The Truth will prevail, But only if we Demand it from Congress!
9-11 Inside Job and Neocons Hacked 2004
LewRockwell.com
by Gary North
The bailout of IndyMac’s depositors will probably deplete 10% of the
FDIC’s reserves.
Congress will back up the FDIC if the FDIC ever (1) runs out of
T-bills to sell (2) to raise money (3) to pay off depositors of
insolvent banks. But where will Congress get this money? From the
Federal Reserve System, if lenders will not fork over the money.
The Federal Reserve System backs up Congress. This is the heart of
the threat to the solvency of the dollar.
The $4 billion that the FDIC will pay to a handful of depositors at
IndyMac is hush money. It is paid to them to silence every other
depositor in the country. "Don’t spread rumors about any insolvent
bank." Why not? "Because, in a fractionally reserved system, all of
them are technically insolvent." They are all borrowed short and
lent long.
NO PANIC . . . YET
The failure of IndyMac this month was unique. We have not seen a
bank failure this large since 1984. In one sense, this reminded the
general public that individual banks can go bankrupt.
The most common reason for bankruptcy is that the bank has lent
money to purchasers of real estate, which is a long-term debt, yet
depositors have the right to withdraw money at any time. The bank is
lent long and borrowed short. Yet this is true of every bank. The
ones that get caught, which is a rare event, have merely indulged in
long-term lending more than the average bank.
The failure of an individual bank does not produce mass panic any
longer. It has been so long since Americans have seen a bank run
that they pay no attention to a rare bank failure. Because the FDIC
presently does have sufficient reserves in Treasury debt to sell and
compensate depositors, depositors around the country are not tempted
to go to their bank and demand currency.
The fact that the FDIC could cover the deposits of no more than a
dozen banks the size of IndyMac does not disturb them.
They know nothing about the FDIC, other than the crucial fact: the
United States government stands behind it. The government will
re-capitalize the FDIC.
The experts who really do understand the nature of the bank deposit
insurance program, as incarnated by the FDIC, know that the Federal
Reserve System in turn stands behind the Federal government. So,
there is no question that individual depositors in individual banks
will be bailed out by the FDIC directly, or by the United States
government through the FDIC if the FDIC runs out of T-bills to sell.
What will happen when the Federal Reserve System runs out of
Treasury debt to sell or swap? It has unloaded almost 40% of its
holdings since last December.
When that day comes, a lot of geese will get cooked.
TWO KINDS OF BANK FAILURES
There is an enormous difference – a literally life-and-death
difference – between individual bank failures and a systemic banking
failure. I do not believe we are facing a systemic banking failure.
But we are facing more individual bank failures.
Americans have seen very few bank failures ever since the
establishment of the FDIC in 1934. Depositors trust the FDIC to
intervene and protect the money in their bank accounts. They do not
withdraw currency from their accounts in a banking crisis because
they believe that the FDIC will intervene to protect them. This
confidence has kept almost all American banks from experiencing bank
runs since 1934.
This is the most important of all "moral hazards." A moral hazard is
the expected subsidy from the government to protect investors from a
major collapse that their own stupidity and greed has caused. All
the talk by Ben Bernanke or anyone else about trying to avoid moral
hazard is propaganda for the rubes. Moral hazard is at the bottom of
the banking system, beginning with the Federal Reserve Act of 1913.
The entire banking system rests on this premise: the banking system
must be saved from bad investment decisions of reckless bankers
whose banks go bankrupt, thereby causing doubts about the solvency
of an entire system that is borrowed short and lent long, a system
built on a lie: "We will pay you interest by lending out your
deposit, but everyone can get his money back at any time." This lie
is more widely believed than even this one: "Of course I will still
respect you in the morning."
The FDIC was set up to use government money, if required, to protect
bankers against two groups: (1) depositors, (2) foolhardy rival
bankers who go bust. Bankers fear depositors’ decisions to withdraw
currency, thereby imploding the fractionally reserved banking
system. They fear busted banks because of the potential domino
effect: "all fall down."
WITHDRAWAL AND RE-DEPOSIT
When an individual withdraws currency from his bank account, he
reverses the expansion process of fractional reserve banking. For
every paper dollar that an individual deposits, the banking system
as a whole multiplies the quantity of money by nine to one. It may
multiply it even more if this deposit is not in an urban bank.
Similarly, when a person withdraws currency from his bank, and does
not redeposit it, the banking system contracts the deposits by nine
to one.
Who withdraws currency from a bank? You and I withdraw currency from
ATMs, but we intend to spend this currency. Whenever we spend it, it
winds up in the cash drawer of a retail company. The company at the
end of the day deposits this currency into its bank. So, the banking
system as a whole does not experience contraction. The money supply
therefore does not contract.
The only contraction that is permanent is the contraction of
currency withdrawn from a local bank and then sent to relatives
outside the United States. When this is done, there is a permanent
contraction of digital money in the banking system. But this rate of
withdrawal is fairly constant, and so the banking system does not
contract unexpectedly. This process actually reduces the rate of
monetary inflation and the rate of price inflation in the United
States. Immigrants send money to their relatives, and American
consumers find that imported goods are paid for in effect by pieces
of paper with Presidents’ pictures on them. Foreigners do not use
the money to buy American goods, leaving prices lower in the United
States than they otherwise would have been.
The banking system as a whole is not threatened by individual bank
failures. The money that a failed bank has lent out does not
disappear when the lending bank fails. It remains in circulation.
The money that depositors might otherwise have lost is returned to
them by the FDIC. So, individual bank failures do not alter the
total money supply.
Those few individuals who deposited more than $100,000 in accounts
at a local bank that fails will lose most of their money above
$100,000. They have learned their lesson through IndyMac. It is
likely that wealthy depositors have already taken steps by now to
defend themselves against further bank failures. They have spread
the money around. If not, they are slow learners.
THE REAL THREAT
The problem with individual bank failures is not the threat of a
collapsing banking system. The problem is that bank failures send a
message to depositors: the economy is being managed by people who do
not have good economic judgment. Depositors begin to distrust the
economy as a whole. It is not that they distrust the banking system
as a whole. There is nothing they can do individually to pull the
plug on the banking system as a whole, other than withdrawing all of
their money from the bank and sending it abroad to people they
barely know. This is not going to happen.
The threat to the banking system is that failed banks are a yellow
flag to consumers. It warns them that the economy as a whole is at
risk. Bank failures testify to the incompetence of supposed experts
who manage the public’s money. When the average investor begins to
lose confidence in the money managers, they may decide that
discretion is the better part of valor. At some point, he will call
his pension fund or stock mutual fund and tell the person at the
other end of the line to sell the stocks. He will have to buy
something, and what he will buy will be short-term money market
instruments. He may also buy U.S. Treasury bonds.
The problem with this is that long-term money, meaning long-term
capital to be used in long-term projects, will become less
available. The government will spend any money that the public
invests in Treasury debt. Businesses will find that it is more
difficult to gain access to long-term capital. This will slow the
rate of economic growth in the United States. This will remove the
engine of economic growth. By moving their money out of the private
sector, and especially out of equities, investors will contract the
overall economy.
It is not that individual bank failures threaten the banking system
as a whole. The banking system as a whole is a gigantic cartel, and
this cartel has as its protector the Federal Reserve System. The
Federal Reserve System is legally allowed to monetize anything it
wants to monetize. It can buy any asset, and it can create the money
to buy this asset.
The Federal Reserve can intervene to save individual banks, or large
financial institutions. Not only can it do this, it is doing it on a
constant basis. At some point, it will not be able to do this
without monetizing assets that it cannot offset by the sale of
existing Treasury debt in its possession. Beginning in December
2007, the Federal Reserve System has sold Treasury debt whenever it
has increased its purchase of questionable assets that it has bought
from banks and large financial institutions. It has unloaded about
40% of its holdings of liquid Treasury debt. This has kept it from
inflating the money supply at a dramatic rate.
At some point, it will run out of Treasury debt to sell to the
general public in order to offset the increase of its purchase of
questionable assets held by the financial system. At that point, the
great inflation will begin.
This could be a year away. This could be a month away. All we know
is this: when the Federal Reserve system runs out of Treasury debt
to sell, its purchase of all assets will be inflationary. The
banking system as a whole is protected. What is not protected is the
purchasing power of the dollar.
In order to guarantee the survival of the banking system as a whole,
the existing legal structure has created an enormous risk factor:
the destruction of the dollar. Legal solvency can be maintained by
the banking system as a whole, but this legal solvency comes at a
price: the threat of the insolvency of the dollar itself.
This has always been true. The public has never thought this
through. It is beyond the voters’ comprehension. Congress, which has
authorized the legislation that has led to this system ever since
passing the Federal Reserve Act in late December, 1913, has also not
thought about the implications of this system of guaranteed legal
solvency for the banking system. But the insolvency of the dollar is
the ultimate implication of the legal structure of today’s
fractionally reserved banking cartel.
The major threat to the banking system is from outside the banking
system. The major threat is the insolvency of a major company that
has guaranteed the bonds of private corporations and agency bonds of
the United States government, such as Fannie Mae and Freddie Mac.
These supposed guarantees have made possible the system of bond
portfolios that can be broken up into 125 levels of risk, with
appropriate rates of return on each of the slices. The system is so
complex that no one understands it.
Hedge funds have invested in these assets, called collateralized
mortgage obligations. They have borrowed from banks to buy them. The
leverage of the hedge fund system is enormous. It is probably a
hundred to one. The guarantees against loss that undergird the
financial system are guarantees made by organizations that cannot
possibly fulfill their contracts during an anomalous event, such as
an attack on Iran by the Israeli air force. When the promises cannot
be fulfilled, interest rates will rise for all American bonds except
those of the United States Treasury. This will trigger additional
demands placed on the guarantors of these contracts, which will
threaten the solvency of the bond system.
At that point, bank capital will collapse as a result of the losses
that the banks have sustained because they lent hedge funds money to
invest in the bonds. The collapse of the Carlyle Capital Corp.
earlier this year took less than a week. It was borrowed at least 32
to one by ten major banks of the United States. Those banks lost
100% of these their investment in one week.
When banks lose capital, they must either find new investors, or
else they must reduce their loans. When they reduce their loans,
they refuse to roll over existing lines of credit to American
corporations. This is the major threat to the system. It is not a
threat of the bankruptcy of the banks; it is the threat of the
reduction of lines of credit to American corporations – corporations
that are dependent on these lines of credit.
In a financial panic, American investors will move from corporate
bonds and stocks and put their money in Treasury debt. This
threatens the solvency, not simply of individual banks, but of
individual corporations that are dependent upon lines of credit
issued by specific banks. American corporations are not dependent on
the banking system as a whole. They are dependent on continuing
lines of credit from specific banks. They do not have time to
renegotiate loans with other banks. They have to meet their
payrolls. This will become increasingly difficult to do in the
environment created by constant reports of individual failures of
specific banks.
This is the famous and widely denied crowding-out effect. The
Federal government’s debt certificates are trusted; the private
capital markets are less trusted. In order for the private capital
markets to continue to operate in such a hostile environment, they
will have to offer greater economic returns than Treasury debt. It
will become more expensive for private companies to attract
long-term investment, precisely because individual banks are
failing.
Obviously, the companies would all fail if the banking system as a
whole collapsed. The entire society’s existence would be at risk if
the entire banking system collapsed. There is no a safe hedge
against such a scenario. The division of labor would collapse.
Cities would not be resupplied with goods. It would be like all the
disaster movies combined. It would take only a matter of weeks for
the death rate to jump. So, anyone who talks about the collapse of
the banking system who has not retreated to a small farm located 100
miles from a major city does not take seriously his own scenario.
The problem is not the collapse of the banking system as a whole.
The problem is the crowding out by government, especially the
Federal government, of capital that would otherwise have gone into
the private sector. The threat is the long-term erosion of
confidence in the private capital markets.
This is not a minor threat. This is a major threat. It threatens the
long-term growth of the American economy. It threatens the long-term
growth of an economy which is heavily indebted to foreign investors.
When foreign investors perceive that growth has stopped, they are
going to cease lending money to Americans to sustain their present
patterns of consumption. The dollar will fall. The price of imported
goods will increase. The public will have to readjust its household
budgets. When the public must readjust spending patterns, the result
is recession. In a major readjustment of their budgets, the result
is a deep depression. We have not seen this since the 1930s.
When we read of more bank failures, we will grow more nervous. It is
not that tens of millions of depositors will go down to their banks
and take out currency. A few million people may do this to a limited
extent, but most people will not. This is because they do not have
sufficient reserves in their bank accounts to enable them to take
out $1000 in currency and not use that money to spend on household
bills. So, they won’t do this. (You probably should.)
The long-run effectiveness of withdrawing currency to protect
yourself from a complete collapse is essentially useless. You cannot
buy much in a complete collapse. Most things are produced and
delivered based on bank credit. We are hooked.
The likelihood of the complete collapse of banks is extremely low.
It could happen, but it is highly unlikely. What is likely in a
scenario of failing banks is the increasing loss of public
confidence in the private capital markets. When that happens, the
rush to buy Treasury debt, which means the rush to hand over our
economic future is to the United States Congress, will lead to the
de-capitalization of the private companies that increase our
standard of living.
THE REAL PRICE OF BANK GUARANTEES
The public has encouraged the United States government to protect
voters from unexpected bank failures. Congress has complied. The
banking cartel has welcomed this cooperation. The Federal Reserve
System has inflated. The dollar has depreciated by 95% since 1914.
This is a result of the creation of the Federal Reserve System,
which was created in the name of stable money. In other words, it is
one more example of Ludwig von Mises’ rule: whenever the government
interferes with the market, the result will be the opposite of what
the legislators said they intended to achieve.
The greater the threat to the individual banks’ solvency, the louder
the public will demand additional government intervention. Congress
will respond. The result will be the creation of a set of conditions
in which the Federal Reserve System will have to monetize the
overleveraged hedge fund system which has grown up over the last
decade. It will find that it must monetize so much, so fast, on all
sides, that it will not be able to offset the creation of new money
by the sale of existing Treasury debt.
Bernanke has done his best to keep the helicopter full of fiat money
from having to take off and do its work. But he cannot resist the
demands of Congress once it is clear the public that a series of
bank bankruptcies is threatening the public’s confidence in the
economy as a whole. The banks are protected. The purchasing power of
the United States dollar is not.
Eventually, Bernanke’s hush money helicopter will fly.
So, we face a recession. We also face bankruptcies of overleveraged
small banks like IndyMac. But the large banks are far more leveraged
than the public understands. They have lent huge chunks of their
capital to hedge funds that are leveraged 100 to one. A 1% move
opposite to what a hedge fund has expected can wipe out 100% of a
100-to-one fund’s equity. It can be insolvent faster than you can
say Carlyle Capital Corporation.
Warren Buffett says that the stages of the investment cycle is
managed by three successive groups: first, the innovators; second,
the imitators; third, the idiots. We are well into stage three.
CONCLUSION
In 1998, a weekend intervention by the President of the New York
Federal Reserve Bank got a dozen banks to pony up $3.6 billion of
new loans to keep the insolvent Long Term Capital Management hedge
fund. The fund was leveraged 30 to one and would have to sell off
$125 billion in assets at a loss. Since much of the portfolio was in
assets that had fallen to zero – defaulted Russian bonds – this
would be painful. Sales of the liquid assets would have tanked the
international bond market. The bailout gave the banks time to sell
the still-marketable assets over the next two years.
Now the hedge funds are international. The obligations are in the
trillions.
Who can bail out a large busted fund now? The banks are in hock to
all of them, and one of them can bring down the system.
Bernanke will need a lot of hush money.
July 26, 2008
Gary North [send him mail] is the author of Mises on Money. Visit
http://www.garynorth.com.He is also the author of a free 20-volume
series, An Economic Commentary on the Bible.
Copyright © 2008 LewRockwell.com
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