By Ellen Brown / Original to ScheerPost

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“It was not the highly visible acts of Congress but the seemingly mundane and often nontransparent actions of regulatory agencies that empowered the great transformation of the U.S. commercial banks from traditionally conservative deposit-taking and lending businesses into providers of wholesale financial risk management and intermediation services.”

— Professor Saule Omarova, “The Quiet Metamorphosis, How Derivatives Changed the Business of  Banking” University of Miami Law Review, 2009

While the world is absorbed in the U.S. election drama, the derivatives time bomb continues to tick menacingly backstage. No one knows the actual size of the derivatives market, since a major portion of it is traded over-the-counter, hidden in off-balance-sheet special purpose vehicles. However, when Warren Buffet famously labeled derivatives “financial weapons of mass destruction” in 2002, its “notional value” was estimated at $56 trillion. Twenty years later, the Bank for International Settlements estimated that value at $610 trillion. And financial commentators have put it as high as $2.3 quadrillion or even $3.7 quadrillion, far exceeding  global GDP, which was about $100 trillion in 2022. A quadrillion is 1,000 trillion.

Most of this casino is run through the same banks that hold our deposits for safekeeping. Derivatives are sold as “insurance” against risk, but they actually add a heavy layer of risk because the market is so interconnected that any failure can have a domino effect. Most of the banks involved are also designated “too big to fail,” which means we the people will be bailing them out if they do fail.

Derivatives are considered so risky that the Bankruptcy Act of 2005 and the Uniform Commercial Code grant them (along with repo trades) “super-priority” in bankruptcy. That means if a bank goes bankrupt, derivative and repo claims are settled first, drawing from the same pool of liquidity that holds our deposits. (See David Rogers Webb’s The Great Taking and my earlier articles here and here.) A derivatives crisis could easily vacuum up that pool, leaving nothing for us as depositors — or for the “secured” creditors who are junior to derivative and repo claimants in bankruptcy, including state and local governments.

As detailed by Pam and Russ Martens, publisher and editor, respectively of Wall Street on Parade, as of Dec. 31, 2023, Goldman Sachs Bank USA, JPMorgan Chase Bank N.A., Citigroup’s Citibank and Bank of America held a total of $168.26 trillion in derivatives out of a total of $192.46 trillion at all U.S. banks, savings associations and trust companies. That’s four banks holding 87 percent of all derivatives at all 4,587 federally-insured institutions then in the U.S.

In June 2024, the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board jointly released their findings on the eight U.S. megabanks’ “living wills” – their resolution or wind-down plans in the event of bankruptcy. The Fed and FDIC faulted all of the four largest derivative banks on shortcomings in how they planned to wind down their derivatives.

How Banks Guarding Our Deposits Became the Biggest Gamblers in the Derivatives Casino

Banks are not just middlemen in the derivatives market. They are active players taking speculative positions. In this century, writes Professor Omarova, the largest U.S. commercial banks have emerged “as a new breed of financial super-intermediary—a wholesale dealer in financial risk, conducting a wide variety of capital markets and derivatives activities, trading physical commodities, and even marketing electricity.” She notes that the Federal Reserve has allowed several financial holding companies to purchase and sell physical commodities (including oil, natural gas, agricultural products and electricity) in the spot market to hedge their commodity derivative activities, and to take or make delivery of those commodities to settle the transactions.

It was not Congress that authorized that expansive definition of permitted banking activities. It was the Office of the Comptroller of the Currency (OCC), part of the “administrative deep state,” that permanent body of unelected regulators who carry on while politicians come and go. As Omarova explains: 

“Through seemingly routine and often nontransparent administrative actions, the OCC effectively enabled large U.S. commercial banks to transform themselves from the traditionally conservative deposit-taking and lending institutions, whose safety and soundness were guarded through statutory and regulatory restrictions on potentially risky activities, into a new breed of financial “super-intermediaries,” or wholesale dealers in pure financial risk. …

“Moreover, some of the most influential of those decisions escaped public scrutiny because they were made in the subterranean world of administrative action invisible to the public, through agency interpretation and policy guidance. “

The OCC’s authority to regulate banks dates back to the National Bank Act of 1863, which grants national banks general authority to engage in activities necessary to carry on the “business of banking”, including “ such incidental powers as shall be necessary to carry on the business of banking”. The “business of banking” is not defined in the statute. Omarova writes:

“Section 24 (Seventh) of the National Bank Act grants national banks the power to exercise all such incidental powers as shall be necessary to carry on the business of banking; by discounting and negotiating promissory notes, drafts, bills of exchange, and other evidences of debt; by receiving deposits; by buying and selling exchange, coin, and bullion; by loaning money on personal security; and by obtaining, issuing, and circulating notes. “

No mention is made of derivatives trading or dealing.

The powers of banks were further limited by Congress in the Glass-Steagall Act of 1933, which explicitly prohibited banks from dealing in corporate equity securities, and by other statutes passed thereafter. However, the portion of the Glass-Steagall Act separating depository from investment banking was reversed in the Commodity Futures Modernization Act in 2000. Omarova writes that this allowed the OCC to articulate “an overly expansive definition of the ‘business of banking’ as financial intermediation and dealing in financial risk, in all of its forms, and … this pattern of analysis allowed the OCC to expand the range of bank-permissible activities virtually without any statutory constraint” .

What Then Can Be Done?

The 2008 financial crisis is now acknowledged to have been largely a derivatives crisis. But massive efforts at financial reform in the following years have failed to fix the underlying problem. In a Forbes article titled “Big Banks and Derivatives: Why Another Financial Crisis Is Inevitable,” Steve Denning writes:

“Banks today are bigger and more opaque than ever, and they continue to trade in derivatives in many of the same ways they did before the crash, but on a larger scale and with precisely the same unknown risks.

Most of this derivative trading is conducted through the biggest banks. A commonly held assumption is that the real derivative risk is much smaller than the “notional amount” stated on the banks’ balance sheets.

[A]s we learned in 2008, it is possible to lose a large portion of the “notional amount” of a derivatives trade if the bet goes terribly wrong, particularly if the bet is linked to other bets, resulting in losses by other organizations occurring at the same time. The ripple effects can be massive and unpredictable.

In 2008, governments had enough resources to avert total calamity. Today’s cash-​strapped governments are in no position to cope with another massive bailout.”

He concludes:

“Regulation and enforcement will only work if it is accompanied by a paradigm shift in the banking sector that changes the context in which banks operate and the way they are run, so that banks shift their goal from making money to adding value to stakeholders, particularly customers. This would require action from the legislature, the SEC, the stock market and the business schools, as well as of course the banks themselves.”

A Paradigm Shift in “the Business of Banking”

In a September 2023 paper titled “Rebuilding Banking Law: Banks as Public Utilities,” Yale law professor Lev Menand and Vanderbilt law professor Morgan Ricks propose shifting the goal of banking so that chartered private banks are “not mere for-profit businesses; they have affirmative obligations to the public.” The authors observe that under the New Deal framework, which was rooted in the National Bank Act of 1864, banks were largely governed as public utilities. Charters were granted only where consistent with public convenience and need, and only chartered banks could expand the money supply by extending loans.

The Menand/Ricks proposal is quite detailed and includes much more than regulating derivatives, but on that specific issue they propose:

“While member banks are permitted to enter into interest-rate swaps to hedge rate risk, they are not allowed to engage in derivatives dealing (intermediation or market making) or take directional bets in the derivatives markets. Derivatives dealing and speculation do not advance member banks’ monetary function. Apart from loan commitments, member banks would not be in the business of offering guarantees or other forms of insurance. “

Would that mean the end of the derivatives casino? No – it would just be moved out of the banks charged with protecting our deposits:

The blueprint above says nothing about what activities can take place outside the member banking system. It says only that those activities can’t be financed with run-prone debt [meaning chiefly deposits]. In principle, we could imagine a very wide degree of latitude for non bank firms, subject of course to appropriate standards of disclosure, antifraud, and consumer and investor protection. So securities firms and other nonbanks might be given free rein to engage in structured finance, derivatives, proprietary trading, and so forth. But they would not be allowed to “fund short” .

By “funding short”, the authors mean basically “creating money”, for example through repo trades in which short-term loans are rolled over and over. In their proposal, only chartered banks are delegated the power to create money as loans.

Expanding the Model

University of Southampton business school professor Richard Werner, who has written extensively on this subject, adds that banks should be required to concentrate their lending on productive ventures that create new goods and services and avoid inflating existing assets such as housing and corporate stock.

Speculative derivatives are a form of “financialization” – money making money without producing anything. The winners just take money from the losers. Gambling is not illegal under federal law, but the chips in the casino should not be our deposits or loans made with the backing of our deposits.

The Menand/Ricks proposal is for private banks, but banks can also be made “public utilities” through direct ownership by the government. The stellar model is the Bank of North Dakota, which does not speculate in derivatives, cannot go bankrupt, makes productive loans, and has been highly successful. (See earlier article here.) The public utility model could also include a national infrastructure bank, as proposed in H.R. 4052, which currently has 37 co-sponsors.

The “business of banking” can include making money for private shareholders and executives, but that business should be junior to the public interest, which would prevail when they conflict.

Unfortunately, only Congress can change the language of the controlling statute; and Congress has been motivated historically to make major changes in the banking system only in response to a Great Depression or Great Recession that exposes the fatal flaws in the existing system. With the reversal of “Chevron deference”, however, the OCC’s rules can now be challenged in court. A powerful citizen’s movement might be able to catalyze needed changes before the next Great Depression strikes.

A financialized economy is not sustainable and not competitive. The emphasis should be on investment in the real economy. That is the sort of paradigm shift that is necessary if the U.S. is to survive and prosper.

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First published on Scheerpost.com

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By Ellen Brown / Original to ScheerPost

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Reading the tea leaves for the 2024 economy is challenging. On January 5^th, Treasury Secretary Janet Yellen said we have achieved a “soft landing,” with wages rising faster than prices in 2023. But critics are questioning the official figures, and prices are still high. Surveys show that consumers remain apprehensive.

There are other concerns. On Dec. 24, 2023, Catherine Herridge, a senior investigative correspondent for CBS News covering national security and intelligence, said on “Face the Nation,” “I just feel a lot of concern that 2024 may be the year of a black swan event. This is a national security event with high impact that’s very hard to predict.”

What sort of event she didn’t say, but speculations have included a major cyberattack; a banking crisis due to a wave of defaults from high interest rates, particularly in commercial real estate; an oil embargo due to war. Any major black swan could prick the massive derivatives bubble, which the Bank for International Settlements put at over one quadrillion (1,000 trillion) dollars as far back as 2008. With global GDP at only $100 trillion, there is not enough money in the world to satisfy all these derivative claims. A derivative crisis helped trigger the 2008 banking collapse, and that could happen again.

The dangers of derivatives have been known for decades. Warren Buffett wrote in 2002 that they were “financial weapons of mass destruction.” James Rickards wrote in U.S. News & World Report in 2012 that they should be banned. Yet Congress has not acted. This article looks at the current derivative threat, and at what might motivate our politicians to defuse it.

What Regulation Hath Wrought

Derivatives are basically just bets, which are sold as “insurance” — protection against changes in interest rates or exchange rates, defaults on loans and the like. When one of the parties to the wager has a real economic interest to be protected – e.g. a farmer ensuring the value of his autumn crops against loss — the wager is considered socially valuable “hedging.” But most derivative bets today are designed simply to make money from other traders, degenerating into what has been called “casino capitalism.”

In 2008, derivative trading brought down investment bank Bear Stearns and international insurer A.I.G. Both institutions could not be allowed to fail, because the trillions of dollars in credit default swaps on their books would have been wiped out, forcing their counterparty banks and financial institutions to write down the value of their own risky and now “unhedged” loans. Bear and A.I.G. were bailed out by the taxpayers; but the Treasury drew the line at Lehman Brothers, and the market crashed.

Under the rubric of “no more bailouts,” the Dodd Frank Act of 2010 purported to fix the problem by giving derivatives special privileges. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy, but many derivative contracts are exempt from these stays. Counterparties owed collateral can grab it immediately without judicial review, before bankruptcy proceedings even begin. Depositors become “unsecured creditors” who can recover their funds only after derivative, repo and other secured claims, assuming there is anything left to recover, which in the event of a major derivative crisis would be unlikely. We saw this “bail-in” policy play out in Cyprus in 2013.

That’s true for deposits, but what of stocks, bonds and money market funds? Under the Uniform Commercial Code (UCC) and the Bankruptcy Act of 2005, derivative securities also enjoy special protections. “Safe harbor” is provided to privileged entities described in court documents as “the protected class.” Derivatives enjoy “netting” and “close-out” privileges on the theory that they are a major source of systemic risk, and that allowing claimants to jump ahead of other investors in order to net and close out their bets reduces that risk. However, critical analysis has shown that derivative “super-priority” in bankruptcy can actually increase risk and propel otherwise viable financial entities into insolvency.

It is also highly inequitable. The collateral grabbed to close out derivative claims may be yourstocks and bonds. In a 2016 American Banker article called “You Don’t Really Own Your Securities; Can Blockchains Fix That?”, journalist Brian Eha explained:

In the United States, publicly traded stock does not exist in private hands.

It is not owned by the ostensible owners, who, by virtue of having purchased shares in this or that company, are led to believe they actually own the shares. Technically, all they own are IOUs. The true ownership lies elsewhere.

While private-company stock is still directly owned by shareholders, nearly all publicly traded equities and a majority of bonds are owned by a little-known partnership, Cede & Co., which is the nominee of the Depository Trust Co., a depository that holds securities for some 600 broker-dealers and banks. For each security, Cede & Co. owns a master certificate known as the “global security,” which never leaves its vault. Transactions are recorded as debits and credits to DTC members’ securities accounts, but the registered owner of the securities — Cede & Co. — remains the same.

What shareholders have rather than direct ownership, then, “is a [contractual] right against their broker…. The broker then has a right against the depository institution where they have membership. Then the depository institution is beholden to the issuer. It’s [at least] a three-​step process before you get any rights to your stock.”This attenuation of property rights has made it impossible to keep perfect track of who owns what.

Fifty Years of “Dematerialization”

In a 2023 book called The Great Taking (available for free online), Wall Street veteran David Rogers Webb traces the legislative history of these developments. The rules go back 50 years, to when trading stocks and bonds was done by physical delivery – shuffling paper certificates bearing titles in the names of the purchasers from office to office. In the 1970s, this trading became so popular that the exchanges could not keep up, prompting them to turn to “dematerialization” or digitalization of the assets. The Depository Trust Company (DTC) was formed in 1973 to alleviate the rising volumes of paperwork. The DTCC was established in 1999 as a holding company to combine the DTC and the National Securities Clearing Corporation (NSCC).

The DTCC is a central clearing counterparty (CCP) sitting at the top of a pyramid of banks, brokers and exchanges. All have agreed to hold their customers’ assets in “street name,” collect those assets in a fungible pool, and forward that pool to the DTCC, which then trades pooled blocks of stock and bonds between brokers and banks in the name of its nominee Cede & Co. The DTCC, a private corporation, owns them all. This is not a mere technicality. Courts have upheld its legal ownership, even in a dispute with client purchasers. According to the DTCC website, it provides settlement services for virtually all equity, corporate and municipal debt trades and money market instruments in the U.S., and central safekeeping and asset servicing for securities issues from 131 countries and territories, valued at $37.2 trillion. In 2022 alone, the DTCC processed 2.5 quadrillion dollars in securities.

The governing regulations are set out in Uniform Commercial Code (UCC) sections 8 and 9, covering investment securities and secured transactions. The UCC is a set of rules produced by private organizations without an act of Congress. It is not itself the law but is only a recommendation of the laws that states should adopt; but the UCC has now been adopted by all 50 U.S. states and has been “harmonized” with the rules for trading securities in Europe and most other countries.

The Wikipedia summary of the relevant UCC provisions concludes:

The rights created through these links [up the collateral chain] are purely contractual claims ….  This decomposition of the rights organized by Article 8 of the UCC results in preventing the investor to revindicate [demand or take back] the security in case of bankruptcy of the account provider [the broker or bank], that is to say the possibility to claim the security as its own asset, without being obliged to share it at its prorate value with the other creditors of the account provider.

You, the investor, have only a contractual claim against your broker, who no longer holds title to your stock either, since title has been transferred up the chain to the DTCC. Your contractual claim is only to a pro rata share of a pool of the stock designated in street name, title to which is held by Cede & Co.

Rehypothecation: The Problem of Multiple Owners

The Wikipedia entry adds:

This re-characterization of the proprietary right into a simple contractual right may enable the account provider [the “intermediary” broker or bank] to “re-use” the security without having to ask for the authorization of the investor. This is especially possible within the framework of temporary operations such as security lending, option to repurchase, buy to sell back or repurchase agreement.

“Security lending” by your broker or other intermediary may include lending your stock to short sellers bent on bringing down the value of the stock against your own financial interests. Illegal naked short selling is also facilitated by the impenetrable shield of the DTCC, and so is lending to “shadow banks” for the re-use of collateral. As Caitlin Long, another Wall Street veteran, explains:

 [T]he shadow banking system’s lifeblood is collateral, and the issue is that market players re-use that same collateral over, and over, and over again, multiple times a day, to create credit. The process is called “rehypothecation.” Multiple parties’ financial statements therefore report that they own the very same asset at the same time. They have IOUs from each other to pay back that asset—hence, a chain of counterparty exposure that’s hard to track. Although improving, there’s still little visibility into how long these “collateral chains” are.

It is this reuse of the collateral to back multiple speculative bets that has facilitated the explosion of the derivatives bubble to ten times the GDP of the world. It should be the collateral of the actual purchaser, but you, the purchaser, are at the bottom of the collateral chain. Derivative claims have super priority in bankruptcy, ostensibly because the derivative edifice is so risky that their bets need to be cleared.

What About the “Customer Protection Rule”?

Broker-dealers argue that their customers’ assets are protected under the “Customer Protection Rule” of the Securities Investor Protection Corporation (SIPC). The SIPC provides insurance for stocks similar to FDIC insurance for bank deposits, maintaining a pool that can be tapped in the event of a member bankruptcy. But a 2008 memorandum on The Customer Protection Rule from the law firm Willkie Farr & Gallagher asserts:

With respect to cash and securities not registered in the name of the customer, but held by the broker- dealer for the customer’s benefit, the customer would receive a pro rata portion of the aggregate amount of the cash and securities actually held by the broker- dealer. If there is a remaining shortfall, SIPC would cover a maximum of $ 500,000, only $ 100,000 of which may be a recovery for cash held at the broker- dealer.

… [M]ost securities are held by broker-dealers in street name and would be available to satisfy other customers’ claims in the event of a broker- dealer’s insolvency.

If the member has a large derivatives book (JPMorgan holds $54.4 trillion in derivatives and a mere $3.4 trillion in assets), derivative customers with priority could wipe out the pool and the SIPC fund as well.

What Webb worries about, however, is the bankruptcy of the DTCC itself, which could wipe out the entire collateral chain. He says the DTCC is clearly under-capitalized, and that the startup of a new Central Clearing Counterparty is already planned and pre-funded. If the DTCC fails, certain protected creditors can take all the collateral, upon which they will have perfected legal control.

Defensive Measures

In the event of a cyberattack that destroys the records of banks and brokers, there could be no way for purchasers to prove title to their assets; and in the event of a second Great Depression, with a wave of 1930s-style bank bankruptcies, derivative claimants with super-priority can take the banks’ assets without going through bankruptcy proceedings. In today’s fragile economy, these are not remote hypotheticals but are real possibilities, which can wipe out not just the savings of middle class families but the fortunes of billionaires.

And there, argues Webb, is our opportunity. The system by which Cede & Co. holds title to all “dematerialized” securities is clearly vulnerable to being exploited by “the protected class,” and Congress could mitigate those concerns by legislation. If our representatives realized that they are not the owners of record of their assets but are merely creditors of their brokers and banks, they might be inspired to hold some hearings and take action.

The first step is to shine a light on the obscure hidden workings of the system and the threat they pose to our personal holdings. Popular pressure moves politicians, and the people are waking up to many issues globally, with protests on the rise everywhere — economic, political and social. Possible action that could be taken by Congress includes reversing the “special privileges” granted to the derivatives casino in the form of “super priority” in bankruptcy. A 0.1% Tobin tax or financial transaction tax is another possibility. For protecting title to assets, blockchain is a promising tool, as discussed by Brian Eha in the American Banker article quoted above. These and other federal possibilities, along with potential solutions at the local level, will be the subject of a followup article.

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By Ellen Brown / Original to ScheerPost
12 March 2023

On Friday, March 10, Silicon Valley Bank (SVB) collapsed and was taken over by federal regulators. SVB was the 16^th largest bank in the country and its bankruptcy was the second largest in U.S. history, following Washington Mutual in 2008. Despite its size, SVB was not a “systemically important financial institution” (SIFI) as defined in the Dodd-Frank Act, which requires insolvent SIFIs to “bail in” the money of their creditors to recapitalize themselves.

Technically, the cutoff for SIFIs is $250 billion  in assets. However, the reason they are called “systemically important” is not their asset size but the fact that their failure could bring down the whole financial system. That designation comes chiefly from their exposure to derivatives, the global casino that is so highly interconnected that it is a “house of cards.” Pull out one card and the whole house collapses. SVB held $27.7 billion in derivatives, no small sum, but it is only .05% of the $55,387 billion ($55.387 trillion) held by JPMorgan, the largest U.S. derivatives bank.

SVB could be the canary in the coal mine foreshadowing the fate of other over-extended banks, but its collapse is not the sort of “systemic risk” predicted to trigger “contagion.” As reported by CNN:

“Despite initial panic on Wall Street, analysts said SVB’s collapse is unlikely to set off the kind of domino effect that gripped the banking industry during the financial crisis.

‘The system is as well-​capitalized and liquid as it has ever been,’ Moody’s chief economist Mark Zandi said. ‘The banks that are now in trouble are much too small to be a meaningful threat to the broader system.’

No later than Monday morning, all insured depositors will have full access to their insured deposits, according to the FDIC. It will pay uninsured depositors an ‘advance dividend within the next week.’”

A fuller report on the collapse of SVB will have to wait on developments that occur over the weekend and soon thereafter.

This column, meanwhile, focuses on derivatives and is a followup to my Feb. 23  column on the “bail in” provisions of the 2010 Dodd Frank Act, which eliminated taxpayer bailouts by requiring insolvent SIFIs to recapitalize themselves with the funds of their creditors. “Creditors” are defined to include depositors, but deposits under $250,000 are protected by FDIC insurance. However, the FDIC fund is sufficient to cover only about 2% of the $9.6 trillion in U.S. insured deposits. A nationwide crisis triggering bank runs across the country, as happened in the early 1930s, would wipe out the fund. Today, some financial pundits are predicting a crisis of that magnitude in the quadrillion dollar-plus derivatives market, due to rapidly rising interest rates. This column looks at how likely that is and what can be done either to prevent it or dodge out of the way.

“Financial Weapons of Mass Destruction”

In 2002, mega-investor Warren Buffett wrote that derivatives were “financial weapons of mass destruction.” At that time, their total “notional” value (the value of the underlying assets from which the “derivatives” were “derived”) was estimated at $56 trillion. Investopedia reported in May 2022 that the derivatives bubble had reached an estimated $600 trillion according to the Bank for International Settlements (BIS), and that the total is often estimated at over $1 quadrillion.  No one knows for sure, because most of the trades are done privately.

As of the third quarter of 2022, according to the “Quarterly Report on Bank Trading and Derivatives Activities” of the Office of the Comptroller of the Currency (the federal bank regulator),  a total of 1,211 insured U.S. national and state commercial banks and savings associations held derivatives, but 88.6% of these were concentrated in only four large banks: J.P. Morgan Chase ($54.3 trillion), Goldman Sachs ($51 trillion), Citibank ($46 trillion), Bank of America ($21.6 trillion), followed by Wells Fargo ($12.2 trillion). A full list is here. Unlike in 2008-09, when the big derivative concerns were mortgage-backed securities and credit default swaps, today the largest and riskiest category is interest rate products.

The original purpose of derivatives was to help farmers and other producers manage the risks of dramatic changes in the markets for raw materials. But in recent times they have exploded into powerful vehicles for leveraged speculation (borrowing to gamble). In their basic form, derivatives are just bets – a giant casino in which players hedge against a variety of changes in market conditions (interest rates, exchange rates, defaults, etc.). They are sold as insurance against risk, which is passed off to the counterparty to the bet. But the risk is still there, and if the counterparty can’t pay, both parties lose. In “systemically important” situations, the government winds up footing the bill.

Like at a race track, players can bet although they have no interest in the underlying asset (the horse). This has allowed derivative bets to grow to many times global GDP and has added another element of risk: if you don’t own the barn on which you are betting, the temptation is there to burn down the barn to get the insurance. The financial entities taking these bets typically hedge by betting both ways, and they are highly interconnected. If counterparties don’t get paid, they can’t pay their own counterparties, and the whole system can go down very quickly, a systemic risk called “the domino effect.”

That is why insolvent SIFIs had to be bailed out in the Global Financial Crisis (GFC) of 2007-09, first with $700 billion of taxpayer money and then by the Federal Reserve with “quantitative easing.” Derivatives were at the heart of that crisis. Lehman Brothers was one of the derivative entities with bets across the system. So was insurance company AIG, which managed to survive due to a whopping $182 billion bailout from the U.S. Treasury; but Lehman was considered too weakly collateralized to salvage. It went down, and the Great Recession followed.

Risks Hidden in the Shadows.

Derivatives are largely a creation of the “shadow banking” system, a group of financial intermediaries that facilitates the creation of credit globally but whose members are not subject to regulatory oversight. The shadow banking system also includes unregulated activities by regulated institutions. It includes the repo market, which evolved as a sort of pawn shop for large institutional investors with more than $250,000 to deposit. The repo market is a safe place for these lenders, including pension funds and the U.S. Treasury, to park their money and earn a bit of interest. But its safety is insured not by the FDIC but by sound collateral posted by the borrowers, preferably in the form of federal securities.

As explained by Prof. Gary Gorton:

“This banking system (the “shadow” or “parallel” banking system) – repo based on securitization – is a genuine banking system, as large as the traditional, regulated banking system. It is of critical importance to the economy because it is the funding basis for the traditional banking system. Without it, traditional banks will not lend and credit, which is essential for job creation, will not be created.”

While it is true that banks create the money they lend simply by writing loans into the accounts of their borrowers, they still need liquidity to clear withdrawals; and for that they largely rely on the repo market, which has a daily turnover just in the U.S. of over $1 trillion. British financial commentator Alasdair MacLeod observes that the derivatives market was built on cheap repo credit. But interest rates have shot up and credit is no longer cheap, even for financial institutions.

According to a December 2022 report by the BIS, $80 trillion in foreign exchange derivatives that are off-balance-sheet (documented only in the footnotes of bank reports) are about to reset (roll over at higher interest rates). Financial commentator George Gammon discusses the threat this poses in a podcast he calls, “BIS Warns of 2023 Black Swan – A Derivatives Time Bomb.” Another time bomb in the news is Credit Suisse, a giant Swiss derivatives bank that was hit with an $88 billion run on its depositsby large institutional investors late in 2022. The bank was bailed out by the Swiss National Bank through swap lines with the U.S. Federal Reserve at 3.33% interest.

The Perverse Incentives Created by “Safe Harbor” in Bankruptcy.

In The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences, Prof. David Skeel refutes what he calls the “Lehman myth”—the widespread belief that Lehman’s collapse resulted from the decision to allow it to fail. He blames the 2005 safe harbor amendment to the bankruptcy law, which says that the collateral posted by insolvent borrowers for both repo loans and derivatives has “safe harbor” status exempting it from recovery by the bankruptcy court. When Lehman appeared to be in trouble, the repo and derivatives traders all rushed to claim the collateral before it ran out, and the court had no power to stop them.

So why not repeal the amendment? In a 2014 article titled “The Roots of Shadow Banking,” Prof. Enrico Perotti of the University of Amsterdam explained that the safe harbor exemption is a critical feature of the shadow banking system, one it needs to function. Like traditional banks, shadow banks create credit in the form of loans backed by “demandable debt”—short-term loans or deposits that can be recalled on demand. In the traditional banking system, the promise that the depositor can get his money back on demand is made credible by government-backed deposit insurance and access to central bank funding. The shadow banks needed their own variant of “demandable debt,” and they got it through the privilege of “super-priority” in bankruptcy. Perotti wrote:

“Safe harbor status grants the privilege of being excluded from mandatory stay, and basically all other restrictions. Safe harbor lenders, which at present include repos and derivative margins, can immediately repossess and resell pledged collateral. This gives repos and derivatives extraordinary super-priority over all other claims, including tax and wage claims, deposits, real secured credit and insurance claims. [Emphasis added.]”

The dilemma of our current banking system is that lenders won’t advance the short-term liquidity needed to fund repo loans without an ironclad guarantee; but the guarantee that makes the lender’s money safe makes the system itself very risky. When a debtor appears to be on shaky ground, there will be a predictable stampede by favored creditors to grab the collateral, in a rush for the exits that can propel an otherwise-viable debtor into bankruptcy; and that is what happened to Lehman Brothers.

Derivatives were granted “safe harbor” because allowing them to fail was also considered a systemic risk. It could trigger the “domino effect,” taking the whole system down. The error, says Prof. Skeel, was in passage of the 2005 safe harbor amendment. But the problem with repealing it now is that we will get the domino effect, in the collapse of both the quadrillion dollar derivatives market and the more than trillion dollars traded daily in the repo market.

The Interest Rate Shock.

Interest rate derivatives are particularly vulnerable in today’s high interest rate environment. From March 2022 to February 2023, the prime rate (the rate banks charge their best customers) shot up from 3.5% to 7.75%, a radical jump. Market analyst Stephanie Pomboy calls it an “interest rate shock.” It won’t really hit the market until variable-rate contracts reset, but $1 trillion in U.S. corporate contracts are due to reset this year, another trillion next year, and another trillion the year after that.

A few bank bankruptcies are manageable, but an interest rate shock to the massive derivatives market could take down the whole economy. As Michael Snyder wrote in a 2013 article titled “A Chilling Warning About Interest Rate Derivatives:”

“Will rapidly rising interest rates rip through the U.S. financial system like a giant lawnmower blade? Yes, the U.S. economy survived much higher interest rates in the past, but at that time there were not hundreds of trillions of dollars worth of interest rate derivatives hanging over our financial system like a Sword of Damocles.

“… [R]ising interest rates could burst the derivatives bubble and cause “massive bankruptcies around the globe” [quoting Mexican billionaire Hugo Salinas Price]. Of course there are a whole lot of people out there that would be quite glad to see the “too big to fail” banks go bankrupt, but the truth is that if they go down, our entire economy will go down with them. … Our entire economic system is based on credit, and just like we saw back in 2008, if the big banks start failing, credit freezes up and suddenly nobody can get any money for anything.

There are safer ways to design the banking system, but they are not likely to be in place before the quadrillion dollar derivatives bubble bursts. Snyder was writing 10 years ago, and it hasn’t burst yet; but this was chiefly because the Fed came through with the “Fed Put” – the presumption that it would backstop “the market” in any sort of financial crisis. It has performed as expected until now, but the Fed Put has stripped it of its “independence” and its ability to perform its legislated duties. This is a complicated subject, but two excellent books on it are Nik Bhatia’s Layered Money (2021) and Lev Menand’s The Fed Unbound: Central Banking in a Time of Crisis (2022).

Today the Fed appears to be regaining its independence by intentionally killing the Fed Put, with its push to raise interest rates. (See my earlier article here.) It is still backstopping the offshore dollar market with “swap lines,” arrangements between central banks of two countries to keep currency available for member banks,  but the latest swap line rate for the European Central Bank is a pricey 4.83%. No more “free lunch” for the banks.

Alternative Solutions.

Alternatives that have been proposed for unwinding the massive derivatives bubble include repealing the safe harbor amendment and imposing a financial transaction tax, typically a 0.1% tax on all financial trades. But those proposals have been around for years and Congress has not taken up the call. Rather than waiting for Congress to act, many commentators say we need to form our own parallel alternative monetary systems.

Crypto proponents see promise in Bitcoin; but as Alastair MacLeod observes, Bitcoin’s price is too volatile for it to serve as a national or global reserve currency, and it does not have the status of enforceable legal tender. MacLeod’s preferred alternative is a gold-backed currency, not of the 19^th century variety that led to bank runs when the banks ran out of gold, but of the sort now being proposed by Sergey Glazyev for the Eurasian Economic Union. The price of gold would be a yardstick for valuing national currencies, and physical gold could be used as a settlement medium to clear trade balances.

Lev Menand, author of The Fed Unbound, is an Associate Professor at Columbia Law School who has worked at the New York Fed and the U.S. Treasury. Addressing the problem of the out-of-control unregulated shadow banking system, he stated in a July 2022 interview with The Hill, “I think that one of the great possible reforms is the public banking movement and the replication of successful public bank enterprises that we have now in some places, or that we’ve had in the past.”

Certainly, for our local government deposits, public banks are an important solution. State and local governments typically have far more than $250,000 deposited in SIFI banks, but local legislators consider them protected because they are “collateralized.” In California, for example, banks taking state deposits must back them with collateral equal to 110% of the deposits themselves. The problem is that derivative and repo claimants with “supra-priority” can wipe out the entirety of a bankrupt bank’s collateral before other “secured” depositors have access to it.

Our tax dollars should be working for us in our own communities, not capitalizing failing SIFIs on Wall Street. Our stellar (and only) state-owned model is the Bank of North Dakota, which carried North Dakota through the 2008-09 financial crisis with flying colors. Post-GFC (the Global Financial Crisis of ’07-’09), it earned record profits re-investing the state’s revenues in the state, while big commercial banks lost billions in the speculative markets. Several state legislatures currently have bills on their books following the North Dakota precedent.

For a federal workaround, we could follow the lead of Jesse Jones’ Reconstruction Finance Corporation, which funded the New Deal that pulled the country out of the Great Depression. A bill for a national investment bank currently in Congress that has widespread support is based on that very effective model, avoiding the need to increase taxes or the federal debt.

All those alternatives, however, depend on legislation, which may be too late. Meanwhile, self-sufficient “intentional” communities are growing in popularity, if that option is available to you. Community currencies, including digital currencies, can be used for trade. They can be “Labor Dollars” or “Food Dollars” backed by the goods and services for which the community has agreed to accept them. (See my earlier article here.) The technology now exists to form a network of community cryptocurrencies that are asset-backed and privacy-protected, but that is a subject for another column.

The current financial system is fragile, volatile and vulnerable to systemic shocks. It is due for a reset, but we need to ensure that the system is changed in a way that works for the people whose labor and credit support it. Our hard-earned deposits are now the banks’ only source of cheap liquidity. We can leverage that power by collaborating in a way that serves the public interest.

First published on Scheerpost.com.

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By Michael Hudson
12 March 2023

The collapses of Silvergate and Silicon Valley Bank are like icebergs calving off from the Antarctic glacier. The financial analogy to the global warming causing this collapse is the rising temperature of interest rates, which spiked last Thursday and Friday to close at 4.60 percent for the U.S. Treasury’s two-year bonds. Bank depositors meanwhile were still being paid only 0.2 percent on their deposits. That has led to a steady withdrawal of funds from banks – and a corresponding decline in commercial bank balances with the Federal Reserve.

Most media reports reflect a prayer that the bank runs will be localized, as if there is no context or environmental cause. There is general embarrassment to explain how the breakup of banks that is now gaining momentum is the result of the way that the Obama Administration bailed out the banks in 2008. Fifteen years of Quantitative Easing has re-inflated prices for packaged bank mortgages – and with them, housing prices, stock and bond prices.

The Fed’s $9 trillion of QE (not counted as part of the budget deficit) fueled an asset-price inflation that made trillions of dollars for holders of financial assets, with a generous spillover effect for the remaining members of the top Ten Percent. The cost of home ownership soared by capitalizing mortgages at falling interest rates into more highly debt-leveraged property. The U.S. economy experienced the largest bond-market boom in history as interest rates fell below 1 percent. The economy polarized between the creditor positive-net-worth class and the rest of the economy – whose analogy to environmental pollution and global warming was debt pollution.

But in serving the banks and the financial ownership class, the Fed painted itself into a corner: What would happen if and when interest rates finally rose?

In Killing the Host I wrote about what seemed obvious enough. Rising interest rates cause the prices of bonds already issued to fall – along with real estate and stock prices. That is what has been happening under the Fed’s fight against “inflation,” its euphemism for opposing rising employment and wage levels. Prices are plunging for bonds, and also for the capitalized value of packaged mortgages and other securities in which banks hold their assets on their balance sheet to back their deposits.

The result threatens to push down bank assets below their deposit liabilities, wiping out their net worth – their stockholder equity. This is what was threatened in 2008. It is what occurred in a more extreme way with S&Ls and savings banks in the 1980s, leading to their demise. These “financial intermediaries” did not create credit as commercial banks can do, but lent deposits out in the form of long-term mortgages at fixed interest rates, often for 30 years. But in the wake of the Volcker spike in interest rates that inaugurated the 1980s, the overall level of interest rates remained higher than the interest rates that S&Ls and savings banks were receiving.

Depositors began to withdraw their money to get higher returns elsewhere, because S&Ls and savings banks could not pay their depositors higher rates out of the revenue coming in from their mortgages fixed at lower rates. So even without fraud Keating-style, the mismatch between short-term liabilities and long-term interest rates ended their business plan.

The S&Ls owed money to depositors short-term, but were locked into long-term assets at falling prices. Of course, S&L mortgages were much longer-term than was the case for commercial banks. But the effect of rising interest rates has the same effect on bank assets that it has on all financial assets. Just as the QE interest-rate decline aimed to bolster the banks, its reversal today must have the opposite effect. And if banks have made bad derivatives trades, they’re in trouble.

Any bank has a problem of keeping its asset valuations higher than its deposit liabilities. When the Fed raises interest rates sharply enough to crash bond prices, the banking system’s asset structure weakens. That is the corner into which the Fed has painted the economy by QE.

The Fed recognizes this inherent problem, of course. That is why it avoided raising interest rates for so long – until the wage-earning bottom 99 Percent began to benefit by the recovery in employment. When wages began to recover, the Fed could not resist fighting the usual class war against labor. But in doing so, its policy has turned into a war against the banking system as well.

Silvergate was the first to go, but it was a special case. It had sought to ride the cryptocurrency wave by serving as a bank for various currencies. After SBF’s vast fraud was exposed, there was a run on cryptocurrencies. Investor/gamblers jumped ship. The crypto-managers had to pay by drawing down the deposits they had at Silverlake. It went under.

Silvergate’s failure destroyed the great illusion of cryptocurrency deposits. The popular impression was that crypto provided an alternative to commercial banks and “fiat currency.” But what could crypto funds invest in to back their coin purchases, if not bank deposits and government securities or private stocks and bonds? What is crypto, ultimately, if not simply a mutual fund with secrecy of ownership to protect money launderers?

Silicon Valley Bank also is in many ways a special case, given its specialized lending to IT startups. New Republic bank also has suffered a run, and it too is specialized, lending to wealthy depositors in the San Francisco and northern California area. But a bank run was being talked up last week, and financial markets were shaken up as bond prices declined when Fed Chairman Jerome Powell announced that he actually planned to raise interest rates even more than he earlier had targeted. Rising employment rates make wage earners more uppity in their demands to at least keep up with the inflation caused by the U.S. sanctions against Russian energy and food and the actions by monopolies to raise prices “to anticipate the coming inflation.” Wages have not kept pace with the resulting high inflation rates.

It looks like Silicon Valley Bank will have to liquidate its securities at a loss. Probably it will be taken over by a larger bank, but the entire financial system is being squeezed. Reuters reported on Friday that bank reserves at the Fed were plunging. That hardly is surprising, as banks are enjoying record interest rate spreads. No wonder well-to-do investors are running from the banks.

The obvious question is why the Fed doesn’t simply bail out banks in SVB’s position. The answer is that the lower prices for financial assets looks like the New Normal. For banks with negative equity, how can solvency be resolved without sharply reducing interest rates to restore the 15-year Zero Interest-Rate Policy (ZIRP)?

There is an even larger elephant in the room: derivatives. Volatility increased last Thursday and Friday. The turmoil has reached vast magnitudes beyond what characterized the 2008 crash of AIG and other speculators. Today, JP Morgan Chase and other New York banks have tens of trillions of dollar valuations of derivatives – casino bets on which way interest rates, bond prices, stock prices and other measures will change.

For every winning guess, there is a loser. When trillions of dollars are bet on, some bank trader is bound to wind up with a loss that can easily wipe out the bank’s entire net equity.

There is now a flight to “cash,” to a safe haven – something even better than cash: U.S. Treasury securities. Despite the talk of Republicans refusing to raise the debt ceiling, the Treasury can always print the money to pay its bondholders. It looks like the Treasury will become the new depository of choice for those who have the financial resources. Bank deposits will fall. And with them, bank holdings of reserves at the Fed.

So far, the stock market has resisted following the plunge in bond prices. My guess is that we will now see the Great Unwinding of the great Fictitious Capital boom of 2008-2015. So the chickens are coming hope to roost – with the “chicken” being, perhaps, the elephantine overhang of derivatives fueled by the post-2008 loosening of financial regulation and risk analysis.

First published on Michael-Hudson.com.

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Back when I was a youth (yes, it was before TV, Taco Bell, and Twitter) when milk was delivered to our house by an actual milkman, we used to get our entertainment in the Summer (and get out of our parent’s hair) by attending local movie theaters. We’d walk over to the Ramona Theater on Gratiot and McNichols (6 Mile to natives of “The Strait”) and catch the Saturday matinee, usually featuring a western where the good guys wore white hats (and were white), a serial where Commander Cody saved the world from creepy denizens of another country or alternate universe, and in between a cartoon, usually starring some Warner Brothers character like Bugs Bunny or Yosemite Sam with the voice of Mel Blanc (“white” as well) who wisecracked through some slapstick routine extolling the merits of hoarding carrots or gold at the expense of swarthy varmints bent on world domination or socialism.

Sometimes the cartoon was a “sing-a-long”, sort of a precursor to karaoke, where the audience was invited by the “performers” on screen to join in with a rendition of a popular song. It didn’t matter if you could carry a tune or not, you’d be drowned out by the chorus of caterwalling that came from the audience as a whole anyway, usually pre-pubescent males with high voices. In order to keep everyone on tempo and in time with the performers, there would be a line of subtitles displaying the lyrics along with a white bouncing ball which would undulate along the text in time with the music as an aid to the tone deaf. The captive audience was then prompted to ‘”follow the bouncing ball” and join the group in destroying some classic by Cole Porter or Lerner and Lowe a la Mitch Miller.

Well, keeping up with the spirit of group participation, no matter how painful or redundant, I’d like to invite you to “follow the bouncing ball” as we try to fathom all of this immigrant-bashing and debt ceiling bullshit that is being pumped down our throats as partisan politics, government ineffectiveness, the need for austerity when it comes to pensions & entitlements, and the criminalization of women, the working class and the poor as a drain on the economy. The “ball” in this case in money. And the “bounce” is profits. It is all about profits. Here is the plan.

Let’s take as an example the real targets here, Social Security and Medicare. The Social Security Trust was created by congress and FDR in the 1930’s to in part ensure that seniors had at least some modicum of financial support in their declining years. The Trust and Medicare are (still) supported by contributions from payroll taxes matched by employers from current workers.; the ultimate “paying it forward” scenario. After all, you’ll be seniors some day too, right? All things being equal (the rate and wage ceiling) the more workers that are employed, the higher the contributions to the Trust. The fewer the number of employed workers, the fewer the taxes that are collected and the lower the contributions to the Trust and to Medicare. But the important thing to remember about the Social Security Trust is that by law it is self funded and does not contribute one red cent to the National Debt [which now exceeds $1 trillion annually]. What is in the Trust? What kind of assets are held in it? Gold? Cash? Securities? Right now most of the assets in the Trust are US Treasury Bonds. Why just Treasuries? Good question.

US Treasury Bonds are considered by governments and financial institutions around the world as a safe bet, backed by the respect and faith in the US government. Investors feel that Treasuries are relatively liquid – they can recoup their investments relatively easily by trading them on securities markets or selling them back to the Federal Reserve in exchange for other forms of debt. The banks can borrow from the Federal Reserve at next to zero interest, then turn around and leverage more loans for up to 50 times the original amount they borrowed using Treasuries as “reserves” to meet Dodd-Frank guidelines for liquidity thresholds. The one glaring shortcoming with Treasuries is that they carry a small return for the investor, less than 1% or nearly zero depending on market conditions. What does this mean for the Social Security Trust?

It means the Trust is earning close to zero on the “assets” it holds. This is so because of a least two reasons. The first is to make it appear that the Trust is in trouble because the perceived value of its holdings are not increasing In comparison to “yields” shown by the Stock Market, thus fueling concern about it going bankrupt sometime in the future. The second reason is tied to the ongoing charade of governing by crisis currently being deployed by right wing elements funded by Neoliberal corporate interests bent on privatizing all aspects of the social safety net. If the government is shown to be incapable of managing its finances, then Wall Street must take over (because they’ve been so competent at managing theirs and ours in the past).

The best way of proving that the government is being mis-managed is to shut it down by refusing to pay for commitments that it has already made. What this action will do is create mistrust and fear on international markets so that Treasuries holders (like the BRICS nations) will cash out glutting the market and forcing the value of Treasuries already on the market to decline since no one wants them … plus causing market rates for new Treasuries to effectively increase to the point that the U.S. government cannot afford to issue new ones because of the increased debt service “demanded” by investors who would not otherwise buy them. This scenario would then further depress the asset holdings of the Social Security Trust fueling more demands to change it by, among other options, turning it over to the gamblers whom have rigged the game to begin with.

Remember, the lifeblood of Neoliberal Capitalism is debt. In this mutant form of capitalism, creating money from nothing also produces debt. Debt is also its Achilles Heel. If you reduce the debt, you shrink the economy by taking money out of it that otherwise would stay in circulation, producing income, creating jobs, fueling growth and —- oh yeah — help to fund the Social Security Trust, Medicare and replenish the Treasury with tax revenues.

So who gets saddled with paying back all of this debt; the banking corporations who created the debt in the first place or the entities whom agreed to take it on? That would be too logical. You’ve heard of derivatives? They’re essentially a huge interlocking network of Ponzi schemes; insurance policies taken out by speculators who create debt, indemnifying themselves against any financial responsibility for default, that in turn can be marketed as securities to investors like countries, municipalities and 401K plans as hedges against market fluctuations usually secured by tranches of debentures or mortgages re-branded as bespoke tranche opportunities — in other words — debt backed up by more debt that by most recent estimates totals more than $1.2 Quadrillion.

In the Neoliberal austerity game plan, when these bets go South, it is the taxpayer who is on the hook because the meme “faith in government” means indemnification up by its people. Just look at those so-called “lazy Greeks” with all their social programs and all that debt they owe to the ECB and the IMF. A debtor should really not be entitled to a social safety net. A debtor’s only right is to pay. Never mind that all of that Greek debt was created by private enterprise in the free market economy. Again, follow the bouncing ball to the money. And by the way, the real entitlement here is the “bounce”; the interest on all this debt which is — profit for the Rentier Class.

The way out of this downward spiral for the Trust and the government as a whole would be to eliminate the debt ceiling altogether by decreeing a debt jubilee; use fiat currency programs to increase employment by investing in infrastructure; gut funding for the Forever War machine; impose new taxes – first a  70-80% on all accumulated wealth held by entities of more than $1 Billion, and second a .25% tax on all Wall Street and FIRE sector transactions;  raise both the contribution rate (now at 12.4%) and annual compensation limit (projected for 2019 to be $132,900) to Social Security; move all health care coverage to a single payer system like Medicare; and create a Universal Basic Income [UBI] – universally.

Of course none of this is likely to happen while the congress remains under the bilateral. bi-polar, neoliberal capitalist duopoly that functions solely for the benefit of the Rentier Class…so convert your money — if you have any — to cash and put it in a Public Bank. Get out of stocks, bonds and Real Estate which are really bets on the value of debt; do not invest in Bit Coin [$50K per coin current market] or even blockchain tech because AI’s are about to take over that part of the the Finance market [if it hasn’t already], which is the latest flavor of what is essentially a Ponzi Scheme. If you’re in on the ground floor you’re cool; but if you’re “johnny come lately” just go to Vegas and place your wad on the “Come Line”. Seriously, this is what neoliberal capitalism is — one massive “shell game” in which The House always wins because it owns both the Shell and the casinos which is leveraged to the one-arm bandits anyway. We will never be the House, so let’s just burn that House down.

“Do not go gentle into that good night,
Old age should burn and rave at close of day;
Rage, rage against the dying of the light.”

….Dylan Thomas

BDS.

© Kazkar Babiy ™ MMXIII

Updated from the original October 13, 2013 post.

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This work is published by www.parrhesiastes.net © MMXIII All Rights Reserved.

POVERTY MATTERS

Poverty is created. Poverty is neither inherent in nor a product of nature since by its nature, poverty is an unnatural state imposed upon the powerless. Humans have created engines for extracting vast amounts of wealth from nature, using the economic power of that largesse to exploit, subjugate and marginalize the majority of the world’s population in effect keeping them in a chronic state of poverty.

How much of the global population? A recent post on Fast Company by Jason Hickle, Martin Kirk and Joe Brewer puts it this way:

For a start, it all rests on The World Bank’s $1.25-a-day poverty line, which is insultingly low. The UN body UNCTAD has pointed out that anyone living on less than $5 a day is unable to achieve “a standard of living adequate for health and wellbeing”: the inalienable right enshrined in the Universal Declaration of Human Rights. If you use that figure, a soul-scorching 5.1 billion people, or 80% of humanity, are living in those conditions today…The recognition that the only way for a tiny group of people to become obscenely rich is for huge masses of others to be kept chronically poor.

Even the mass media, so full of stories extolling the elegant lifestyles of the elites, while lamenting the tribulations of the underclass tradespeople and domestics a la Downton Abbey, reinforce this myth of noblesse oblige being a fount of reason and a cornucopia of good intentions for solutions to world hunger – as if the poor need the permission of the rich to eat or even survive, when in reality, it is these elites and the economic rules they dictate that creates poverty. Time to change those rules.

HISTORY MATTERS

We are a nation of immigrants – even the indigenous societies that thrived on the North American continent before the invasive European culture all but wiped them out came from somewhere else. Our story then is a tale told by immigrants. Here is one such tale.

Anna and Ivan emigrated to this country a little more than a century ago, amid a trans-generational and pan-cultural diaspora that emanated largely from Central and Eastern Europe, Russia, and the Middle East, which was precipitated by a revolt of the ethnic underclasses against the ruling monarchies and dynasties of the 19th Century, an upheaval that would ultimately lead to The Great War and result in the deaths of tens of millions of the underclass, including Slavs and the lumpen conscripted to actually fight it.

Anna took the more conventional route, boarding the S.S. König Albert in Bremerhaven for the week-long voyage across the Atlantic in steerage. Ivan took a more adventurous path, moving to Italy for a time and then on to France where he got a berth on a freighter bound for Tampa Bay, Florida. Soon after his arrival there, he “jumped ship” – leaving his job and effectively severing all ties with Europe and his homeland Galicia, which was then part of the Austro-Hungarian Empire.

Ivan and Anna met for the first time in New York City – even though their families had lived within a few kilometers from each other back in Galicia separated by the River Strypa – and were soon married in NYC during May of 1916 at a local Greek Orthodox Church.

From New York City they began a nomadic trek across the Northeastern U.S., hiring on as migrant farm workers where and when they could find the jobs and shelter, winding up for a time in Cleveland before ultimately moving North to Michigan where they settled in the Thumb District.

They were of the peasant class who worked the Earth, dirt poor immigrants who didn’t speak English — at least not very well. Everybody had to work, even the children. Because Ivan was a “wetback” — technically an illegal alien — the family kept their heads down, didn’t speak to anyone, labored as hard as they could and as “foreigners” tried not to raise the suspicions of the conservative country folk they worked for.

There was no welfare – not that they would even have been able to get it. There was no healthcare. If you got sick, there was the local GP but you had to pay or barter for medicines such as there were. Then there was the Depression. They moved often from one tenancy to the next, once three times in one day. At final count they lived in or worked on more than 20 different farms in 25 years until finally being able to afford a small house with a white picket fence on Main Street [actually Howard Street] across from the bank in Croswell.

Yet they raised four kids; two boys who went off to fight heroically in WWII; and two girls – one who became a banker and the other ran her own hair salon; children whom had families of their own producing ten grandchildren, and more than score of great-grandchildren.

There was a great celebration when Anna finally received her official naturalization papers in 1945 – 32 years after she first stepped across the portal at Ellis Island.

Ivan had to wait until 1947 for his but lived only three more years when he was diagnosed with terminal cancer. Since there was no Medicare, and he was unable to pay for surgery and the subsequent therapy even after selling off his beloved Ford tractor, he suffered in constant pain until at the age of 58 he took his own life.

The extended family grew. The grandchildren and great-grandchildren all became great consumers under the economic caste system that citizens of the world have become dependent upon, succumbing to the mandate to be the pliable good citizens necessary for such systems to flourish and even to survive.

HAPPINESS IS AN EMPTY WALLET

There is then this symbiotic co-dependency between such an economic system and we, its consumer subjects. In order for the former to continue to function, the latter must stay lashed to the wheel and consume so that the system self-perpetuates. If consumer behavior patterns are altered, either by choice, by happenstance, or more than likely mandated by changes in economic policy, this cycle of production-for-consumption can become less efficient, forcing the casino-mentality of both the banking sector that funds it all, built largely upon highly leveraged speculation over the projected cash flows emanating from consumers, and the corporate entities with their well-insulated senior management that roll the dice, altering their market strategies by either cutting costs in order to produce a cheaper and by inference more profitable product or by consolidating industry positions through merger and acquisition or both.

That’s why if you read any business cash flow projection (if you can break into a Board Room and steal one) for a publicly-traded business, there will always be a targeted increase in year over year revenue flows. Why? The expectation of growth affects stock prices which are essentially bets on future dividends – meaning fee and interest income for brokers and lenders, stock options and carried interest for senior management and a taste left over for the shareholder. Revenues are always inflated while operating costs must be minimized.

But don’t actual stock market results have more of an effect on share prices, you ask? Of course, but the stock market is a casino plain and simple. So for every leveraged-to-the-hilt loser there is at least one winner and the house – the bank – dictates the odds, takes its cut, and controls the outcome.

The inherent flaw in such a system and in reality its Achilles Heel is that its target, the ever-loyal consumer is also its greatest risk. Too much consumption creates too much debt which results in default. Too many defaults create a recession. Recessions are bad for business but good for elites because they get to gobble up the assets of distressed businesses and non-performing properties at bargain-basement prices. Recessions are an integral part of a plutocracy. They are the mechanism for how the elites consolidate power.

If this economic engine of inconspicuous consumption stalls out, constricting the cash flow Wall Street gamblers need for creating interest and fee income from bets on future output, then this whole Ponzi Scheme called The Free Market starts to cost the plutocracy that benefits from its neoliberal policies more than it is worth — and the owners do not want that to happen.

How do these owners prevent this from happening? One methodology – let’s categorize it as a macro-social construct (a loosely-related metaphor for Ferdinand Tonnies’ Gesellschaft concept of society) – is to implement political strategies that promote the Four D’s of economic assimilation: the destabilization of an economy, the destruction of its public safety net, the enforced deprivation of the middle and lower classes, culminating in complete dependency on privatized services – and to do this in perpetuity – aimed at entirely eliminating any competing socio-economic entities and their constituents. Everybody is an enemy until they are commodified into paying customers .

Another tactic – we can term it micro-social in scope since it is targeted more toward groups of individuals or a community – is accomplished through the branding of Happiness. The average citizen is bombarded by mass media propaganda campaigns, targeting them both directly and subliminally literally hundreds of instances each day, extolling the twin virtues of demonstrating good citizenship and of being fulfilled through the very act of consumption by simply emptying one’s wallet.

What is the basis for these micro and macro-social programs? Economic power. What are its goals? Domination and control. What is the nature of these campaigns? Class warfare. What is this strategy called? The Forever War. How is it then implemented? By disseminating and imposing the economies of power through a privatized international banking system solely created for and controlled by the owners of capital. Here is how it works.

ECONOMIES OF SCALE

The Money Supply

First some background. Central banking systems were created to perform a dual role. As the monetary authority for a given country, they are tasked to plan and manage economic programs that both shape the financial health and well-being of their constituent member banks and ensure the financial stability of the economy that these banks themselves function in. The tool that these central banking authorities employ to implement such plans is called Monetary Policy – basically the control of the money supply. To expand the supply of money, a central bank could opt to print more money or to reduce interest rates – which makes existing money cheaper – or in some combination of the two, do both. To contract the money supply – a strategy we have come to know as “austerity” – an opposite monetary policy would pertain making money harder to get and by inference more expensive.

Quantitative Easing

There is a third option open to central banks for stimulating the economy, deployed when standard monetary policy has become ineffective – meaning short-term interest rates have approached or reached zero and cannot be adjusted any lower in order to effectively increase the money supply. It is called Quantitative Easing (QE).

A central bank enacts quantitative easing by purchasing—without reference to the interest rate — a set quantity of bonds or other financial assets on financial markets from private financial institutions. The goal of this policy is to facilitate an expansion of private bank lending; if private banks increase lending, it would increase the money supply. Additionally, if the central bank also purchases financial instruments that are riskier than government bonds, it can also lower the interest yield of those assets. —- Wiki.

The effectiveness of QE strategies is hotly debated. On the one hand, as in the case of the ongoing QE1, QE2, and QE3 programs conducted by The Fed since the 2008 Great Recession, QE has been credited by some to have propped up the balance sheets of the banks making them appear more solvent; kept interest rates low resulting cheap money for debtors and stimulated large asset purchases; led to a surge in stock prices as investors moved their money from low yield bonds; taken risky or even toxic bonds and mortgage securities off the market while the housing market rebounds; and contributed to increased consumer confidence and consumption.

Critics however, argue that QE has led to increased income inequality since most of the cash generated from such programs adhere to investors in the form of profits or are used by banks to either invest in emerging markets, commodities, and to speculate in highly profitable derivatives or to lend out to its corporate clients at low rates who in turn use the cheap money to buy back some of their outstanding shares, which in turn inflates their stock values, thereby creating conditions conducive for another global meltdown. Other criticisms have centered on charges that QE is just “printing money” which has the effect of monetizing debt — or financing the government’s deficit. As a point of reference, as of the end of 2014, the Fed held $4.5 Trillion in such “assets” it had taken off the market.

Leverage

In a recent post on her blog Web of Debt titled “How America Became an Oligarchy”, attorney and founder of the Public Banking Institute Ellen Brown traces the rise of the international private banking industry and how it has controlled political fortunes and ultimately turned democracy into oligarchy by controlling the money supply. Citing theologian and environmentalist Dr. John Cobb’s recent paper titled “The Collapse of Democratic Nation States”, Brown excerpts the following quote:

The influence of money was greatly enhanced by the emergence of private banking. The banks are able to create money and so to lend amounts far in excess of their actual reserves. This control of money-creation … has given banks overwhelming control over human affairs. In the United States, Wall Street makes most of the truly important decisions that are directly attributed to Washington.

The vast majority of the money supply in North America and Europe is created by private bankers – 97% according to PositveMoney.org. In the US, functional control of the currency rests with the Federal Reserve which doles out money to its privately-held member banks at “low or no” interest rates, but titular control of the money supply rests with the Department of The Treasury whose head, the Secretary of The Treasury is a political appointee.

The Treasury actually prints the money through the Bureau of Printing and Engraving and its system of mints, then “sells” paper currency to the Federal Reserve at cost and the coins at face value (even though in some cases they cost more than face value to mint). More on this process later. But the bulk of the money supply is neither created from nor backed by specie but by paper in the form of government or corporate bonds, loan contracts, stocks, and lines of credit created by private bankers.

How do these privately-owned banks create money? By giving out credit lines to businesses, mortgages to prospective “homeowners”, and loans to other banks in exchange for debt – a contractual promise to pay off the loan plus interest over a given time period or term. These banks can then potentially “grow” the money supply by enormous amounts limited only by statutetory restrictions on funds they must keep on their Balance Sheets as a Reserve against potential defaults.

Fractional Reserves

For example, during lean times this fractional reserve requirement might limit a bank’s loan to reserve or liquidity ratio to 10%. This means the bank would have to keep as a reserve – on deposit with its district Federal Reserve branch – a minimum of 10 percent of its outstanding customer deposits or liabilities, so theoretically it could loan out $10 for every $1 in reserves. During flush times like before the 2007 banking collapse, this liquidity ratio had ballooned in some cases to 80:1. That meant certain highly-leveraged banks had loaned out $80 for every $1 in reserves and were also collecting interest at market rates on the $79 differential on top of the fees they collected for funding the loans in the first place.

Based upon the projected cash flow from just such an income stream, a lender bank could aggregate or package these loans as securities, often called collateralized debt obligations or CDOs (since 2008 re-branded as Bespoke Tranche Opportunities), and after first making sure to receive the blessings of the ratings agencies such as Moody’s and Standard & Poor’s, sell them to insurance companies, pension funds, municipalities or even banks in foreign countries like Iceland, Ireland, Greece, and Spain who would in turn further leverage the potential income stream from these CDOs to finance additional consumer lending programs, to fund home mortgages, create bond issues for capital improvements, engage in international trade balance of payments transactions, or to buy additional securities on the stock markets.

So you can see that the original $79, potentially being leveraged many times over with this “multiplier effect”, could cause both the money supply to expand significantly and also create the risk of a burgeoning mountain of debt that would have to be paid at some point in the future.

Derivatives

In order to insulate themselves from market fluctuations and potential default, the lender banks would take out insurance policies – derivatives with exotic names like Credit Default Swaps (CDS) or Capital Relief Trades underwritten by other financial institutions including investment banks, hedge funds, and insurance companies.

In a post from 2008 titled It’s The Derivatives Stupid! on her Web of Debt blog, Ellen Brown explains what a derivative is:

“Derivatives are financial instruments that have no intrinsic value but derive their value from something else. Basically, they are just bets. You can “hedge your bet” that something you own will go up by placing a side bet that it will go down.”

So how does the most common form of credit derivative, the Credit Default Swap (CDS) work? A CDS is a bet between two parties on whether or not a given company will default on its credit obligations — typically a contract or a bond. Ellen Brown illuminates further:

“In a typical default swap, the “protection buyer” gets a large payoff from the “protection seller” if the company defaults within a certain period of time, while the “protection seller” collects periodic payments from the “protection buyer” for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes…. In one blogger’s example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money – free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.”

This is how banks and investors ostensibly manage risk. The underwriters themselves might subsequently aggregate these risk management swaps or even create new ones, whose relative value to potential investors is derived solely from the future expectations on the market value of the original underlying CDOs they were created as insurance for in the first place (hence the name “derivatives”), and sell them as well to similar institutional customers even further expanding portfolios of assets with little or no actual value other than from expectations, and also exponentially multiplying the potential for loss.

Next – most likely immediately post-sale – the underwriters might earmark a portion of the proceeds of such a swaps transaction, (which to be clear, amounts to issuing an insurance policy with a cash value equal to the agreed upon notional value of the package of swaps (the CDO) being insured, in exchange for a transaction fee and an either fixed or variable periodic “premium” to be paid by the insuree), in order to purchase futures contracts that allow the underwriter the option to claim the right to buy back or “short” these futures, at pre-determined prices levels, along with certain “stop points” if expectations rise – essentially placing a bet that the future value of the original securities (CDO) would fluctuate up or down over a given period and if so, serve as a hedge against the whole deal going South.

Because the derivatives marketplace, unlike that of the insurance industry, is completely opaque to regulation, the underwriting agency might then be able to create multiple CDS agreements that each cover all or a portion of the same CDO tranche, and market them to any third party investor willing to bet against the potential change in value of the underlying “assets” of the CDO.

An Example
So for instance, if the original package of CDOs had a “notional” (face) value of $100K, our underwriting agency could issue additional swaps “policies” (CDS), to as many completely independent investors as are willing, whom have no other stake in the transaction other than speculative, each CDS contract having the same face value of $100K. For the sake of our example we’ll use four. As long as the original institutional customers keep their monthly premiums current on the original swaps contract with our underwriter and the CDO portfolio keeps producing the expected income stream, everything is gravy for both the institutional investors and the underwriter who is collecting monthly premiums on both the original CDS and the secondary CDS contracts held by our four unrelated investors.

Our four speculators (we’ll call them hedge funders) however, who are really betting that the whole deal will wind up in the shit can, might individually or in collusion take out contrary futures positions on the original CDO tranche or even on the potential cash flow of the original institutional customers, in an attempt to negatively influence market expectations or credit ratings, and drive down the ability of the institution to generate enough income to operate. Plus, depending on their expectations about future market interest rates, our hedge funders might go to back to these institutional customers and offer to engage in an interest rate swaps deal.

Interest rate swaps transactions are based upon relative expectations about fluctuations in future market interest rates. They typically involve two parties, with an intermediary fiduciary serving as a clearinghouse, who agree to swap income streams based on assets (but not the assets themselves) having the same “notional” value, for a contractual period of time; one income stream whose payments terms specify a fixed rate of return to be exchanged for another that has a variable rate coupon.

Thus our hedge funders might believe that future interest rates will trend downward for a time, hence be tempted to offer our institutional customers an income stream from one or more bond portfolios with a variable coupon rate in exchange for that from the CDO which might be based on a fixed rate. If the hedge funders are right, they will profit and the institutional customers will lose money on the swaps deal – potentially having the desired negative effect on value of the investor-held portfolios or operations (at least for the term of the swaps), possibly triggering a default on the CDS contract with the underwriter and subsequently force the underwriter to fork over the cash value of the swaps contract ($400K). If they’re wrong, the hedge funders will be out the income stream differential on the interest rate swaps contract plus they are still making payments on the CDS contract they bought into from the underwriter.

This illustrates the power of leverage. In our example, the underwriter has multiplied both its $100K liability and its income from the CDS contracts four times, solely based upon expectations. If the expectations prove out, it will enjoy a profit. But leverage can work both ways both here and in the real world, resulting in an explosion of potential debt that far exceeds the value of any underlying assets making such overextended wagers extremely vulnerable to speculative pressures from potential competitors.

Gamesmanship

Here is a real-world example of how risky leverage can be. In a post from 2012, Web of Debt posted an article referencing a report from Rudy Avizius of the Market Oracle U.K. about a then major global financial derivatives broker called MF Global that was forced into bankruptcy because of more than $6 Billion in losses on highly leveraged repurchase agreements based on the bonds of several European nations including Greece. Avizius writes:

[A]n agreement was reached in Europe that investors would have to take a write-down of 50% on Greek Bond debt. Now MF Global was leveraged anywhere from 40 to 1, to 80 to 1 depending on whose figures you believe. Let’s assume that MF Global was leveraged 40 to 1, this means that they could not even absorb a small 3% loss, so when the “haircut” of 50% was agreed to, MF Global was finished. It tried to stem its losses by criminally dipping into segregated client accounts, and we all know how that ended with clients losing their money. . . .

However, MF Global thought that they had risk-free speculation because they had bought these CDS (Credit Default Swaps) from these big banks to protect themselves in case their bets on European Debt went bad. MF Global should have been protected by its CDS, but since the ISDA would not declare the Greek “credit event” to be a default, MF Global could not cover its losses, causing its collapse.

So who is the ISDA? Well it is the International Swaps and Derivatives Association consisting of more than 800 members who themselves are derivatives dealers, banks, insurance companies, and something called “end users”. More than often these are the very entities that underwrite derivatives contracts like CDS. So if a client’s bets go South, the affected ISDA member – a bank who issued the CDS to cover these bets – has fork over the cash value of the insurance.

However, in the case of the ill fated MF Global, the house decided there was no default, in effect ruling that one of its Club members didn’t have to pay the insurance it owed on the CDS to MF Global, forcing the firm out of business – a classic case of “we don’t like the game, so we’ll take the our ball and go home”.

The Grexit

Greece was seemingly in the financial spotlight every week as analysts wring their hands over possible default on the EuroBonds the country has been saddled with coupled with the very real possibility of Greece’s exit from the EEU and the potential global economic fallout from such a happenstance.

Goldman Sachs has had its tentacles wrapped around Greece for almost a decade coercing the government to accept opaque derivatives contracts in exchange for loans that would not show up on the books thereby concealing the real size of Greece’s debt load. To cover is ass, Goldman then shorted those bets and in 2009 joined with other Wall Street predators in a concerted move against the Euro further exacerbating the Greek financial crisis. Predictably, these bets didn’t go so well for the Greeks.

Goldman Sachs, the infamously-branded Vampire Squid – an appellation courtesy of Rolling Stone’s Matt Taibbi – even levied a thinly-veiled threat to the Greek Parliament earlier that year, demanding it appoint a pro-austerity prime minister or risk having central bank (ECB) liquidity cut off to their banks.

In an interview with Der Spiegel early in 2015, then newly-elected Prime Minister Alexis Tsipras is quoted as saying that the European Central Bank (ECB), the bank that manages the EU money supply, was “holding a noose around Greece’s neck.” Ellen Brown in a March 2015 post on Web of Debt explains:

The noose around Greece’s neck is this: the ECB will not accept Greek bonds as collateral for the central bank liquidity all banks need, until the new Syriza government accepts the very stringent austerity program imposed by the troika (the EU Commission, ECB and IMF).

That means selling off public assets (including ports, airports, electric and petroleum companies), slashing salaries and pensions, drastically increasing taxes and dismantling social services, while creating special funds to save the banking system.

These are the mafia-like extortion tactics by which entire economies are yoked into paying off debts to foreign banks – debts that must be paid with the labor, assets and patrimony of people who had nothing to do with incurring them.

And this is not limited to just Greece. All banks are dependent on the liquidity provided by central banks because they all leverage debt and lend money that they don’t have. The central bank is the “lender of last resort” providing the fiat currency and credit to keep them in business. Central banks have the power to control the currency and as such the economy.

But with respect to Greece, as with other real-world examples we will offer, there is a kicker. All of that public debt — leveraged by bonds, Credit Default Swaps, interest rate swaps, currency swaps, and other exotic financial instruments — were bought, funded by loans from a central bank, by its private banking customers who after all are members in The Club who get bailed out by the central bank if their bets don’t pan out. How does this work? Ellen Brown continues:

Essentially, Greece’s public debt went from private to public hands when the ECB and the IMF rescued private (German, French, Spanish) banks. The debt, of course, ballooned. The troika (ECB, IMF, and the EU) intervened, not to save Greece, but to save private banking. The ECB bought public debt from private banks for a fortune, because the ECB could not buy public debt directly from the Greek state. The icing on this layer cake is that private banks had found the cash to buy Greece’s public debt exactly from…..the ECB, profiting from ultra-friendly interest rates. This is outright theft. And it’s the thieves that have been setting the rules of the game all along.

So who gets left with the tab? Get out your wallets again citizens.

The primary takeaway from this discussion so far, aside from the fact that the potential events in our example actually played out albeit with vastly greater consequences, is that the process of creating money under just such a privately-owned and run banking system allows an influential few who have it, to control the destiny of the many who have been made to believe that they need it in order to spend it so they can become model citizens.

What is often lost in the fine print is the fact that all of this money is created literally out of thin air and carries with it a vastly greater burden of leveraged debt – the original principal plus the interest plus wagers on the future performance of the original debts – owed to whomever holds the debt contracts – which is usually the insider clients of the private banking entity that creates the debt and controls the money supply. The operative word here is control. How much are we talking about? Estimates including reports from the Bank for International Settlements, dating as far back as 2008 put the total “notional” value of outstanding derivatives — potential face value of debt from bets – at $1.2 Quadrillion. Yes, that’s a “Q”.

THE POWER OF CENTRAL BANKS

The Bank For International Settlements (BIS).

Let’s get back to the power wielded buy the Central Banks, specifically the Bank For International Settlements. Most people have never even heard of it. Dr. Carroll Quigley – a professor of history at Georgetown University and mentor to President Bill Clinton wrote in Tragedy and Hope: A History of the World in Our Time (1966):

“[T]he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences. The apex of the system was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world’s central banks which were themselves private corporations.”

To Professor Quigley the key to success for this exclusive banker’s club would be that both the political and economic systems of its member countries would be controlled by a network of bankers and not by the citizens of those countries. In fact there were two basic tenets or rules of order for governing the internal strategies at the BIS – the first being that banks should act independently from their governments and, second that politicians must not be allowed to dictate policy for the international monetary system. Initially the BIS kept a low profile, operating out of an abandoned hotel, the Grand et Savoy Hotel Universe, with an annex above a chocolate shop. But in 1977 it moved to an eighteen storey circular tower replete with its own nuclear fall-out shelter, dubbed by pundits as the Tower of Basel.

Founded in 1930, the BIS was to function as a depository for Germany’s war reparations payments mandated by the Treaty of Versailles but its real purpose was to become an international clearinghouse for central banks — the first in the history of the world. The bank’s key architects were Montagu Norman, who was then the governor of the Bank of England, and Hjalmar Schacht, then the president of the Reichsbank.

In his book Tower of Basel: The Shadowy History of the Secret Bank that Runs the World, author Adam LeBor states the case that during WW II “the BIS became a de-facto arm of the Reichsbank, accepting looted Nazi gold and carrying out foreign exchange deals for Nazi Germany” even though at the time its president was an American, Thomas McKittrick and its General Manager a Frenchman Roger Auboin.

A few miles away, Nazi and Allied soldiers were fighting and dying. None of that mattered at the BIS. Board meetings were suspended, but relations between the BIS staff of the belligerent nations remained cordial, professional, and productive. Nationalities were irrelevant. The overriding loyalty was to international finance.

— Excerpt from LeBor, Adam (2013-05-28). Tower of Basel: The Shadowy History of the Secret Bank that Runs the World.

As Ellen Brown points out in her book The Public Bank Solution: From Austerity to Prosperity:

The BIS has been called “the most exclusive, secretive, and powerful supranational club in the world.” Its purpose was to allow bankers to make money no matter what, and to continue exercising their vast powers, including making agreements on “the economic future of the chief areas of the globe.” Today the BIS has governmental immunity, pays no taxes, and has its own private police force. It is, as its founders envisioned, above the law.

The Federal Reserve.

The central bank here in U.S. is the Federal Reserve. It is a hybrid institution, a publicly run, yet for the most part privately-owned banking system. It was created in 1913 when then U.S. president Woodrow Wilson signed into law The Federal Reserve Act. The seven bankers that sit on its Board of Governors together with its Chairperson are appointed by the President of the United States and approved by the US Senate. The directors of its twelve regional branches are elected by nationally-chartered member commercial banks from their respective districts, whom are required to hold stock in the Fed.

In practice, all members of both the the Fed’s Board Governors and its regional branch boards are bankers, most of whom are Wall Street insiders who’ve either worked at or will work at the large commercial investment banks such as Goldman Sachs or JP Morgan Chase. The money supply for the US, although it is ostensibly controlled by the Treasury Department whose Treasury Secretary has historically been a Wall Street insider, effective control is managed through the Federal Reserve. The stated reason for this public-private duality goes as follows:

The Federal Reserve is theoretically free from political pressure and considers itself an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. — Wiki.

The Federal Reserve, like all central banks makes a lot of money because it controls the money supply. The majority of its revenue comes from open market operations—specifically the interest on the its own portfolio of Treasury securities as well as the money that comes from the buying and selling of the securities in its portfolio and their underlying derivatives. So the Fed is also making bets using taxpayer money. Some critics view private-banker control over the creation the money supply to be a scam. But it has been a profitable relationship for the Treasury. In 2014, the Fed sent $98.7 billion of its $101.5 billion total net income to the U.S. Treasury.

Other Fed revenue comes from the sale of financial services like check and electronic payment processing and discounts (fees) on loans to member banks. There also is interest and fees on foreign deposits held within the Federal banking system. However, the Fed doesn’t really keep the profits. The Fed transfers all profits to the Treasury after deducting a 6% dividend for its member banks and certain expenses.

Fiscal Policy

It is evident then that Central banks, after taking their cut, make a lot of money for their governments that ostensibly can be used for running public programs like administrative agencies, healthcare, education, transportation, social services, and defense. When combined with revenues received from taxes, borrowing, or the sale of assets, this income stream is the life blood of publicly-run institutions and greatly affects their role in the local and national economy. The control and management of this income stream is called Fiscal Policy and its tools – implemented and administered politically via the executive and legislative processes – are the levying of taxes, setting tax rates, the collection of fees for licenses and public services, and borrowing for civic improvements or operations funded via bond issues. And much like Monetary Policy that is exercised by the Fed, Fiscal Policy is very sensitive to interest rates. How senstive?

Libor

Remember the LIBOR scandals that have rocked the financial industry in Europe and implicated HSBC, JP Morgan Chase, RBS, Barclays, CitiGroup, Bank of America, and others? So what is LIBOR? It is an acronym standing for London Interbank Offer Rate, an interest benchmark based on the rates at which banks lend unsecured funds to each other on the London interbank market, and is published daily by the British Bankers’ Association (BBA).

Each morning, global banks submit their (estimated) borrowing costs to the Thomson Reuters data collection service. The calculation agent throws out the highest and lowest 25 percent of submissions and then averages the remaining rates to determine Libor. Calculated for fifteen different maturities and ten different currencies, Libor is considered the most critical global benchmark for short-term interest rates. Eighteen banks submit rates for the U.S. dollar LIBOR.

Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans. Indeed, hundreds of trillions of dollars in securities and loans are linked to Libor, including auto and home loans, according to the U.S. Commodities Futures Trading Commission. When Libor rises, rates and payments on loans often increase; likewise, they fall when Libor goes down. Some 45 percent of adjustable-rate prime mortgages and 80 percent of adjustable-rate subprime mortgages are based on Libor, while half of variable-rate private student loans are set to Libor. —- Council On Foreign Relations.

Crikey!  What’s the big deal here anyway? How does monkeying with interbank interest rates affect you and me? Well, LIBOR is used as a benchmark to set payments on those $1.2 quadrillion of notional financial instruments, ranging from complex interest-rate derivatives to simple mortgages. The number determines the global flow of trillions of dollars each year and you have to wonder what role the BIS has in setting these LIBOR rates.

Because LIBOR is used in US derivatives markets, an attempt to manipulate Libor is an attempt to manipulate US derivatives markets, and thus a violation of American law. Since mortgages, student loans, financial derivatives, bond issues, and other financial products often rely on Libor as a reference rate, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide.

The inescapable conclusion here is that we have a worldwide banking system that for a period of time, manipulated inter bank interest rates at will in order to stiff the borrower – the consumer – and pocket the profits as capital gains. If you as as a broker under such a scheme could shave off even one thousandth of a point (.001%) from the lending rate on such a sum and pocket the difference it would amount to $12 billion!

Flash Trading

Then there is Flash Trading better known as High Frequency Trading (HFT). In his book Flash Boys, Michael Lewis exposed the dangers of high-frequency trading in the equities markets where traders front-run securities trades using state-of-the-art technologies like fiber optic cable and microwave transmission systems to shave milliseconds off of the time it takes to complete a transaction on the stock market.

Many such HFTs are the result of using electronic platforms for entering trading orders with an algorithm which executes pre-programmed trading instructions accounting for a variety of variables such as timing, price, and volume. Algorithmic trading, thought to be a contributing factor in the Flash Crash of May 2010, is widely used by investment banks, pension funds, mutual funds, and other buy-side (investor-driven) institutional traders, to move large securities trades, dividing them into several smaller trades to ease their relative market impact and and to manage risk. While Lewis can only estimate the cost to investors of the abuses, he believes it is over $5 billion per year, perhaps as much as $15 billion per year or even higher.

Dark Pools

There are also securities trading forums called Dark Pools. Dark pools are run by private brokerages which operate under fewer regulatory and public disclosure requirements than public exchanges. The bulk of dark pool trades represent large trades by financial institutions that are offered away from public exchanges like the New York Stock Exchange and the NASDAQ, so that such trades remain confidential and outside the purview of the general investing public. The fragmentation of financial trading venues and electronic trading has allowed dark pools to be created, and they are normally accessed via private contractual arrangements.

Caveat Emptor

What the existence of the above unregulated financial market exchanges, both those visible and those more opaque, illustrate is the almost limitless power these institutions have over the global economy, having the potential to bring down governments and dictate the future of entire economic ecosystems because such systems are being and have been used to move large volumes of debt from market to market largely out of the purview of regulatory agencies for stupendous profits.

Remember, debt carries with it a demand to be repaid, wielded by central banks like a bludgeon in their campaigns of economic class warfare. Why, besides for the money? Because these neoliberal money factories have bought and sold governments and entire countries for decades. Historically we can cite some famous examples: Cuba in the 1960’s; the southern cone of South America in the 1970’s; Russia and Poland in the 1980’s; Iraq; Iceland; Spain; and currently Venezuela, Syria, Greece, and Ukraine.

But more to our point, central banks also aggressively market and fund this Forever War in order to perpetuate a climate of fear. They work doggedly, most often in secret to keep the populations at large marginalized; unemployed, poor, hungry, disorganized and imprisoned by debt. Banksters and the elites they work for are not interested in democracy. They are interested in privacy. Membership to the Club is restricted. They do not want to live in a world where everyone has a equal voice. That would constitute a threat to the invisible hand of the Free Market. Remember Occupy?

If you are not a member of the Club, you can’t complain about the service. The only freedom neoliberal economics offers non-members is the freedom to choose when to buy. Through their Chicago-school Free Market dogma, neoliberal capitalists have purposely hyperextended the global economy to the tune of $1.2 Quadrillion by gambling with OPM; other people’s money.

So the operative question, given our already empty wallets, is not if but when will we be given the freedom to pick up the tab?

© Kazkar Babiy MMXIV.

Be sure to read Chapter One, Chapter Three and Chapter Four of The Neoliberal Book of the Dead.  Just follow the links provided.

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