've quite reached that point in the U.K."

In a note on Wednesday, Goldman Sachs analysts pointed out that recent moves in the pound and U.K. bond yields were more typical for emerging markets with weak fundamentals. However, they added, the analogy isn't justified over the long term. Indeed, the firm recommended that investors buy the pound as well as U.K. bonds.

While the dollar continues to benefit from its unique position in financial markets for now, it is far from clear that the resilience will last. "Right now the market is beating up on the pound, but at some point it will look for something else to pick on," says Paul Mackel, a currency strategist at HSBC in London.

The fact that the Federal Reserve stands ready to use a host of unconventional measures to flood the economy with liquidity in an effort to stimulate growth "could hurt the dollar quite badly" later this year, he says.


Psychology of Entitlement

This article pretty much speaks for itself. It is truly sickening to think of it. As our economy crashes, these people order themselves a fresh round of bonuses. Makes perfect sense though, as they know how bad things are going to get, they are getting theirs while they still can. Great example of why an industry as vital as banking should be carefully regulated.

The news that Merrill Lynch paid out $15 billion in bonuses is sure to ignite new questions about the wisdom of bailing out Wall Street. Merrill Lynch took $10 billion from the TARP, allegedly to fill holes in its balance sheet. But instead of using that to repair its financial health, it simply put the money into the pockets of its employees. There is no way to defend this disgusting payout.

But that won’t stop Bank of America, which now owns Merrill, from defending the bonuses. And across Wall Street there are lots of people who actually believe that Merrill did the right thing.

How can so many smart people be so dumb?

Easily. There is a sick psychology of entitlement on Wall Street that was created during the bubble years. Many simply cannot believe that they do not deserve huge pay packages. Their brains have not caught up with the idea that they are working in broken institutions that would be unable to pay to keep the lights on if not for the fact that Washington has given them billions of taxpayer dollars.

Of course, smart people are very good at rationalizing their fantasies, especially when the fantasy serves to make them money. There are three rationales they’ll offer when pressed on this. Each one is easily skewered.

"We made money. It was just one part of the firm that lost it all. So we deserve to be paid." Sorry, buddy. That’s not the way capitalism works. Ask the guy who just lost his job installing seat belts in GM cars. He was really good at that but since no one is buying those cars, he’s out of a job. Being really good at what you do doesn’t matter if your firm is broke—and your firm is broke. It’s now on taxpayer supported life-support.
"We didn’t use taxpayer money to pay the bonuses." This is the most ridiculous idea ever. Money is fungible. If you use billions to pay bonuses and then need to ask the government for money to stay alive, you are using taxpayer money to fill in the hole you dug by paying the bonuses.
"We’ll lose all the greatest people if we don’t pay them." Oh really? Where will they go? Who, exactly, is going to hire them? Also: so what? That’s how capitalism works. Failing firms that cannot afford to pay for talent lose that talent to successful firms. That’s an important part of market discipline.
"If we don't pay bonuses when firms take the TARP, they won't take it." This is the most sophisticated argument for huge bonuses. In Germany, this actually happened. As it turns out, executives would rather risk their firm collapsing due to lack of capital than give up their big paydays. But there's an easy solution to this: throw the bastards out. The boards of every single financial company that turned down bailout bucks with a bonus limit could demand a full accounting of why a bank's executives think it is healthy enough to forego a bailout. And if they aren't satisfied they should just fire the management.
Look. We’re not hysterical opponents of paying big bonuses. Actually, I'm on the record as defending huge bonuses from a couple of years ago. If your firm makes money, it can decide how to reward its employees. If it loses money, it can still decide to pay bonuses if it still has cash on hand. But when you pay yourself a bonus with taxpayer money you are simply taking money from someone who earned it and giving it to someone who didn't. If the government hadn’t supplied the means for redistributing that money, you’d just be a mugger.

It was only a few months ago that we were being told that Merrill Lynch, among others, desperately needed billions of dollars to survive, that without injections of new capital the financial system would come crashing down around us. If any of this was true, it should have been impossible for Merrill to pay out $15 billion in bonuses. Even the sharpest critics of the bailout never imagined that it would be used to make wealthy idiots even wealthier.

All of this is a reminder of why it is very, very dangerous to allow the government to rescue firms instead of allowing the market to decide who should survive. Perhaps instead of a bailout, we should have confined the TARP to overseeing the orderly disolution of failed financial institutions.


Wednesday, January 21, 2009

Addressing Objections to Jubilee

Thank you for your comments, I have tried to address them individually.

"You are advocating theft on a stunning scale."

Jubilee is the opposite of theft. Jubilee is returning assets to their rightful owners. Bankers don't create wealth, in fact, they are just parasites on the productive economy. Our economy is overrun with parasites right now, and we need to shake them off.

"What level of "moral hazard" would arise from government mandated cancellation of whole classes of debt? "

Jubilee actually has a very low "moral hazard", as it prevents the same problem from happening again because credit would be tight after a Jubilee. Jubilee also dramatically decreases the moral hazard inherent in banking, since the threat of Jubilee keeps the money-lenders in check, preventing them from recklessly gambling with other people's money for their own profit, creating bubbles and crashes the way they have recently (and throughout history when under-regulated).

"The closest parallel would be Russia after the Soviet victory when the workers' paradise revoked all indebtedness. Immediately the was nation plunged into penury."

America's wealth is not based on debt, it is based on capital, skills, knowledge, and initiative. If we cancelled all debt tomorrow, heck, if we got rid of all money, we would still be as wealthy as the day before.

"I would venture that you have much more debt that you do "paper" (your scornful term) assets."

Paper is not an asset, it is just a claim on someone else's productive work. In our current crises, all paper assets are being shown for what they really are: paper. However, it is causing a collapse of the real economic system, which can be avoided.

"So you are probably arguing for your own benefit."

True, but it is also to everyone's benefit. Well, except the parasitic bankers, who have amassed personal fortunes leading our economic system to ruin.

"You are also conflating the grifters in the fixed income units of Wall Street firms with the buyers of the "debt" instruments they created. How different from the scamsters are you? "

Jubilee is not a scam. In fact, it is the end of the debt scam.

"The managers of a Landsbank in Germany who bought mortgage backed securities rated by Standard and Poors as AAA should not be penalized for making what they have reason to believe in foresight was a sound investment. Nor should the CFO of a manufacturing company who bought commercial paper as working capital to be liquidated over the coming year as needed for operating costs."

I agree, no one should be punished for making what they thought was a sound investment. Our banker-created bubble has made victims out of everyone, a Jubilee would just punish the right party - the banks - not the innocent.

"You make it sound as if the credit markets are an expendable luxury. I managed accounts payable for a small warehouse business; believe me I know that credit is essential for any business, small or large."

Operating costs mainly have to be paid for out of cash reserves and cash flow. If a company is a going concern with a valid business model, they wil be able to get credit even after a Jubilee, but a Jubilee will force us to switch back to the savings model rather than the debt model of economic growth.

"The debt cancellation must also accompany the confiscation of contracted collateral."

No, a Jubilee involves no confiscation.

"FDIC is not meant to guard against a complete bailout of every single saving account holder to 250K. This is what a Jubilee would guarentee -- that the FDIC will have to pony up for each savings account, since the bank assert are basically junk in a Jubilee."

Instead of throwing trillions at banks, we would be throwing trillions at individual citizens. That is right, and correct.

"There'll be no money available anywhere (you just jubilee'd it away!) Yeah, there's plenty of "free and clear" assets sitting around, but nobody have money to lend to anyone else as credit."

Money, even though it is fiat paper, would not disappear. We would still be able to conduct trade with currency. Banks would also be able to lend out what they had in savings, just as they do now.

"If you cancel or default on every debt, then you become untrustworthy. By definition, future interest rate will be either confiscatory (would you want to lend to someone who drops his debt?); or hard to come by."

No one's individual credit-worthyness would be impacted, as Jubilee is a general amnesty. The American federal government would be uncreditworthy, but that would be a good thing, forcing our federal government to keep balanced and backward-looking budgets.

"Your Jubilee is a "Fairy tale" scenario where people in the story say "oh, too bad. It's ok. I forgive you" and happily goes on to continue lending / giving money at the same rate to the little bad boy who borrows and splurge on random things."

Debt forgiveness is no fairy tale, it happens all the time. Nor do I assume lending would occur on the same basis as before. A Jubilee would forcible shift the economy from a debt to a savings basis, and thereby make it more sustaibable and rational.

"It also assumes that the act of Jubilee itself doesn't destroy the source of the money itself. "

Debt is not money, debt is not wealth. We would still have the same money and wealth after the Jubilee, just not burdened with unpayable debt.

Soros Sees Depression, Recommends Debt Cancellation

Soros is of course correct that we need radical and unorthodox policy measures, focused on cancelling debt. We disagree only on the recapitalizing banks part. I think the Jubilee should wipe out debt first, then let the market fill the coffers of the bankers after resetting the system, with government recapitalization as needed only for the transition phase to prevent business closures.

The stimulus plan the U.S. government is currently considering is necessary to help American citizens, but it will likely not reverse the country's economic decline, hedge fund manager and billionaire philanthropist George Soros said on Monday. "It is not enough to turn the situation around," Soros told the U.S. Conference of Mayors about the $850 billion proposal to increase spending and cut taxes. The plan, which was introduced in the U.S. House of Representatives last week and will likely be passed by next month, will help state and local governments balance their budgets and preserve important social services, Soros said.

Soros said the United States needed "radical and unorthodox policy measures" to prevent a repeat of the Great Depression of the early 20th century that include recapitalizing banks and writing down the country's accumulated debt. Also, he said, it should create more money to offset the collapse of credit and then rapidly pull that cash out of the system when inflation emerges. The government would have to be very nimble in the timing of such moves, he said. "If they are successful...the deflationary pressures will be replaced by the specter of inflation and the authorities will have to drain the excess money from the economy almost as quickly as they pumped it in. Of the two operations the second one is going to be, politically, even more difficult than the first," he said.

At the same time, the $700 billion financial bailout known as TARP for Troubled Assets Relief Program had been carried out in a "haphazard and capricious way" and "without proper planning," he said. "Unfortunately it was misused and the way it was done has poisoned the well. It has created tremendous ill will toward putting up more money," Soros said. For more than a year, the United States has been crippled by a recession that was triggered by a housing market downturn. Last summer, financial institutions with exposures to securities backed by bad mortgages began to buckle. The government stepped in with the TARP to inject liquidity into struggling firms. Last week, President-elect Barack Obama requested Congress release the second half of the funds.

Soros advocated using bailout money to recapitalize banks, but said the $350 billion would not be enough. He said such a move would take more than the entire $700 billion. The bursting housing bubble "acted like a detonator that exploded a much larger bubble," he said. "The economies of the world are falling off a cliff. This is a situation that is comparable to the 1930s. And once you recognize it, you have to recognize the size of the problem is much bigger," he said.


Mortgage Banks Near Collapse

Again, more news that the banking system is totally broken, beyond bailing out. Time to cancel the debt and free the economy.

Federal Home Loan Banks may have to borrow from U.S.

Losses from mortgage-related investments are causing some banks' capital to fall close to or below required minimums. The banks say accounting rules make their situation look worse than it is.
By Binyamin Appelbaum
January 20, 2009

Washington -- The mortgage crisis is seeping into one of the last dry corners of the mortgage business, the regional network of Federal Home Loan Banks, which provide U.S. banks with hundreds of billions of dollars in low-cost funding to support lending to home buyers.

The little-known network has grown in importance as banks lose access to other sources of funding because of the credit crunch. The volume of outstanding loans provided by the home-loan banks has increased by 58% since the beginning of 2007, to more than $1 trillion at the end of September.

But several of these banks hold mortgage-related investments that have plummeted in value. The losses are draining the capital foundations of the home-loan banks, forcing them either to reduce their lending -- making mortgages more expensive and harder to get -- or to raise additional capital.

The money could come from taxpayers. The Treasury Department created a program in September that for the first time allows the home-loan banks to borrow directly from the federal government. That hasn't happened yet, but some financial experts said it was looking increasingly likely.

A report from Moody's Investors Service last week citing "the demonstrated importance of the [home-loan banks] to the banking system through the credit crisis" concluded that the government was likely to provide the necessary support to keep loans flowing.

The 12 home-loan banks are collectives chartered by the federal government and owned by member financial firms. The government's sponsorship allows the collectives to borrow money at low cost, which they lend to banks of all sizes, including giants such as Bank of America Corp. and small community lenders. Nearly all U.S. banks are members of at least one of the collectives.

As with other banks, federal regulators require the home-loan banks to keep a certain amount of money as a capital foundation to support their lending.

The home-loan bank in Seattle, which serves the northwestern United States, said last week that the declining value of its investments probably dropped its capital below a level required at the end of the year, though a final determination won't be made until the bank completes its fourth-quarter bookkeeping.

The home-loan bank in Pittsburgh warned Friday that it too was in danger of dropping below a capital threshold.

And Moody's estimated that six more banks could follow Seattle and Pittsburgh.

The most immediate effect is that the collectives are paying less to their members. Several of the collectives have suspended dividend payments. The 12 collectives had paid about $1 billion in dividends to member banks during the first nine months of the year. The payments are an important source of revenue, particularly for smaller banks.

Many banks also hold relatively large amounts of stock in the collectives. In normal times, the banks can sell that stock back to the collectives, redeeming their investments. But several of the collectives have announced moratoriums on redemptions, freezing access to the money.

And if the situation continues to deteriorate, the collectives could require members to make additional investments.

The collectives got into trouble by investing $76.2 billion in private mortgage securities, packages of mortgages not guaranteed by Fannie Mae or Freddie Mac. The market value of those securities had dropped to $62.7 billion at the end of September and has almost certainly continued to fall.

The Pittsburgh collective, for example, spent $8.8 billion on securities that declined in value to about $6.4 billion by the end of December.

The banks have not sold the securities, so they have not incurred a loss, but accounting rules require them to acknowledge some of the loss in value and set aside capital in a proportionate amount.

As a result, the Pittsburgh bank is running short on capital. At the end of September, it had $2.6 billion more than the federal minimum. The bank estimates that it exceeded the minimum by only $72 million at the end of December.

The home-loan banks contend that the accounting rules are creating a misleading impression by requiring them to prepare for losses that won't happen because they don't plan to sell the securities.

"The banks are very healthy. The accounting doesn't represent the true economic picture," said John von Seggern, chief executive of the Council of Federal Home Loan Banks, which represents the network in Washington. He said the banks want regulators to change the rules.

Proponents of the accounting rules, however, say this system is the most accurate way of measuring the value of securities. Experts on the home-loan banks also note that the institutions already have lower capital requirements than commercial banks, leaving little room for error.

The collectives are regulated by the Federal Housing Finance Agency, which said it was reviewing the capital rules.

The agency's director, James B. Lockhart III, said he believed that the home-loan banks on the whole remained healthy. "The overall system is in good shape, and I still believe it is unlikely that anyone would need to tap the liquidity facility," he said.

The home-loan banks have also found themselves at the center of a firestorm over their lending to some of the nation's most troubled institutions.

Lockhart said the Federal Housing Finance Agency had ordered the collectives to work with regulators to control the flow of funding to troubled banks.


British Failed Debt Greater than GDP

There is only one solution when guaranteed debt is greater than GDP: Jubilee!

They don't know what they're doing, do they? With every step taken by the Government as it tries frantically to prop up the British banking system, this central truth becomes ever more obvious.

Yesterday marked a new low for all involved, even by the standards of this crisis. Britons woke to news of the enormity of the fresh horrors in store. Despite all the sophistry and outdated boom-era terminology from experts, I think a far greater number of people than is imagined grasp at root what is happening here.

The country stands on the precipice. We are at risk of utter humiliation, of London becoming a Reykjavik on Thames and Britain going under. Thanks to the arrogance, hubristic strutting and serial incompetence of the Government and a group of bankers, the possibility of national bankruptcy is not unrealistic.

The political impact will be seismic; anger will rage. The haunted looks on the faces of those in supporting roles, such as the Chancellor, suggest they have worked out that a tragedy is unfolding here. Gordon Brown is engaged no longer in a standard battle for re-election; instead he is fighting to avoid going down in history disgraced completely.

This catastrophe happened on his watch, no matter how much he now opportunistically beats up on bankers. He turned on the fountain of cheap money and encouraged the country to swim in it. House prices rose, debt went through the roof and the illusion won elections. Throughout, Brown boasted of the beauty of his regulatory structure, when those in charge of it were failing to ask the most basic questions of financial institutions. The same bankers Brown now claims to be angry with, he once wooed, travelling to the City to give speeches praising their "financial innovation".

Does the Prime Minister realise the likely implications when the country joins the dots? He has never been wild on shouldering blame, so I doubt it. But Brown is a historian. He should know that when a nation has put all its chips on red and the ball lands on black, the person who made the call is responsible. Neville Chamberlain discovered this in May 1940 with the German invasion of France.

We're some way from a similar event. But do not underestimate the gravity of the emergency and potential for disgrace.

The Government's bail-out of the banks in October with £37 billion of taxpayers' money was supposed to have "saved the world", according to the PM, but now it is clear that it has not even saved the banks. Our money kept the show on the road for only three months.

As the Liberal Democrats' Treasury spokesman Vince Cable asks: where has the £37 billion gone? The answer, as Cable knows, is that it has disappeared down the plug hole.

It is finally dawning on the Government that the liabilities of the British banks grew to be so vast in the boom years that they now eclipse the entire economy. Unfortunately, the Treasury is pledged to honour those
liabilities because it has guaranteed not to let a British bank go down. RBS has liabilities of £1.8 trillion, three times annual UK government spending, against assets of £1.9 trillion. But after the events of the past year, I wager most taxpayers will believe the true picture is worse.

Meanwhile, the assets are falling in value. This matters, because post-nationalisation these liabilities are now yours and

And they come piled on top of the rocketing national debt, charitably put at £630 billion, or 43 per cent of GDP. The true figure is much higher because the Government has used off-balance sheet accounting to hide commitments such as PFI projects.

Add to that record consumer indebtedness and Britain becomes extremely vulnerable. The markets have worked this out ahead of the politicians, as usual, and are wondering what to do next. If they decide our nation is a basket case, they will make it so.

The PM and the Chancellor , both looking a year older every day, tell us that for their next trick they will buy more bank shares, create a giant insurance scheme for bad debt, pledge to honour liabilities without limit, cross their fingers and hope it all works. The phrase "bottomless pit" springs to mind for a reason: that is what they have designed.

In this gloom, the Prime Minister has but one slender hope: that somehow, by force of personality, the new President Obama engineers a rapid American recovery restoring global confidence, energising the markets and making us all forget this bad dream.

Obama is talented but he is not a magician. Instead, Gordon Brown's nightmare, in which we are all trapped, is going to get much worse.


US Banks Insolvent

Well, this certainly does simplify things doesn't it? The sooner we internalize the fact that our whole banking system, the sooner we come to the obvious conclusion: Jubilee! We can either do this the easy way (Jubilee) or the hard way (deflationary depression).

Roubini: US Banking System Insolvent, Another $2.5 Trillion Of Losses Coming

Henry Blodget | Jan 20, 09 10:05 AM
A couple of years ago, when Nouriel Roubini predicted that US financial-system losses would total $1 trillion, everyone thought he was insane. He has since revised his estimate. Now he's looking for $3.6 trillion:

Bloomberg: U.S. financial losses from the credit crisis may reach $3.6 trillion, suggesting the banking system is “effectively insolvent,” said New York University Professor Nouriel Roubini, who predicted last year’s economic crisis.

“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”

Losses and writedowns at financial companies worldwide have risen to more than $1 trillion since the U.S. subprime mortgage market collapsed in 2007, according to data compiled by Bloomberg.

President Barack Obama will have to use as much as $1 trillion of public funds to shore up the capitalization of the banking sector, following the $350 billion injection by the Bush administration, Roubini told Bloomberg News. Congress last year approved a $700 billion rescue fund, of which half remains to be disbursed.

Why Money Management Always Leads to Collapse

The Real Cause of the Financial Crisis: An MIT Blackjack Team Perspective
By Guest Author Semyon Dukach

The mathematics of probability that govern the trade-offs of risk and reward are fundamentally counter-intuitive. The reason that societies ban pyramid schemes outright, instead of relying on the market to make them unprofitable, is that most people trust their intuition, and their intuition leads them astray.

If you were to wait for the market to run its course on a pyramid scheme, the losses could devastate a whole country, as Albanians found out a few years ago.

In our (MIT Blackjack Team) days of outwitting casinos around the world, we have come across many people who thought that they also had a great system, but were in fact compulsive gamblers who eventually lost everything. Among the false systems that intuitively feel right, there is none as insidious and deadly as the Martingale, where a player doubles his bet after every loss.

The Martingale system works as follows: suppose you need an extra $100. You go down to your nearest casino, and bet $100 on a hand of blackjack, or on any other almost 50/50 proposition. Should you win right away, you have reached your goal and gotten your money.

Now if you lose, you bet $200. If you win the second bet, you’re up $100 over all and once again successful. But a little more than one out of four times you’ll lose both, and end up down $300. In that event you simply bet $400. If you lose again you bet $800, and you just keep doubling your bet until you win once.

Clearly you have to win at least once eventually, and with this system you end up with your $100 profit even if you start out losing for a while. If you’re willing to bet up to ten times for instance, your chance of losing all ten bets is close to one in a thousand. That means that with a probability of almost 99.9%, you will win one of those ten bets, and therefore walk away with your $100.

Of course there’s a catch that few people notice. When the unlikely one in a thousand event happens and you do lose ten in a row, the actual amount that you’ve lost is over $100,000, all risked to win a mere hundred bucks. You might not have any way of doubling up again. You might even need some sort of bailout.

In the world of investments, there are many ways more subtle than the Martingale to guarantee a better return over a period of months, years, and even decades, at the cost of certain ruin way down the road.

Let’s say for instance that you’re managing a hedge fund which invests in stocks. Your strategy of sound fundamental analysis is fairly well understood. You have found that you can generate an average return of 6% per year, and so can most of your equally qualified competitors who have access to the same talent pool and knowledge base as you do.

But then one of your competitors realizes that he can automatically increase his return to 9% by selling something called “out of the money puts” on the market. This means that the competitor’s fund essentially sells insurance against the market crashing dramatically. In normal times his fund will gain the premium from selling this insurance which boosts his returns.

However, in the rare event of an extreme market crash his investors will lose everything. This form of Martingale can be easily tuned to work for various time periods with various chances of collapse.

When investors see a fund manager generate a higher return than his competitors, they will move their money into that fund and out of the other ones. And money managers are rewarded based on the size of their fund, or the level of returns.

The managers do not risk their own money. If they can provide a bigger gain for a few years, they win everything. They might even be lucky enough to be retired by the time their investors are paying the piper. The managers who have the discipline to understand and avoid the Martingale tricks will not be able to compete on the basis of their returns over a few years, and will eventually lose their funds and their jobs.

But many people managing large funds are men and women of integrity. They will not willingly expose their investors to total loss in order to line their own pockets with cash. Yet the system as it presently works does not allow them to compete without some kind of trade-off of long term risk versus short term reward.

The solution that they usually flock to is to create such a complex Martingale system that they themselves cannot understand the longer term risk implications. As long as the mathematical analysis of the risk of ruin lies beyond the understanding of the CEOs, the money managing organizations can stay competitive by employing their latest version of a return-boosting Martingale, without admitting to themselves or to others that they have been peer-pressured into the financial equivalent of selling their soul to the Devil.

In the 80’s the emerging Martingales were called junk bonds and LBO’s. In more recent times they are known as mortgage backed securities and credit default swaps.

You can regulate mortgages half to death and try to control what kind of risks various kinds of investment organizations are legally allowed to take. You can even forbid short selling and ban golden parachutes. But as long as managers are paid a percentage for managing other people’s money, they will compete with each other based on the returns they appear to generate.

The pressure to create out-sized returns will eventually force them to invent the latest complex scheme which will have the same effect: eventually the investors lose it all.

Complex financial structures will once again emerge that even the best professional investors cannot fully understand. People will always move their money into the places that give the best return over a few years, no matter how many times they are warned with the disclaimer that “past performance is no indication of future returns.” And eventually the crisis that results will reach global dimensions beyond the means of a government bailout, especially if part of the risk managing strategy becomes counting on bailouts happening every decade or so.

The only solution is to forbid money management as we know it.

We could certainly have people like Warren Buffet manage investors’ money alongside their own, with no additional percent-based compensation beyond their own investment gains. But we must remove the incentive to create Martingales, and protect people from their own intuitive desire to move their money into the funds which generate out-sized returns, without understanding the long term risks which create them.

In our globalized free market world, almost everyone is ultimately an investor, whether by owning a house or merely holding a job in a company which depends on access to capital. The scope of the current bailout has reached the point of real danger. We must fix the underlying problem before doubling down again as a society, or risk going the way of Albania.


Tuesday, January 20, 2009

An Example of Banks Destroying the Economy

TEMPE, Ariz. — Dave Brown, one of this city’s best-known home builders, had kept his head above water through the housing downturn, not missing a single interest payment on his loans.

Dave Brown, a builder in Tempe, Ariz., had never missed an interest payment, but his bank shut down his projects anyway.
So he was confounded a few months back when one of his banks, spooked by the decline in his company’s revenue, suddenly demanded millions of dollars in additional collateral to continue carrying loans on his projects.

He was unable to come up with the money, and in October, JPMorgan Chase foreclosed on five of his developments. Shortly thereafter, Brown Family Communities, 33 years in the business, decided to shut its doors.

“They treated me like a deadbeat who missed his car payment,” said an embittered Mr. Brown, 76. “They wanted their money now.”

After riding high on one of the greatest housing booms in American history, the nation’s home builders today face a devastating reversal of fortune.

Although the housing crisis is nearly two years old, many banks had refrained from cracking down on small home builders.

They are starting to do so, and a wide swath of the industry could be forced out of business in the next few years. The trouble is concentrated especially in the Sun Belt, the scene of so much overbuilding.

Not only have new-home sales stagnated, but builders confront a rising wave of foreclosed properties coming to market at prices below the cost of building a new home. To move houses, they have to mark them down to less than the cost of construction.

The convergence of these problems is bringing many small and medium-size builders — who account for about 70 percent of new-home construction in the United States — to their knees.

“The reality is, we’re seeing conditions in home construction and home finance that are the worst since the Depression,” said Steve Fritts, associate director of risk management policy at the Federal Deposit Insurance Corporation, the government agency that insures bank deposits.

Life has been difficult for large publicly traded home-building companies as well, where stock prices have collapsed and construction sharply cut back. Yet for now, many of the public companies can meet their obligations.

“They’re better capitalized and they have cash on hand,” said Ivy Zelman, a housing analyst. “They’re in a much better position than the private builders.”

No hard count exists of precisely how many builders have gone out of business since the downturn began. According to an estimate by the National Association of Home Builders, at least 20,000 builders — about a fifth of the total nationwide — have closed up shop in the last two years.

With the industry still owing hundreds of billions of dollars in loans made at the market peak, many more face insolvency in the coming months and years. “Probably north of 50 percent will fail,” Ms. Zelman said.

Much of that borrowed money went to finance land deals that now appear to have been catastrophic miscalculations. In cities like Phoenix, where housing starts are near record lows, demand for undeveloped land has plummeted, and prices have followed.

As defaults and delinquencies rise, home builders, once prized banking customers, have become pariahs. Even builders who are up to date on their interest payments or still managing to sell houses are getting trampled, as in the case of Mr. Brown.

“They’re not distinguishing the track records of one borrower against another,” said John Fioramonti, a real estate consultant in Scottsdale, Ariz. “If you’re a builder, you are a bad risk.”

With the pullback accelerating, complaints among builders of hardball tactics and shoddy treatment by banks are mounting, as is a general sense of betrayal.

“The behavior of the banks is unprecedented,” said Mick Pattinson, a home builder from Carlsbad, Calif. who has organized a national coalition of builders to draw attention to what they regard as unreasonable treatment. “Yes, there was overleveraging in the industry. But the aftermath doesn’t need to have been as brutal as it has been.”

Some experts defend the banks, saying they are starting to do what is necessary to come to grips with the turmoil in real estate. For months, they have been under pressure from federal bank regulators and their own shareholders to curtail lending to a faltering industry.

“The lenders are not operating irrationally or unfairly, generally speaking,” Mr. Fritts said. “They have to protect themselves.”

Access to credit is essential to builders, who rely heavily on borrowed money to finance land acquisitions and home construction.


What a Jubilee Would Do

In a Jubilee, you get to keep all of your real asset (cars, homes, etc). You would lose you paper assets if they involve debt to someone else. You would not lose your savings accounts, within the 250K FDIC coverage. The banking industries would be hit hard, obviously, but could quickly rebuild based on the new spending, saving, and investing, as the real economy was jumpstarted. Imagine how the economy would take off if no one had any house payments, no car payments, no credit card payments, and our gov't no longer had to pay interest on its debt. As you can easily see, there would be little credit, but lots of savings. Governments would be forced to run balanced budgets, as well as a balanced trade account. The upside, for just about everyone, would be huge.

Friday, January 16, 2009

Short-Circuit the Credit Crisis

Our whole economy is jammed up because we have fictional debts that are tied to assets that are no longer worth their book values. In reality, we are as wealthy as we were last month, last summer, or last year, but our economy is no longer functioning because of accounting rules that declare the debts greater than the assets, and thereby prevent banks from fulfilling their function of lending money. The still-collapsing housing prices continue to wreak havoc on the financial industry, by introducing a general deflation into the economy. This deflation is sending everyone's balance sheets further upside-down, since those balance sheets are based on debt that is tied to an inflated asset price.

Everyone sees that we are in a short circuit, an ever-widening crash, but no one can grasp how to break the cycle. The original idea of the bailout was to use government money to buy distressed assets. Then the idea has morphed to wholesale cash injections into troubled companies and industries. Now the Fed is buying and backing debt securities, basically saying to the banks, yes, we know the debt is bad, but we'll cover all your losses. Congress and the new President are floating new rounds of economic stimulus packages, cash gifts to the population, based on government IOUs.

But none of these measures can work. We have already crossed over the event horizon into a deflation, and that deflation is still picking up steam. There is no going back to the artificial boosts of inflationary spending. Extra money put into the system now is unable to bridge the gap between deflated asset value and the debt book value. The banks themselves are unable to release the extra money, because their asset levels are continually falling and they need the extra money to shore up their reserve requirements. Extra money given to consumers in an economic downturn only gets hoarded, not spent, thus preventing any stimulus from happening. Further, because most of our productive economy is based overseas, it is not clear how much the American economy would benefit much from the increased spending, as the stimulus would mainly benefit some foreign country's productive output. And, as we have seen, government redistribution does not increase real wealth anyway, so how does that help? If not redistributing wealth, the government has to rely on more debt spending, which is the source of the problem to begin with!

There is only one way to end the financial short circuit, to get us out of the destructive black-hole void of debt. The solution to our current crisis is quite simple really: cancel the debt itself. All debt, credit cards, car notes, mortgages, the national debt, all of it. Hit the reset button on the financial system. We have reached the blue screen of death, the system is totally locked up. The negative effects of the financial melt down are now negatively affecting the real productive economy. We have already entered a worldwide recession, this is getting really serious.

By releasing all debt, people will get a fresh slate, and can start saving again. Banks, whose only assets are completely fiction -- they call debt an asset -- would take a big hit, but so what? Banks don't contribute to national wealth anyway. Their only utility is to enable real productivity, and in that basic function, they have completely failed, and are in fact, counter-productive right now.

Despite having most of their assets (our debts) completely liquidated, the banking system would quickly recover anyway, because we could use our incomes to start saving again. The productive economy would be truly stimulated and bank accounts would fill up quickly, because all the money we currently use to pay off debt would go into savings, investment, and consumption. Imagine not having to pay all that money every month to your mortgage or car payment. All that money is going to go somewhere, either spent or saved. Given that financing life through credit would no longer be an option, people would begin saving in earnest again.

In short, everyone is given clear title to all their assets that banks currently have liens on. Instead of having to spend thousands of dollars on their mortgages and car payment and credit cards every month, the families of America would be able to save and spend that money. The people who lost their jobs in the financial industry would be able to find new employment quickly in the productive economy.

The American economy resets, the banks reset, we start from scratch, with all of our wealth freed from the fictional burden of debt. From this point forward, people, businesses, and governments are forced to spend only out of their savings, leading to the always-rising standard of living that America experienced for its first 150 years.

Recent Evolution of Banks

Banking is a commodity business. Banking deals with information…I am holding $100.00 of yours in something called a transaction account…I am holding your IOU for $1,000,000.00. Whereas, historically, these sums had to do with a physical quantity…something like gold…now all banking is basically conducted in 0’s and 1’s.

Banking is just information and the movement of information. Banking is a commodity business.

Yes, there are some other products and services connected with the banking business. There is safe keeping…you can get coin and currency back from your transaction account. We will clear payments for you though the banking system so that you can pay people from your account without the use of coin and currency and you can receive payments from others, which will be put into your account. That is, we clear transactions through the banking system. We will do your accounting for you and send you a monthly statement. We will make loans to you and provide many different kinds of services for you connected with your loan. And there are many other products and services that banks provide their customers…individuals, businesses, and governments.

Banks used to be paid for these services primarily in interest payments or in deposit balances that were kept at the bank. In the 1980s, however, we got another idea. The banks decided that they could isolate these products and services, account for them, and then charge the customer fees for the particular products, and the services that they use. Then, we (the banks), won’t have to build-in payment for the customers in the interest rates charged on the loans or by means of the deposit balances that the customer had been required to keep at the bank.

Fees are good because they don’t depend upon loan or deposit balances, but depend upon other products or services rendered.

In the 1980s, depository institutions found another way to generate fee income. In the 1970s, the government had invented a new financial instrument called a mortgage-backed security. This could help financial institutions make more money available to people who wanted to own homes and the depository institution could make these mortgage loans, securitize them so they could sell them and not hold them on their balance sheets, and collect fees for originating and, possibly servicing them. Furthermore, the banks would not have to worry about the interest rate risk that came from holding assets with long-term maturities like mortgages and support them with deposits that were available on demand or had short-term maturities.

Banks liked fees and started to build businesses based on fee income. They looked farther and farther in an effort to find more sources of fee income. They built or acquired subsidiaries that generated fee income, and as a result, banking companies grew and became diversified…even conglomerate in nature.

However, the banks saw that more than just mortgages could be securitized and they saw that these securitized loans could be traded and in so doing more and more fees could be generated, but they also found that they could make trading profits from dealing in these securitized loans. And banks began trading in securitized loans, otherwise called derivatives, and developing arbitrage strategies to take advantage of market discrepancies. However, to take advantage of market discrepancies they had to increase the amount of leverage they used to earn competitive returns.

Yet, the nature of banking did not change. Banking is a commodity business.

Not only is the business of borrowing money in the form of deposits and lending that money out to businesses and consumers in different kinds of loans a commodity business, the banks found that competition made all the products and services they offered into commodities as well. Trading – well, no one makes money over the longer haul on trading - because it, too, is composed of transactions in commodities.

Banks can earn a return on capital that is equal to what the capital can earn elsewhere given the normal risk a bank assumes, but banks cannot mold themselves into institutions that can produce and sustain competitive advantages over other firms and industries. The business model they tried did not work. Yet, like other firms and other industries that come to believe in a business model that doesn’t work, their continued efforts to make the business model work only exacerbated the problem. Generally, this extra effort meant taking more and more risks and then even using extra-legal means to produce the results wanted.

I am not saying that banks committed fraud, but I have very serious concerns about the off-balance sheet practices along with other accounting efforts that the banks used in an attempt to generate the higher returns they felt they had to earn. However, the competitive pressure to perform does push people and organizations to walk the edge of ethical practices.

Citigroup (C) had a business model that did not work, this model was tested over about a decade, and it never worked. The investment community realized this and was only lukewarm about the company’s stock. Yet, management stuck with the model and tried all the tricks to make its business model work. They were true believers.

No one stood up, however, and mentioned that the emperor didn’t have on any clothes.

Banking is a commodity business. Citigroup is said to be cutting back its organization by a third, and this is from the reduction in size that had already been achieved. It is supposedly getting back to fundamentals, and going into areas in which it has a core competency. Supposedly, its management has a better appreciation of the markets it will be working in. Let’s hope so.

So, the debt deflation goes on. The example of the banks, and of Citigroup, shows why it is so difficult to achieve a turnaround in the financial system and the economy during a time such as this. In the previous forty years or so, many companies, like Citigroup, took advantage of the almost continuous expansion of the economy and the government support of that expansion. Now the re-construction of these companies must take place.

The big question on the table right now concerns the stimulus plan being put together by President-elect Obama and his team. With companies like Citigroup drawing back and restructuring, how much effect can the stimulus plan have on the economy? The stimulus plan must not only attempt to reverse the economic down-term but must overcome the impact of the companies that are deleveraging their financial structure or are withdrawing from markets. The administration is shooting at a target that is moving away from it.


Volker to Reign Banks In

Re-learning the lessons they learned back in the 1930s, which we ignored and undid from the 1980s on.


Group Led by Volcker Urges More Oversight of Banks (Update1)

By Alison Fitzgerald

Jan. 15 (Bloomberg) -- A group led by Paul Volcker, an adviser to President-elect Barack Obama, called for a regulatory crackdown that would curtail risk-taking by systemically important financial institutions and limit their share of deposits.

The panel of former central bankers, finance ministers and academics known as the Group of Thirty advised that regulators impose capital limits on proprietary trading and bar large banks from running hedge funds and private-equity firms that mix their own and their clients’ money. In a report released today, the group also urged governments worldwide to tighten supervision of insurance companies, investment banks and large broker-dealers.

The recommendations come as U.S. lawmakers and the incoming Obama administration consider ways to overhaul regulation after major financial institutions reported almost $1 trillion in losses and writedowns stemming from the credit crisis.

Volcker, former chairman of the Federal Reserve, said at a press conference in New York that he’ll make the recommendations to Obama, adding that the report is “a reasonable indication of the direction in which we might go.” He was named by Obama to lead a panel of advisers on how to pull the U.S. out of the recession.

The financial system has “failed the test of the marketplace,” said Volcker, 81, chairman of the Trustees of the G-30. He endorsed the recommendations as an individual and not as a representative of the incoming Obama administration, the statement said.

Volcker characterized the banking system using “a four- letter word: It’s a mess.”

Advisory Board

Volcker is set to be chairman of the President’s Economic Recovery Advisory Board after Obama takes office Jan. 20.

“The worst Wall Street financial crisis has gone global, and not a regulator worth his salt will back down from tightening up the regulatory regime,” Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said before the report was released. “Volcker has Obama’s ear and there is no doubt that the U.S. will be on the same page as most of these G-30 recommendations for greater financial- services regulation.”


Volcker’s report calls for clear distinctions between institutions, such as former investment banks, that deal mainly in capital markets, and commercial banks that take deposits and make loans.

“We are making a distinction between what appears to be institutions that are becoming larger and doing banking business,” Volcker said at a news conference in New York today. “They should give their loyalty to their clients and customers. Those functions should not be carried out in the context of an institution that is carrying out very risky capital market activities.”

He said the report seems to speak directly to news this week that Citigroup will sell off many of its businesses and that Bank of America Corp. has asked the government for an additional capital infusion to help it complete the purchase of Merrill Lynch.

“It’s been proven that they’re unmanageable, the existing conglomerates,” he said.

Not Glass-Steagall

Volcker said the recommendation fall short of a revival of the Glass-Steagall law that separated insurance, commercial banking and investment banking.

The 18 sets of guidelines call for greater transparency, stricter corporate-governance standards and tougher oversight of financial firms whose failure could bring down the financial system.

The goal is to “restore strong, competitive, innovative financial markets to support global economic growth without once again risking a breakdown in market functioning so severe as to put the world economies at risk,” Volcker said in the statement.

The group recommends that money-market mutual funds that offer banking services reorganize as special-purpose banks and submit to supervision. It also calls for government oversight and capital requirements for hedge funds and private-equity firms that are deemed “too big to fail.”

The report’s co-chairs were former Italian Finance Minister Tommaso Padoa-Schioppa, and Arminio Fraga, former president of the Central Bank of Brazil. The three principals said not all members of the group, which includes Bank of England Governor Mervyn King, TIAA CREF Chief Executive Roger Ferguson, and Bank of Israel Governor Stanley Fischer, agreed with the report.

Reining in Risk

The goal of the recommendations is to create a system that would avoid a repeat of the current financial meltdown by reining in risk and boosting oversight. The report is entitled “Financial Reform: A Framework for Financial Stability.”

“There were major failures in risk management to a point that is mind boggling,” Fraga-Neto said today.

The group recommends that money market mutual funds that offer traditional banking services reorganize as special-purpose banks and submit to supervision and that a systemic-risk regulator oversee and impose capital requirements on hedge funds and private equity firms that are deemed “too big to fail.”

“It’s quite clear that hedge funds can be big enough, and volatile enough to be systemically important,” Volcker said.

Credit Ratings

Regulators should also recommend a different payment model for credit ratings that would avoid the conflicts of interest inherent in the current system, in which major rating firms, such as Moody’s and Standard & Poor’s, are paid by the firms issuing debt, the group said. Companies that use credit ratings should seek independent opinions.

Some of the group’s recommendations, including the one regarding rating companies, jibe with proposals that Obama put forth during his campaign.

Obama has pledged to replace the government-sponsored mortgage finance giants Fannie Mae and Freddie Mac “with a structure that is engaged in helping people buy homes, not engaging in market speculation.” The companies were placed into government receivership in September. Volcker’s group recommends against “hybrids with private ownership and government sponsorship.”

Obama said he’ll streamline overlapping regulatory agencies, and that he wants any company borrowing from the federal government to be subject to regulation. He’s also looking to strengthen capital requirements on mortgage securities and derivatives, and require financial institutions to better disclose to investors and companies with whom they do business the kinds of assets they hold.

The G-30 report recommends countries “reevaluate their regulatory structures with a view to eliminating unnecessary overlaps and gaps in coverage and complexity” and it also calls for transparency in credit default swaps, and structured and securitized products.