Destined to fail – the world’s financial system
Examine the growth of debt and leverage in the global economy and it is difficult to conclude that the route to salvation is additional stimulus from governments, taking on yet more debt to accelerate growth. Public sector deficits and consumer indebtedness weigh heavily upon economic activity and more debt will add fuel to a potential meltdown. But how did the world arrive at this parlous state? The responsibility rests not with individuals, politicians or otherwise. It is the result of a system with skewed incentives exemplified by the banks’ profiting from ever expanding debt. Banks wield such power that governments’ policies inevitably pander to their interests. If one doubts this statement, one only needs to look at the sub-prime mortgage crisis which was created by perverse structural incentives to obscure the truth. The major culprits were the banks which issued and traded mortgage backed securities and derivatives. But others were by no means blameless.
The often fraudulent mortgage loans were made either to people on low incomes, allowing them to buy houses they couldn’t afford, or to speculators who hoped to make a profit through a quick sale in a rising market. The house buyers had every incentive to hide that fact they wouldn’t be able to keep up the payments. The real estate agents were earning higher commissions as prices were inflated by excessive liquidity. The originating lenders were able to sell bad debts enabling them to write more mortgage business. Investors were earning high yields on AAA rated securities, relying on the credit rating agencies’ due diligence. Meanwhile, the ratings agencies quadrupled their turnover between 2000 and 2006 as the demand for their services from the issuing banks increased. The issuing banks were making money from origination and sales of securities and, in some cases, by shorting their book at the expense of their clients. All of these players had a strong incentive to hide the toxic nature of subprime mortgages.
What was the response to the crisis? The banks frightened politicians into bailing them out, threatening that if they did not agree the banking system would collapse. Congress was pressured into passing legislation for the Troubled Asset Relief Program (TARP) to cover the banks’ subprime losses. Meanwhile, the meeting to agree the bailout of AIG was attended by Lloyd Blankfein, the CEO of Goldman Sachs and Hank Paulson, US Treasury Secretary and former CEO of Goldmans. Goldman Sachs received $13bn of the resulting AIG bailout fund enabling them to pay $billions in bonuses in the following quarter. Weaker banks were driven into the arms of the bulge bracket banks creating even larger behemoths which tightened their grip on the political process and tilted the financial landscape yet further in their favour. To this day, no organisation or individual of significance has been held to account for the crisis. The credit rating agencies continue to be rewarded by the issuers, a fundamental root cause of the crisis. Up until the 1970s, investors paid for credit ratings but thereafter the issuing banks paid the ratings agencies, sowing the seeds of the subprime crisis.
But subprime mortgage backed securities are only one artifice in the burgeoning array of instruments allegedly designed to reduce risk while offering higher returns. The credit default swap (CDS) market is unregulated and expanding exponentially as banks supposedly lay off the risks on their balance sheets. According to the Bank of International Settlements in 2006, the notional value of credit default swaps was $20 trillion, more than a threefold increase from two years earlier. Who knows the value today because they are traded over the counter and not registered on any exchange? However, these instruments and others like them are not the cause of our economic woes but symptoms of a dysfunctional financial system which is out of control.
A quotation attributed to Amschel Rothschild in 1838: ”Let me issue and control a Nation’s money and I care not who makes its laws”. And here is the problem. The fractional reserve banking system, on which our economic system is based, combined with the power of banks over the issuance of money is leading to the expansion of public debt to the point where the interest thereon will exceed the income available to service it. The US Federal Reserve Board is a private bank owned by other banks, in turn, controlled by private interests. The International Monetary Fund and Bank of International Settlements are also privately owned. Many of the world’s central banks are in private ownership and all are under the influence of banking interests.
The debt created by the US Federal Reserve is created out of nothing. A digital entry on the Fed’s balance sheet costs it nothing. But the obligation to pay interest on the notional debt is real and payable by US taxpayers. The balance then created is distributed through the banking system and used as capital by the banks to make loans many times the value of the created money. This is the magic of the fractional reserve banking system. Not only is money created out of nothing but it is then leveraged throughout the banking system, allowing the banks to make ever higher profits. Then through the banks’ principal trading and securitisation activities leverage continues to inflate the bubble even further. What applies to the US Fed applies to every other central bank.
We now have a “debt/leverage” mountain which dwarfs the amount of money required to finance the “real” economy, ie. that needed for trade, infrastructure, commerce etc. Disruption in the “debt/leverage” economy has an exaggerated effect on real industrial and commercial activity. The financial system is no longer the means to facilitate trade and industry, which should be its primary purpose.
The banks have an inbuilt incentive to inflate the money supply and unsurprisingly, central banks act in their interests. Since the bailing out of banks in 2008, a precedent has been set whereby not only do the banks get to make money on the back of ever expanding government debt but their trading losses are now also underwritten by taxpayers. Support for European banks holding Greek debt is but the latest example. Government policy is dictated by those who understand the alchemy of fractional reserve banking; banking alumni populate finance ministries while ordinary politicians have little understanding thereof. Some politicians have been schooled in conventional economic theory which is, of course, supportive of banking interests.
The only possible outcome from ever expanding debt is collapse of indebted economies and globalisation will ensure contagion. Civil unrest will grow as the fabric of society unravels. It is time for those working within the financial system to recognise that satisfying their short term interests will be to their detriment in the long term. The French Revolution demonstrated with horrifying clarity how the disaffected and dispossessed can wreak revenge on those perceived to be authors of their misery.
The current tinkering with financial regulation will, at best, delay the inevitable collapse. What is required is a radical change to remove the inbuilt incentives to expand the money supply. Governments around the world need to take back the control of the issuance money. Then they can then begin to control the banking system to which we are all enslaved.
If you doubt the rationale expounded here, consider the financial history of America. One of the factors in the American War of Independence was the colonies issuing their own, interest free, money which deprived the British of what they considered to be their rightful tax receipts and British bankers of their power over the money supply of a thriving colonial economy. “The refusal of King George to allow the colonies to operate an honest money system, which freed the ordinary man from clutches of the money manipulators was probably the prime cause of the revolution” -Benjamin Franklin, Founding Father. Having wrested control from the British, the founding fathers sought to protect the American people from the power of banks. However, through buying influence over members of congress, the banks managed to achieve legislation to create a central bank in 1791 but its unpopularity was such that its twenty year charter wasn’t renewed. An another attempt was made in 1816 but it too failed to get its charter renewed, in 1836. Andrew Jackson, who became president in 1828, denounced the central bank as an engine of corruption. However, the banks maintained their persistence and in 1913, the Federal Reserve Act, creating the Federal Reserve Board, was signed into law. The act passed on 23rd December when there were only three senators present for the vote. Woodrow Wilson, the president who signed the act into law, wrote that it was the biggest regret of his term in office. Following the stockmarket crash of 1929 and the ensuing depression, the banks were brought partially to heel by the Glass-Steagall Act but in the last thirty years progressive financial deregulation has awarded banks unprecedented power and not just over the economy. Financial interests dominate political, military, media and commercial activity.
Banking regulation is conducted under the influence of banking interests and is consequently a charade. Those responsible for the subprime crisis have not been held to account for criminal acts. There has been no material change in the financial system which precipitated the crisis and the major banks enjoy even more power than before. Meanwhile, the debt/ leverage mountain continues to expand which will result in an even worse collapse.
The Vickers’ banking report proposals are akin to reordering the deckchairs on the Titanic. Rules based regulation failed to stop the collapse of Barings, $5 billion worth of trading losses at Societe Generale or the subprime crisis. The proposed “ring fencing” of retail banking in the UK will do little to delay the inevitable. Systemic collapse is unavoidable unless people throughout the world, through their governments, recover the monopoly power to issue their own currency.