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That “Giant Sucking Sound”? It’s the Fed

Posted by
August 23, 2011

Black HoleFrom the Washington Post:

“Citigroup Inc. and Bank of America Corp. were the reigning champions of finance in 2006 as home prices peaked, leading the 10 biggest U.S. banks and brokerage firms to their best year ever with $104 billion of profits.

By 2008, the housing market’s collapse forced those companies to take more than six times as much, $669 billion, in emergency loans from the U.S. Federal Reserve. The loans dwarfed the $160 billion in public bailouts the top 10 got from the U.S. Treasury, yet until now the full amounts have remained secret. [emphasis added]”

Thanks to Freedom of Information Act (FOIA) inquiries we now know that even the publicly announce bailouts of large American financial firms was really just the tip of the iceberg.  Unlike the iceberg that sank the “too big to fail” Titanic almost 100 years ago, however, this iceberg appears to be the only thing that kept the paragons of finance afloat.  Also unlike the killer iceberg of 1912, this one is made, not of frozen water but of the surreptitiously confiscated wealth of all holders of U.S. dollars the world over; and far from being an error in judgment on the part of an inexperienced night watchman, this was orchestrated at the highest levels of government and the nation’s federally protected banking cartel.

“You’re talking about the aristocracy of American finance,” noted former Justice Department official Robert Litan who had been involved in investigating the S&L crisis of the 1990’s.  Ayn Rand would have called them the “aristocracy of pull.[1]”  Those banks, both domestic and foreign (including, but not limited to “…Edinburgh-based Royal Bank of Scotland Plc, which took $84.5 billion. Germany’s Hypo Real Estate Holding AG borrowed $28.7 billion…”) were able to accomplish what lawmakers decried was one of the worst effects of the financial crisis on families and small businesses: get loans to avoid bankruptcy.  While politicians decried a tight credit market, the banks were given “almost three times the size of the U.S. federal budget deficit that year [2008] and more than the total earnings of all federally insured banks in the U.S. for the decade through 2010.”

The Fed had attempted to block release of the information, taking it all the way to the Supreme Court (which thankfully declined to hear the case), claiming that to do so would jeopardize the reputations of the banks on the receiving end of the largesse, perhaps even causing a run on the institutions.  It is my opinion, though, that in the Bizarro World of American finance, this will actually turn out to be a sign of strength, signaling to potential investors and depositors that at these banks, and these alone (RIP Lehman Bros. et al), are tapped into the veins of the world’s dollar-based economy.

“Mark Lake, a spokesman for New York-based Morgan Stanley, said the crisis caused the industry to “fundamentally re- evaluate” the way it manages its cash. While Lake said the bank had applied “the lessons we learned from that period,” he declined to specify what changes the bank had made. [emphasis added]”  Perhaps the lesson they learned was that the free market for money is a sucker’s game, and that dealing directly with the State is far safer, and more lucrative.  In fact, “the Fed’s last-resort lending programs generally charge above-market interest rates to deter routine borrowing, that practice sometimes flipped during the crisis. On Oct. 20, 2008, for example, the central bank agreed to make $113.3 billion of 28-day loans through its Term Auction Facility at a rate of 1.1 percent, according to a press release at the time.

The rate was less than a third of the 3.8 percent that banks were charging each other for one-month loans on that day. [emphasis added]”  What rational banker would act any other way?

The moral hazard created by these programs is astounding.  Not only should banks not fear the riskiness of their loans, they should embrace it.  For the more tenuous their position, the better the rates they can expect from the Fed. “Whether banks needed the Fed’s money for survival or used it because it offered advantageous rates, the central bank’s lender-of-last-resort role amounts to a free insurance policy for banks in a disaster, Richard Herring, a finance professor at the University of Pennsylvania in Philadelphia said.

Access to Fed backup support ‘leads you to subject yourself to greater risks,’ Herring said. ‘If it’s not there, you’re not going to take the risks that would put you in trouble and require you to have access to that kind of funding.’”

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With gold having peaked at a new nominal high of over $1,900 last night, I thought it would be appropriate to link to an article showcasing some quotes referring to the possibility of gold moving above $1,600.  My personal favorite: “They’ll print money until we run out of trees.”

-Jimmy Rogers

If Sound Money means anything, it is that something like this cannot be done silently in the shadows.  The ability to “create money out of thin air,” aside from being a theft of purchasing power on a grand scale and a tax on all holders of U.S. Federal Reserve Notes that aren’t in Group 1 (those who receive the new money first), distorts the structure of the economy and creates a lawless class of the politically connected whose actions give true Capitalism a bad name.  Read any left-leaning or “Progressive” blog and you will hear this decried as “Capitalism,” followed by shouts for State regulation without a hint of irony.


[1] Rand, A. (2005). Atlas Shrugged. New York: Penguin Group. p. 375.