Tag Archives: fractional reserve lending

Greenspan was Framed! Blame bankers’ moral hazard, not their lackey.

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Source: The Johnsville News

Source: The Johnsville News

The Cover Story

It has become commonplace to lay blame for the greatest of asset bubbles on the inflationary policies of Sir Allen Greenspan and his employer. A typical critique goes something like this: For the last 20 years, every time the market started to liquidate bad debts and malinvestments (the junk bond bust, the crash of ’87, the early ’90s recession, the LTCM blowup, and dot-com crash), Greenspan just turned on the money spigot and made it all better again with lower rates. Because he so encouraged borrowers and lowered or eliminated reserve limits for lenders, we avoided the necessary catharsis and let bad investment pile upon bad investment, with ever increasing asset prices and debt levels, until we reached the stratosphere last year. By then the system had become so saturated with debt, and asset prices so high, that mass bankruptcy and liquidation was inevitable.

The Real Killers

This history is correct, but not complete, and it lays no blame on the true evil at the heart of the age-old problem of the credit cycle. In any analysis of historical events, one must sift through dunes of BS, and the best way to do that is to ask, Qui Bono? (“as a benefit to whom?”). The answer of course, is bankers and their perennial sidekicks, politicians. The latter designation includes the ‘Maestro,’ whom, while valuable for his mastery of obfuscation, could have easily been replaced had he not played ball. Bankers have no qualms about overextending credit, because they, more than any other party, control the government. Politicians and the bureaucracies they create have always worked for money, and bankers have always been the highest bidders.

The Means

The primary mechanism by which bankers steal from the public is fractional reserve lending, which is enabled by the socialization of losses through FDIC insurance and the Federal Reserve’s monopoly over currency.  FDIC absolves commercial bankers from responsibility for their client’s deposits, and the Fed and Treasury lock the public into the rigged system.

The Motive

Within FDIC limits, depositors have no incentive to seek out banks that employ sound lending standards. Because banks are all equally safe from the depositor’s point of view, bankers have no incentive to be cautious. They have a strong disincentive to be so, because the more credit banks extend (the higher their leverage), and the shakier the enterprises to which they lend (at higher interest), the higher their rate of return during the credit expansion (inflation) phase of the cycle. The name of the game is to grow your balance sheet as fast as possible, with little concern as to reserve ratios or collateralization.

The Opportunity

Once the bust arrives, bank executives have already collected so much in salary and bonuses and sold so much stock to an ever-credulous public, that it isn’t very painful for them if their bank fails, since they have become rich. But once a bank gets big enough (remember, the name of the game is to expand your balance sheet), it is easy for its now powerful executives to ‘convince’ politicians that failure would be so damaging that the Treasury (i.e., public) must assume its debts for the greater good.  At critical times, it may be desirable to cut out the middle man and place a trusted member of the cartel directly in the federal executive.

The Fed is Just an Accomplice

In the meantime, the Federal Reserve is called upon to extend cheap credit to banks in general, which often entails the printing of new paper or digital money. The lower base rates that ensue help banks to get off their feet again by encouraging the public to borrow more than is warranted by economic conditions. (Note: The above is how things worked before we reached Peak Credit last year, and the bankers and Fed are trying with all their might to inflate again, but they will be continually confounded. The game is now over, because nobody wants or can afford any more debt, and banks are finally so impaired by defaults that they cannot lend. Also, at $50 trillion in total private debt, the entire mess is now too big to bail, given the Fed’s mere $900 billion balance sheet.)

A Long History of Offense

So that is it in a nutshell: a completely corrupt monetary system. It is nothing new. We have had episodes like this since before Andrew Jackson abolished the first national bank. So long as a national bank has a monopoly on money creation and legal tender laws obligate the public to use fiat currency and not an alternative such as gold, bankers will retain a lock on the economy and the boom-bust cycle will continue, at great expense to our security and quality of life.

Can They Help it? Isn’t it Just Human Nature?

The credit cycle is a natural phenomenon, yes, but so is war. And just as right-thinking people oppose that other means by which the public is exploited by the oligarchy, so they should oppose fractional reserve lending and the institutions that support it: the Federal Reserve system, the FDIC, and legal tender laws.

Whole Foods’ troubles: Sign of an unhealthy system

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I like Whole Foods. In New York, we bought about 50% of our calories from them. There were three stores about equidistant from our apartment.  Anyone who has been in one can tell you how clean they are, how knowledgeable the salespeople are, and what a fantastic selection of really high quality food they stock. I’m a bit of an amatuer foodie, and grocery shopping is always fun for me, but I just had a really good time in these stores. Even the checkout experience is not unpleasant, since they always had at least 10 and sometimes two dozen competent and often friendly clerks working at once.

Their prices on comparable staples were actually usually better than the boring and grungy NYC alternatives, so it was not necessarily a wallet busting habit, unless you went for things like the fancy cheese or boxed snack foods. You can tell that John Mackey and the rest of the crew really care about their stores and good food.

So, while I saw that this stock was a great short, it doesn’t give me the same pleasure as seeing my MER or LEH or COH puts in the money, since a world with fewer Whole Foods is a more drab and dreary and less healthy place. Whole Foods as a concept (a grocery chain that cares about the origins and taste of its wares) doesn’t depend on a credit bubble. It is something that actually enriches our lives, unlike the ponzi schemes of bankers and baubles for the women who love them.

But the credit bubble lead Whole Foods to expand too far too fast, and to depend too much on high-margin and high-priced items like fancy crackers, exotic chocolates and $7-a-pack blueberries. MER and LEH and the rest created the illusion of wealth for the everyman with their easy credit, so people paid those prices and the demand encouraged Whole Foods to build too many stores. I even bet an organic blueberry farmer or two out there expanded his operations and paid a price for land that just isn’t justified now that shoppers only have $2 to spend on berries.

So all of us suffer. Capital was wasted. It was wasted by tearing up the farms and forests to build those new suburbs, it was wasted on the giant new stores, and it was wasted in the efforts of Whole Foods tasters and executives to search out the most exotic snack foods, price be damned, as it was wasted by the manufacturers of those snack foods. It was a waste because those allocations of physical assets and real efforts were based on an illusion of wealth created from nothing: credit.

The banks created credit out of nothing, due to the magical fraud of fractional reserve lending. They had a bit of real wealth on deposit, the product of actual work and production and savings, yet they created many times that amount more dollars to lend out, just because they could. Because they knew that when the castles built by those new dollars came crumbling down, they wouldn’t be on the hook, since Uncle Sam has always had their back. Old Uncle Sam knows what’s good for him, doesn’t he?

If it were only good for the rest of us.