The reason the Federal Reserve is having so little effect is that virtually all of the “bad money” was created out of its reach. People create their own money in many types of transactions, and even if some portion goes through the Federal Reserve, for purposes of accounting between banks, the creation and existence of the “bad” money exists apart from any action taken or not taken by the Federal Reserve. Greenspan might have had it wrong, but he isn’t to blame for the actions of people who were operating outside the scope of his authority or responsibility.
The Glass Steagel Act kept banks and securities firms apart. The simple logic was that neither banks nor securities firms have any direct interest in serving or protecting the public. That can only be achieved by regulation from government. Put them together and you have a recipe for disaster. Banks and securities firms have as their primary goal to make money. And if they get an idea to make a ton of it, no matter how stupid it is, (see Mortgage Meltdown), they will do it. Because in the end, the people who make these decisions do so in a bubble of their own — small wonder they create financial bubbles and crises.
If I agree to lend you $500,000 to buy a house worth $300,000, that is or was a perfectly legal transaction. It also is completely out of reach of the Fed. If you in turn sign papers acquiring the house and I pay the seller the $500,000, the transaction goes through the Fed for accounting purposes in determining the balances at financial institutions. But it is not money created by the Fed nor is it subject to regulation by the Fed. The “money supply” was increased by $500,000 and all the Fed could do is see it but not touch it. Insiders know that $200,000 of “value” is completely fake, but this is carefully scripted to create “plausible deniability.”
If I sell shares in your loan to other people as “derivative mortgage-backed” securities, they sound like pretty good investments to most people and they buy it for perhaps $600,000. Again, money exchanged hands and all the Fed can do is watch. And by the way the “money supply” was just increased by another $100,000 or $600,000 depending upon which theory of econometrics you subscribe to. Again only the insiders know that an additional $100,000 had been added to the completely fake valuation of the original transaction from which the mortgage backed security “derives” its value.
Here we had the perfect storm. The repeal of Glass Steagel which allowed financial institutions (regulated by the Fed) and securities firms (not regulated by the Fed) to become one institution provided they (the banks and securities firms) protect the public from scoundrels. This is akin to delegating the job of creating peace in the Middle East to Saddam Hussein.
Or if you like, it can be compared with the FDA and other agencies that have come under the direct influence and control of corporate America serving the profit motive, shoving aside the duty to serve and protect the people, leaving the citizenry with no protection.
Like the FDA, the law provided shields from the appearance of stupidity. In this case, even though banking and securities were under the roof of one house, it was OK as long as there was a chinese wall between the two functions. Right. I worked in both the banking and securities sectors. There is no wall but they all understand how to create plausible deniability.
The Fed alone is not going to stop the crash that is coming. But these behemoth two-headed monstrosities will probably be allowed to defer the crash with more funny money. This will compound the devaluation of the dollar but give the appearance, for a while, that everything is under control. Most people don’t remember what happened to the value of the dollar in the 1980’s. Few know or remember the 2500% inflation in Germany in one month. It doesn’t take much to crash because money is only an idea, a belief, a confidence in the system. If those ephemeral subjective perceptions of the public change, money is gone — all of it.
If we really want to allow the country to go into recession and not a crash we have to convince ourselves and convince people in other parts of the world that we are again a nations of laws, regulating currency, monetary policy, securities trading, in a sane reasonable manner. An economy based upon getting consumers to go deeper and deeper into debt buying things they don’t need and probably won’t want soon after purchase is not a valid premise.
Economic stimulus is a good thing in theory. But if it consists of getting more money into the hands of consumers and then pressuring them to part with it on objects of doubtful added value, then this plan is no better than the behemoth plan of creating more funny money to cover the old funny money.
The party is over. We are going to have to take the hit on our own nose to show that we are a stand-up crowd and not a rowdy group of criminal greedy myth-sellers. The fundamental premise driving the economy must include consumer spending only in relation to growth in other fundamental areas of commerce and society — innovation, production of products that people in other countries want, and the discovery of intellectual property that is useful in adding sustained value in the perception of consumers.
The answer is neither deregulation nor more regulation. It is changed regulation keeping the long-term viability of the country and its people as the top priority. Anything less will reduce the United States to a third world country that has adopted China as its lender of last resort — a country with no vested interest in doing anything other than using us for economic leverage, and who is now producing the control systems for our weapons, along with sponsoring the migration of Chinese nationals to the U.S. , while they build their own military capability at an alarming rate.
Something has to give folks. Is anyone out there listening?
Filed under: bubble, CDO, community banks, credit unions, currency, Eviction, foreclosure, GTC | Honor, inflation, interest rates, Investor, Mortgage | Tagged: banking, devaluation, Federal reserve, Germany, Glass Seagal, mortgage meltdown |
I marvel that persons such as your good self have been saying this for so long and yet I discover, in 2010, as Britain goes into austerity mode (slashing £81 BILLION from public spending) that some of OUR MP’s (Members of Parliament) have never heard of Glass-Steagall much less realised what it used to do, not to mention the effects of its repeal. This scared the pants of me frankly, that I know more about things economic than members of my government. That is seriously scary stuff. I only discovered it myself three months ago if I am honest but the penny dropped the minute I became aware, a true light-bulb moment if you will and I have made it my personal mission to show the British people that it was NOT our former Prime Minister who stuffed our economy but rather it was the US governments idiotic repeal of the only legislation that stopped banks taking high risks with the money (real or imagined) that the ordinary citizen has (or imagines he has).
The chain of events became crystal clear and suddenly I found myself forced to stand up for our former leader and am now duty bound, through my annoying habit of being honest, to point the finger of blame at the culprit. No doubt this will, in time as my political profile in the UK grows in the months and years ahead, make me a very unpopular man with your government but, as this will put me in the same group as JFK and Martin Luther-King then I will be proud to speak out honestly. We are duty bound all to tell it how it is and if that means upsetting the powers that be then so be it but silent I shall not be. Again my friend I thank you for the work you have put in on this website, and I hope many others will call in to read for themselves your comments. Respect.
wow, thank you for educating me alittle on this subject.any other suggestions for we as citizens to become more informed and to act in helping get some of our country back?
Regarding your article of January 14, 2008:
Does anybody advocate limiting the money supply, as closely as possible, to the actual total wealth of the nation?
This would mean that the only money banks could lend would come from depositors.
The only time more money would be introduced into the economy is when greater wealth is discovered such as massive new oil depositis or powerful new technologies that contribute to wealth.
The central bank would then create the additional money, but rather than route it through the banks, would distribute it randomly in million dollar bundles to the general public.
I feel that these ideas could be terribly naive; however, I read that Milton Friedman once advocated dropping money from a helicopter.
Peter Davis
peter.davis2@sympatico.ca
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The banks would have survived without the repeal of Glass Segal. They may not have returned as much to investors as did some dotcoms, but there were still plenty of folks who relied on banks, made deposits and withdrawals from them, borrowed from them: in other words, used them as banks. The Republicans Congress, with Clinton’s complicity, used the relatively low return of banks to repeal the very prohibition that made our banking system sound–to the present effect that will lead our economic system into a cataclysmic nosedive.
Thanks Bill Clinton. Give another speech, make another million.
I have not worked in either the banking or the investment industry, and have no graduate degrees in economics. But I remember being impressed by the logic behind keeping separate money obtained by speculative investment institutions from banks that received money for long term collateral backed investment.
Combining the two under one decision making roof just seemed like placing money in the hands of a manic depressive schizophrenic, simultaneously an annovative risk taker and an economic conservative with a watch dog (the Federal Reserve ) to keep him straight. Asking the innovative risk taker and the economic conservative to keep thw two thoughts separate seemed a little bit too much.
The ar gument for removing the wall between the two that had been created by created by Glass Segal was that the banks were not making enough profit compared to the risk taking investment side of our economy and could not not attract enough capital to invest. This of course was whwn our economy was overheated, and everone was making money except the banks.
The alternative answers would appear to have been, intentionally put the brakes on the economy, which would be politically extremely unpopular as well as difficult to control, simultaneously regulate the risk favoring investment side, always opposed as interferring with the free market and inhibitting the ability of people to make a fast buck, finding another way for banks to attract a lot of money during those particularly heady times, or let nature take its course and tyhe bubble burst.
It would seem that regulation: primarily with devices to insure transparency might be the first long term step. There is no such thing as a free market. In a totally free market some one , or at mpost two or three by there private agreement, eventually come out on top. And now it is completely frozen and rigid.
In the present instance , I would immediately put home mortgages back under the jurisdiction of the bankruptcy courts. Our legal system is based on the assumption that the parties to a civil suit are the most knowledegable
of how to resove it and the threat of having another person resolving it for them is their best inspiration.
Make it a matter of statutory law that all past and future loans that as made could only show a profit if the borrower is late in payment or default are unenforceable and in the case of future loans the lender will be subject to heavy fines calculated as a large percent of the amount loaned loan.
Make accountants who publish reports on which investors rely responsible to the investors for the honesty of their acccounting , as well as subject to fines even if their dishonesty does not occasion any provable loss.
Longer term, impose strict regulations to insure complete transparency even transparency to the stupid .consumer and the stupid bank.
And perhaps going back to Glass Segal should be considered. If Glass Segcal was in effect, what would have really happened to the economy? Wasn’t there another way for banks to have survived?