Sunday, December 12, 2010

The Century-Old Secretive Banking Elite

A must-read article appeared in today's New York Times: "A Secretive Banking Elite Rules Trading in Derivatives" The NYT, despite numerous examples of leftward media bias and abandonment of objective journalism, is no grocery store tabloid. This story will confirm the worst fears of some conspiracy theorists. Jim Sinclair comments: "What has become of Western Financial Society that it needs to be run by secret cabals? What has become of the people that this can be discussed in the light of day and nobody really cares." I must add that, as an antitrust lawyer, I agree with the legal experts cited in the article that what is described is an illegal conspiracy under the Sherman Act. But bankers are uniquely insensitive to the legality of their actions. After all, the Fed is a cartel and was openly chartered as such. I digress with a little history lesson:
Legal tender greenbacks printed to support the Union war effort established a national currency after 1862; but that did not change the fact that some bankers occasionally underestimated depositors’ demand for money, causing bank panics and runs on the bank. And as commerce grew, the seasonal demand for credit became a larger and larger problem. Prudent bankers simply didn’t have enough money to lend out to businessmen for growth and to farmers at planting time. That was either a lost business opportunity for banks or it encouraged imprudent bankers to lend out more than they should, placing the bank’s stability at risk. It also created a liquidity problem in an economy that was growing increasingly sophisticated and an environment in which business could grow faster with outside financing. The bankers were in a straight jacket imposed by the market which required the banks to have a solid reputation and adequate reserves 100% of the time. And bankers felt a need to safely escape those strictures, which limited the banks’ ability to lend out more money and thus their ability to make more money on banking.

The Federal Reserve System

By 1910 the situation had begun to wear on the banks. And so, some influential people in banking and finance conceived of a central bank where they could pool their resources, to be drawn upon in emergencies. Key influential banking magnates met secretly in Jekyll Island, Georgia, to agree to and create a banking cartel. The cartel was modeled after the European banking cartels that existed at the time. Nelson Aldrich, the Senate Republican Whip and father-in-law of John D. Rockefeller, Jr., was the sole non-banker at the meeting. He described the idea as “not a bank, but a cooperative union of all banks of the country for definite purposes.” It went beyond the notion of private cartels such as we know today, like the DeBeers diamond cartel or OPEC. The notion was to make it a government imposed cartel like the Interstate Commerce Commission and later government agencies such as the Civil Aeronautics Board and Federal Communications Commission, all of which were chartered to give government and its proxies the exclusive right to set prices and allocate markets and resources for private corporations. A. Barton Hepburn of Chase National Bank speaking in support of the legislation said, “The measure recognizes and adopts the principles of a central bank. Indeed, if it works out as the sponsors of the law hope, it will make all incorporated banks together joint owners of a central dominating power.” Thus, in 1913 the Federal Reserve System was born. Unlike the CAB and FCC, however, the Fed is a private central bank owned by its members but imposed on them by law
"Dominating." Hmmm. To be sure.  And that is how the key players understand their role. They justify in their own minds that what they do is patriotism: they preserve the Republic. (Their bonuses are only incidental to a greater good.) But that is clearly a rationalization.

Please remain alert to Congressman Paul's expose in the coming months of the Fed and its minions.

There is no nefarious intent here.  The banks have not set as their goal to own you or your assets, or to run the economy.  They only want to make money and conserve their capital, like any other good business.  But they need to make money honestly, without the application of  "force" (meaning ultimately the guns of the government) to coerce people into transactions (or to avoid them).

Dr. Paul advocates the gold standard, which applied to our money less than a century ago.  That ideal cannot practicably be implemented in today's world economy although it can be approximated.  The point is that we, indeed every nation, need a currency that adheres to an objective standard that is beyond the control of politicians and banking interests that use their inside influence to profit from advantages they gain from a special relationship with the government and its proxies.

A Perspective on the Mortgage Mess

Here is a succinct perspective on the mortgage mess.

1. Ultimately, the people who didn't pay their mortgages will lose their homes.

2. Ultimately, the losses resulting from mortgage defaults will have to show up on someone's books; but they will not show up all at once. Reports of the losses will be bled out quarter by quarter on the "frog in a pot theory" * so that the market is not shocked at the magnitude of the problem.

3. People who bought foreclosed properties and thought they had clear title will find, in significant numbers of cases, that they do not in fact have clear title to their homes -- because it is not clear who had a right to foreclose in the first place or the party who foreclosed and sold the property actually had no right to do so. Either could give rise to the uncomfortable situation in which two (or more) people claim title to the same property.

4. Ultimately, who owns any particular mortgage and note will be sorted out. That process will be tedious, lengthy and contentious as the falsifications, mistakes and systemic flaws surface and reveal that more than just homeowners will lose.

5. Many investors, including not only private parties but also public and private pension funds and corporate treasurers, who thought they bought mortgage-backed securities will find that, as a consequence of the systemic flaws in the MBS creation process, their securities were not in fact mortgage-backed, reducing their investment to an unsecured note of substantially lower value than they thought they had.

6. The parties in every step of the MBS transactions who insured their bonds with Credit Default Swaps -- will call upon their CDS counterparties to cover their losses arising from the mess. Unlike regular insurance, however, CDS counterparties do not ordinarily set aside reserves to cover their CDS obligations. (This ignores the additional problem that because CDS obligations are traded many times over, it is difficult to identify the real counterparty.) The likely tidal wave of CDS demands cannot be met from the capital of the counterparties (usually large banks, investment banks and hedge funds).  And the ensuing chaos from the uncertainty of who owns what will delay and defy resolution.

7. The investors will sue the CDS counterparties, MBS creators, sellers and brokers, the rating agencies, the accountants and the lawyers involved in creating the flawed instruments. Lawyers on all sides will get rich; everyone else will lose. The magnitude of the problem is measured in the $Trillions.

8. The Fed -- which has shown no reluctance to bail out banks, investment banks, hedge funds and commercial businesses by loaning printed money or by buying garbage at par -- will continue to backstop the system. Ultimately, while it could forestall another crash, the money printing and additional credit facilities could cause general price inflation or another bubble somewhere it is not wanted (the law of unintended consequences), either of which will end very badly for the economy. The public is becoming aware of the Fed's actions and is increasingly unhappy that the perpetrators of fraud are escaping prosecution and, instead, are receiving bonuses with public money while the consequences of their acts cause unemployment and decimation of the value of the one asset in which most citizens have invested their meager savings. With Ron Paul as the head of the Monetary Policy Subcommittee, the fireworks are likely to be significant. The efforts of the banks and the Fed to suppress any and all information in this regard will be huge. Fortunately, there is an internet -- where actual events (not just the opinions of bloggers) can be aired and facts checked -- that is, until the internet itself is constrained as a "security risk." (Shut those bloggers up for goodness sake! The truth will kill us all -- Joe Sixpack cannot possibly handle the truth: witness what he did in the last election!)

9. The stock and bond markets are anticipating all of the above. Real interest rates are starting to rise despite the efforts of the Fed to suppress them. And the stock market has recovered, more or less, from its 2008 lows, anticipating (somewhat scizophrenically) that the Fed's efforts to keep the economy afloat will restore consumer confidence.

10. The States, which collect transfer taxes on each real estate transaction (and which are in dire financial straits), are very, very unhappy that the banks created a system in which they tried to evade paying those taxes, even though title to local real estate changed multiple times.

11. Efforts to achieve a global settlement that would validate the flawed system, pardon the frauds, and compensate the States, investors, CDS counterparties and banks for their losses, will be very difficult if not impossible to achieve.

12. Because the underlying failures of the system have not been rectified and the health of our financial institutions restored, the economy and the stock market's hope for a substantive recovery remain fragile. You need to carefully (daily) monitor your investments and the financial news.


*The frog in a pot theory holds that if you put a live frog in a pot of cold water and gradually increase the heat, the frog will stay in the pot until it is cooked. But if you drop a frog in a pot of boiling water, it will jump out immediately.