The “protected class” is granted “safe harbor” only because their bets are so risky that to let them fail could crash the economy. But why let them bet at all?

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By Ellen Brown / Original to ScheerPost
February 14, 2024

This is a sequel to a Jan. 15 article titled “Casino Capitalism and the Derivatives Market: Time for Another ‘Lehman Moment’?”, discussing the threat of a 2024 “black swan” event that could pop the derivatives bubble. That bubble is now over ten times the GDP of the world and is so interconnected and fragile that an unanticipated crisis could trigger the collapse not just of the bubble but of the economy. To avoid that result, in the event of the bankruptcy of a major financial institution, derivative claimants are put first in line to grab the assets — not just the deposits of customers but their stocks and bonds. This is made possible by the Uniform Commercial Code, under which all assets held by brokers, banks and “central clearing parties” have been “dematerialized” into fungible pools and are held in “street name.”

This article will consider several proposed alternatives for diffusing what Warren Buffett called a time bomb waiting to go off. That sort of bomb just detonated in the Chinese stock market, contributing to its fall; and the result could be much worse in the U.S., where the stock market plays a much larger role in the economy.

The Chinese Derivative Crisis

A January 30th article on Bloomberg News notes that “Chinese stocks’ brutal start to the year is being at least partly blamed on the impact of a relatively new financial derivative known as a snowball. The products are tied to indexes, and a key feature is that when the gauges fall below built-in levels, brokerages will sell their related futures positions.”

Further details are in a January 23^rd article titled “’Snowball’ Derivatives Feed China’s Stock Market Avalanche.” It states, “China’s plunging stock market is leading to losses on billions of dollars worth of derivatives linked to the country’s equity indexes, fueling further selling as retail investors offload their positions…. Snowball products are similar to the index-linked products sold in the 2008 financial crisis, with investors betting that U.S. equities would not fall more than 25% or 30%,” which they did.

Chinese shares rose on February 6, as officials took measures to prop up the ailing market, including imposing new “zero tolerance” curbs for malicious short selling.

The Greater U.S. Threat

The Chinese stock market is much younger and smaller than that in the U.S., with a much smaller role in the economy. Thus China’s economy remains relatively protected from disruptive ups and downs in the stock market. Not so in the U.S., where speculating in the derivatives casino brought down international insurer AIG and investment bank Lehman Brothers in 2008, triggering the global financial crisis of 2008-09. AIG had to be bailed out by the taxpayers to prevent collapse of the too-big-to-fail derivative banks, and Lehman Brothers went through a messy bankruptcy that took years to resolve.

In a December 2010 article on Seeking Alpha titled “Derivatives: The Big Banks’ Quadrillion-Dollar Financial Casino,” attorney Michael Snyder wrote, “derivatives were at the heart of the financial crisis of 2007 and 2008, and whenever the next financial crisis happens, derivatives will undoubtedly play a huge role once again…. Today, the world financial system has been turned into a giant casino where bets are made on just about anything you can possibly imagine, and the major Wall Street banks make a ton of money from it. The system … is totally dominated by the big international banks.”

The Speculators Dominate the Regulators

In a 2009 Cornell Law Faculty publication titled How Deregulating Derivatives Led to Disaster, and Why Re-Regulating Them Can Prevent Another, Prof. Lynn Stout proposed stabilizing the market by returning to 20^th century derivative rules. She noted that derivatives are basically wagers or bets, and that before 2000, the U.S. and U.K. regulated derivatives primarily by a common‐law rule known as the “rule against difference contracts.” She explained:

The rule against difference contracts did not stop you from wagering on anything you liked: sporting contests, wheat prices, interest rates. But if you wanted to go to a court to have your wager enforced, you had to demonstrate to a judge’s satisfaction that at least one of the parties to the wager had a real economic interest in the underlying and was using the derivative contract to hedge against a risk to that interest.… Using derivatives this way is truly hedging, and it serves a useful social purpose by reducing risk.

… Under the rule against difference contracts and its sister doctrine in insurance law (the requirement of “insurable interest”), derivative contracts that couldn’t be proved to hedge an economic interest in the underlying were deemed nothing more than legally unenforceable wagers.

Hedge funds, for example, should really call themselves “speculation funds,” as it is quite clear they are using derivatives to try to reap profits at the other traders’ expense.

The rule against difference contracts died in 2000, when the US embraced wholesale deregulation with the passage of the Commodity Futures Modernization Act (CFMA):

The CFMA not only declared financial derivatives exempt from CFTC or SEC oversight, it also declared all financial derivatives legally enforceable. The CFMA thus eliminated, in one fell swoop, a legal constraint on derivatives speculation that dated back not just decades, but centuries. It was this change in the law—not some flash of genius on Wall Street—that created today’s $600 trillion financial derivatives market.

The Casino Gets Special Privileges

Not only are speculative derivatives now legally enforceable, but under the Bankruptcy Act of 2005, derivative securities enjoy special protections. Most creditors are “stayed” from enforcing their rights while a firm is in bankruptcy, but many derivative contracts are exempt from these stays. Similarly, under the Dodd Frank Act of 2010, derivative claimants have “super-priority” in the bankruptcy of a financial institution. They are privileged to claim collateral 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. 

That’s true not only of the deposits in a bankrupt bank but of stocks, bonds and money market funds held by a broker/dealer that goes bankrupt. Under the Bankruptcy Act of 2005 and Sections 8 and 9 of the Uniform Commercial Code (UCC), “safe harbor” is provided to entities described in court documents as “the protected class.” The customers who purchased the assets have only a “security entitlement,” a weak contractual claim to a pro rata share of a residual pool of fungible assets all held in the name of Cede & Co., the proxy of the Depository Trust and Clearing Corp. (DTCC). As Wall Street financial analyst John Rubino put it in a Jan. 27 podcast:

What we used to think of as a bank bail-in where they take your deposit in order to support a failing bank, that is now spread across the entire financial economy where whatever you have in an account anywhere can just disappear, because they’re going to transfer ownership of it to these big dominant entities out there in the financial system that need those assets in order to keep from blowing up.

Derivative speculators are considered “secured” because they post a portion of what they could wind up owing as “margin,” but why that partial security is superior to the 100% security posted by the depositor or purchaser is not explained. The “protected class” is granted “safe harbor” only because their bets are so risky that to let them fail could crash the economy. But why let them bet at all?

The Solution of the Regulators

The fix of the G20 leaders following the global financial crisis, however, was to force banks to clear over-the-counter derivatives through central counterparties (CCPs), which stand between buyer and seller and protect either party if the other blows up. By March 2020, 60% of credit default swaps and 80% of interest rate swaps were centrally cleared. The problem, as noted in a December 2023 publication by the Bank for International Settlements, is that these measures taken to protect the system can actually amplify risk.

CCPs tend to ask for more collateral than banks did in the pre-crisis world; and when a CCP hikes its initial margin requirement to cover the risk of default, this applies to everyone in the market, meaning cash calls are synchronized. As explained in a May 2022 Reuters article:

It’s logical that CCPs ask for more collateral during a panic: that’s when defaults are most likely. The problem is that margin calls seem to have made things worse. In March 2020, for example, a so-called “dash for cash” saw investors liquidate even prime money-market funds and U.S. Treasury securities.

… [R]ampant margin calls have intensified a financial panic twice in as many years, with central banks effectively bailing out markets in 2020. That’s better than in 2008, when taxpayers had to step in. But the problem of margin calls remains unsolved.

… Central counterparty (CCP) clearing houses should consider asking clients for more collateral during good times to reduce the risk of destabilising margin calls during a financial panic, a Bank of England official said on May 19.

Yet all this, as Michael Snyder observes, is to allow the big international banks to run the largest derivatives casino that the world has ever seen. Why not just shut down the casino? Prof. Stout’s suggested solution is for Congress to return to the pre-2000 rule under which speculative derivative bets were not enforceable in court. That would include reversing the “superpriority” privileges in the Bankruptcy Act of 2005 and the Dodd-Frank Act. But it won’t be a quick fix, as Wall Street and our divided Congress can be expected to put up a protracted fight.

What If the DTCC Goes Bankrupt?

In a 2015 law review article titled “Failure of the Clearinghouse: Dodd-Frank’s Fatal Flaw?,” Prof. Stephen Lubben points to a more ominous risk from pushing all derivatives onto exchanges; and that concern is shared by former hedge fund manager David Rogers Webb in his 2024 book “The Great Taking.” The exchanges are supposed to be safer than private over-the-counter trades because the exchange steps in as market maker, accepting the risk for both sides of the trade. But in a general economic depression, the exchanges themselves could go bankrupt. No provision for that is made in the Dodd-Frank Act, which purports to decree “no more bailouts.” Still, reasons Prof. Lubben, the government would undoubtedly step in to save the market from collapse.

His proposed solution is for Congress to make legislative provision for nationalizing any bankrupt exchange, brokerage or Central Clearing Counterparty before it fails. This is something to which our gridlocked Congress might agree, since under current circumstances it would not involve any major changes, wealth confiscation or new tax burdens; and it could protect their own fortunes from confiscation if the DTCC were to go bankrupt.

Other Possible Federal Solutions

Another alternative that not only could work but could fix Congress’s budget problems at the same time is to impose a 0.1% tax on all financial transactions. See Scott Smith, A Tale of Two Economies: A New Financial Operating System, showing that U.S. financial transactions (the financialized economy) are over $7.6 quadrillion, more than 350 times the U.S. national income (the productive economy). See my earlier article summarizing all that here. On a financial transaction tax curbing speculation in derivatives, see also here, here and here.

There are other possible solutions to customer title concerns. There is no longer a need for the archaic practice of holding all securitized assets in the street name of Cede & Co. The digitization of stocks and bonds was a reasonable and efficient step in the 1970s, but today digital cryptography has gotten so sophisticated that “smart contracts” can be attached by blockchain-like distributed ledger technology (DLT) to digital assets, tracking participants, dates, terms and other contractual details. The states of Delaware and Wyoming have explored maintaining corporate lists of stockholders on a state-run blockchain; but predictably, the measures were opposed. The practice of holding assets in street name has proven very lucrative for the DTCC’s member brokers and banks, as it facilitates short selling and the “rehypothecation” of collateral.

In October 2023, the DTCC reported that it has been exploring adopting DLT; but the goal seems only to be speedier and safer trades. No mention was made of returning registered title to the purchasers of the traded assets, which could be done with distributed ledger technology.

South Dakota’s Innovative Solution

The most readily achievable solution is probably that in a South Dakota bill filed on Jan. 29.  The bill is detailed in a Feb. 2 article titled “You Could Lose Your Retirement Savings in the Next Financial Crash Unless Others Follow This State’s Lead”, which observes:

… [I]f your broker … were to go bankrupt, the broker’s secured creditors (the people to whom the broker owes money) would be empowered to take the investments that you paid for in order to settle outstanding debts….

To avoid a catastrophe in the future, a nationwide movement is desperately needed to alter the existing Uniform Commercial Code. Of course, that won’t be easy to accomplish, especially because bank lobbyists and other powerful financial interests will almost certainly fight kicking and screaming to stop policymakers from taking away their advantage over consumers.

The good news is, this “great taking” can be stopped at the state level. Americans don’t need to count on a divided Congress to get the job done. Because the UCC is state law, state lawmakers can take concrete steps to restore the property rights of their constituents and protect them in the event of a financial crisis.

On Monday, South Dakota legislators introduced a bill that would do just that. The legislation would ensure that individual investors have priority over securities held by brokerage firms and other intermediaries.

It would also alter jurisdictional provisions so that cases are determined in the state of the individual investor, rather than the state of the broker, custodian or clearing corporation. This would ensure that individual investors are able to rely on the laws of their local state.

Hopefully, other states will follow South Dakota’s lead. Tennessee, for one, is reported to have such a bill in the works.

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Ellen Brown is a regular contributor to ScheerPost. She is an attorney, founder of the Public Banking Institute, and author of thirteen books including the best-selling Web of Debt. Her latest book is Banking on the People: Democratizing Money in the Digital Age and her 400+ blog articles are at EllenBrown.com.

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By Ellen Brown / Original to ScheerPost
July 12, 2023

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“Rather than collecting taxes from the wealthy,” wrote the New York Times Editorial Board in a July 7 opinion piece, “the government is paying the wealthy to borrow their money.”

Titled “America Is Living on Borrowed Money,” the editorial observes that over the next decade, according to the Congressional Budget Office (CBO), annual federal budget deficits will average around $2 trillion per year. By 2029, just the interest on the debt is projected to exceed the national defense budget, which currently eats up over half of the federal discretionary budget. In 2029, net interest on the debt is projected to total $1.07 trillion, while defense spending is projected at $1.04 trillion. By 2033, says the CBO, interest payments will reach a sum equal to 3.6 percent of the nation’s economic output.

The debt ceiling compromise did little to alleviate that situation. Before the deal, the CBO projected the federal debt would reach roughly $46.7 trillion in 2033. After the deal, it projected the total at $45.2 trillion, only slightly less – and still equal to 115% of the nation’s annual economic output, the highest level on record.

Acknowledging that the legislation achieved little, House Speaker Kevin McCarthy said after the vote that he intended to form a bipartisan commission “so we can find the waste and we can make the real decisions to really take care of this debt.” The NYT Editorial Board concluded:

“Any substantive deal will eventually require a combination of increased revenue and reduced spending …. Both parties will have to compromise: Republicans must accept the necessity of collecting what the government is owed and of imposing taxes on the wealthy. Democrats must recognize that changes to Social Security and Medicare, the major drivers of expected federal spending growth, should be on the table. Anything less will prove fiscally unsustainable.

The Elephant in the Room

Omitted was any mention of trimming the defense budget, which currently accounts for more than half of the federal government’s discretionary spending and nearly two-thirds of its contract spending. Rep. Ro Khanna (D-CA), who cast the sole dissenting vote on the recent $886 billion defense budget in the House Armed Services Committee, has detailed some of the Pentagon’s excesses. For decades, he writes, legacy military contractors have charged the federal government exorbitant sums for everything from fighter jets to basic hardware. Lockheed Martin, for example, has used its monopoly on F-35 fighter jets to profit from maintenance that only they can provide, with the work needed to support and upgrade existing jets projected to cost taxpayers over $1.3 trillion. TransDigm, another contractor responsible for supplying spare parts for the military, was found to be charging the Pentagon more than four times the market price for their products.  Rep. Khanna concludes;

“Keeping America strong starts at home. It means ensuring access to quality, affordable healthcare and education, strengthening our economy with good-paying jobs, and giving Americans the tools they need to pursue the American Dream.… Bloated military spending is not the answer.… We can’t continue to sign a blank check to price-gouging defense contractors while Americans struggle here at home.”

In an address to the UN Security Council on Ukraine aid on June 29, 2023, Max Blumenthal added fuel to those allegations. He said:

Just June 28^th, as emergency crews work to clean up yet another toxic train derailment in the United States, this time on the Montana River, further exposing our nation’s chronically underfunded infrastructure and its threats to our health, the Pentagon announced plans to send an additional $500 million worth of military aid to Ukraine….

This policy, … which sees Washington prioritize unrestrained funding for a proxy war with a nuclear power in a foreign land … while our domestic infrastructure falls apart before our eyes, exposes a disturbing dynamic at the heart of the Ukraine conflict – an international Ponzi scheme that enables Western elites to seize hard-earned wealth from the hands of average U.S citizens and funnel it into the coffers of a foreign government that even Transparency International ranks as consistently one of the most corrupt in Europe.

The U.S. government has yet to conduct an official audit of its funding for Ukraine. The American public has no idea where their tax dollars are going. And that’s why this week we at the Grayzone published an independent audit of U.S. tax dollar allocations to Ukraine throughout the fiscal years 2022 and ’23.

Among other dubious payments they found were $4.5 million from the U.S. Social Security Administration to the Kiev government, and $4.5 billion from USAID to pay off Ukraine’s sovereign debt, “much of which is owned by the global investment firm BlackRock. That amounts to $30 taken from every U.S citizen at a time when 4 in 10 Americans cannot afford a $400 emergency.”

The Black Hole of the Pentagon Budget

The Pentagon failed its fifth budget audit in 2022 and was unable to account for more than half of its assets, or more than $3 trillion. According to a CBS News report, defense contractors overcharged the Defense Department by nearly 40-50%; and according to the Office of the Inspector General for the Defense Department, overcharging sometimes reached more than 4,000%. The $886 billion budget request for FY2024 is the highest ever sought.

Following repeated concerns about fraud, waste and abuse in the Pentagon, in June 2023 a bipartisan group of senators introduced legislation to ensure the Defense Department passes a clean audit next year. The Audit the Pentagon Act of 2023 would require the Defense Department to pass a full, independent audit in fiscal 2024. Any agency within the Pentagon failing to pass a clean audit would be forced to return 1% of its budget for deficit reduction.

Sen. Bernie Sanders (I-Vt.) observed that the Pentagon “and the military industrial complex have been plagued by a massive amount of waste, fraud, and financial mismanagement for decades.… [W]e have got to end the absurdity of the Pentagon being the only agency in the federal government that has never passed an independent audit.”

Sen. Chuck Grassley (R-Iowa) said the Pentagon “should have to meet the same annual auditing standards as every other agency…. From buying $14,000 toilet seats to losing track of warehouses full of spare parts, the Department of Defense has been plagued by wasteful spending for decades. … Every dollar the Pentagon squanders is a dollar not used to support service members, bolster national security or strengthen military readiness.”

But defense audits have been promised before and have not been completed. In 2017, Michigan State University Prof. Mark Skidmore, working with graduate students and with Catherine Austin Fitts, former assistant secretary of Housing and Urban Development, found $21 trillion in unauthorized spending in the departments of Defense and Housing and Urban Development for the years 1998-2015. As reported in MSUToday, Skidmore got involved when he heard Fitts refer to a report indicating the Army had $6.5 trillion in unsupported adjustments (or spending) in fiscal 2015. Since the Army’s budget was then only $122 billion, that meant unsupported adjustments were 54 times the spending authorized by Congress. Thinking Fitts must have made a mistake, Skidmore investigated and found that unsupported adjustments were indeed $6.5 trillion.

Four days after Skidmore discussed his team’s findings on a USAWatchdog podcast, the Department of Defense announced it would conduct its first-ever department-wide independent financial audit. But it evidently failed in that endeavor. As Bernie Sanders observes, the Pentagon has never passed an independent audit. It failed its fifth audit in 2022. Whether it will pass this sixth one, or whether the audit will lead to budget cuts, remains to be seen. The Pentagon budget seems to be untouchable.

Tackling the Other Elephant: The Interest Monster

If the sacrosanct military budget cannot be trimmed, what about that other massive budget item, interest on the federal debt? Promising proposals for clipping both the interest and the debt itself were made in conjunction with earlier debt ceiling crises. In November 2010, Dean Baker, co-director of the Center for Economic and Policy Research in Washington, wrote:

There is no reason that the Fed can’t just buy this debt (as it is largely doing) and hold it indefinitely. If the Fed holds the debt, there is no interest burden for future taxpayers. The Fed refunds its interest earnings to the Treasury every year. Last year the Fed refunded almost $80 billion in interest to the Treasury, nearly 40 percent of the country’s net interest burden. And the Fed has other tools to ensure that the expansion of the monetary base required to purchase the debt does not lead to inflation.

In 2011, Republican presidential candidate Ron Paul proposed dealing with the debt ceiling by simply voiding out the $1.7 trillion in federal securities then held by the Fed. As Stephen Gandel explained Paul’s solution in Time Magazine, the Treasury pays interest on the securities to the Fed, which returns 90% of these payments to the Treasury. Despite this shell game of payments, the $1.7 trillion in US bonds owned by the Fed is still counted toward the debt ceiling. Paul’s plan:

Get the Fed and the Treasury to rip up that debt. It’s fake debt anyway. And the Fed is legally allowed to return the debt to the Treasury to be destroyed.

Congressman Alan Grayson, a Democrat, also endorsed this proposal.

Taxing the Bubble Economy

In a July 8, 2023 article on Naked Capitalism titled “The United States’ Financial Quandary: ZIRP’s Only Exit Path Is a Crash,” economist Michael Hudson points to the speculative bubbles blown by the Fed’s Zero Interest Rate Policy, dating back to the Great Recession of 2008-09. The result is a Ponzi scheme, says Hudson, and there is no way out but to write down the debt or let the economy crash.

According to Fed insider Danielle DiMartino Booth, it is those speculative bubbles that Fed Chair Jerome Powell has attempted to pop with the drastic interest rate hikes of the last year, eliminating the “Fed Put,” the presumption that the Fed will always come to the rescue of the speculative market. That tack actually seems to be working; but the approach has resulted in serious collateral damage to mainstream businesses and the productive economic base. (See my earlier article here.)

Another way to trim the fat from the “financialized” economy is a small financial transactions tax. That solution was also discussed in an earlier article (here), drawing on a 2023 book titled A Tale of Two Economies: A New Financial Operating System for the American Economy by Wall Street veteran Scott Smith. He argues that we are taxing the wrong things – income and physical sales. We actually have two economies – the material economy in which goods and services are bought and sold, and the monetary economy involving the trading of financial assets (stocks, bonds, currencies, etc.) – basically “money making money” without producing new goods or services.

Drawing on data from the Bank for International Settlements and the Federal Reserve, Smith shows that the monetary economy is hundreds of times larger than the physical economy. The budget gap could be closed by imposing a tax of a mere 0.1% on financial transactions, while eliminating not just income taxes but every other tax we pay today. For a financial transactions tax (FTT) of 0.25%, we could fund benefits we cannot afford today that would stimulate growth in the real economy, including not just infrastructure and development but free college, a universal basic income, and free healthcare for all. Smith contends we could even pay off the national debt in ten years or less with a 0.25% FTT.

Funding Infrastructure through a National Infrastructure Bank

Another way to fund critical infrastructure without tapping the federal budget is through a 1930s-style work-around on the model of Roosevelt’s Reconstruction Finance Corporation. HR 4052, a proposal for a national infrastructure bank on that model, is currently before Congress and has widespread support. The proposed bank is designed to be a true depository bank, which can leverage its funds as all banks are allowed to do: with a 10% capital requirement, it can leverage $1 in capital into $10 in loans.

For capitalization, the bill proposes to follow the lead of Alexander Hamilton’s First U.S. Bank: shares in the bank will be swapped for existing U.S. bonds. The shares will earn a 2% dividend and are non-voting. Control of the bank and its operations will remain with the public, an independent board of directors, and a panel of carefully selected non-partisan experts, precluding manipulation for political ends.

America achieved its greatest-ever infrastructure campaign in the midst of the Great Depression. We can do that again today, and we can do it with the same machinery: off-budget financing through a government-owned national financial institution.

Granted, these proposals are not likely to be implemented until we are actually facing another Great Depression, or at least a Great Recession; but Michael Hudson and other pundits are predicting that outcome in the not-too-distant future. It is good to have some viable alternatives on the table for consideration when, as in the 1930s, politicians are compelled to seek them out.

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The Real Goal of Fed Policy: Breaking Inflation, the Middle Class or the Bubble Economy?

By Ellen Brown
December 7, 2022

“There is no sense that inflation is coming down,” said Federal Reserve Chairman Jerome Powell at a November 2 press conference, — this despite eight months of aggressive interest rate hikes and “quantitative tightening.” On November 30, the stock market rallied when he said smaller interest rate increases are likely ahead and could start in December. But rates will still be increased, not cut. “By any standard, inflation remains much too high,” Powell said. “We will stay the course until the job is done.”

The Fed is doubling down on what appears to be a failed policy, driving the economy to the brink of recession without bringing prices down appreciably. Inflation results from “too much money chasing too few goods,” and the Fed has control over only the money – the “demand” side of the equation. Energy and food are the key inflation drivers, and they are on the supply side. As noted by Bloomberg columnist Ramesh Ponnuru  in the Washington Post in March:

Fixing supply chains is of course beyond any central bank’s power. What the Fed can do is reduce spending levels, which would in turn exert downward pressure on prices. But this would be a mistaken response to shortages. It would answer a scarcity of goods by bringing about a scarcity of money. The effect would be to compound the hit to living standards that supply shocks already caused.

So why is the Fed forging ahead? Some pundits think Chairman Powell has something else up his sleeve.

The Problem with “Demand Destruction”

First, a closer look at the problem. Shrinking demand by reducing the money supply – the money available for people to spend – is considered the Fed’s only tool for fighting inflation. The theory behind raising interest rates is that it will reduce the willingness and ability of people and businesses to borrow. The result will be to shrink the money supply, most of which is created by banks when they make loans. The problem is that shrinking demand means shrinking the economy – laying off workers, cutting productivity, and creating new shortages – driving the economy into recession.

Demand has indeed been shrinking, as evidenced in a November 27 article on ZeroHedge titled: “The Consumer Economy Has Completely Collapsed – ‘It’s A Ghost Town’ for Holiday Shopping Everywhere.” But retailers have cut their prices about as far as they can go. While the rate of increase in producer costs is slowing, those costs are still rising; and retailers have to cover their costs to stay in business, whether or not they have customers at their doors. Rather than lowering their prices further, they will be laying off workers or closing up shop. Layoffs are on the rise, and data reported on December 1 showed that U.S. factory activity is contracting for the first time since the lockdowns of the Covid-​19 pandemic.

It is not just activity in shopping malls and factories that has taken a hit. The housing market has fallen sharply, with pending home sales dropping 32% year-over-year in October. The stock market is also sinking, and the cryptocurrency market has fallen off a cliff. Worse, interest on the federal debt is shooting up. For years, the government has been able to borrow nearly for free. By 2025 or 2026, according to Moody’s Analytics, interest payments could exceed the country’s entire defense budget, which hit $767 billion in fiscal 2022. That means major cuts will be needed to some federal programs.

Breaking the “Fed Put”

In the face of all this economic strife, why is the Fed not reversing its aggressive interest rate hikes, as investors have come to expect? Former British diplomat and EU foreign policy advisor Alastair Crooke suggests that the Fed’s goal is something else:

The Fed … may be attempting to implement a contrarian, controlled demolition of the U.S. bubble-economy through interest rate increases. The rate rises will not slay the inflation “dragon” (they would need to be much higher to do that). The purpose is to break a generalized “dependency habit” on free money.

Danielle DiMartino Booth, former advisor to Dallas Federal Reserve President Richard Fisher, agrees. She stated in an interview with financial journalist and podcaster Julia LaRoche:

Maybe Jay Powell is trying to kill the “Fed put.” Maybe he’s trying to break the back of speculation once and for all, so that it’s the Fed – truly an independent apolitical entity – that is making monetary policy, and not speculators making monetary policy for the Fed.

The “Fed put” is the general idea that the Federal Reserve is willing and able to adjust monetary policy in a way that is bullish for the stock market. As explained in a Fortune Magazine article titled “The Stock Market Is Freaking Out Because of the End of Free Money – It All Has to Do with Something Called ‘The Fed Put:’”

For decades, the way the Fed enacted policy was like a put option contract, stepping in to prevent disaster when markets experienced serious turbulence by cutting interest rates and “printing money” through QE [quantitative easing] .

… Since the beginning of the pandemic, the Fed had supported markets with ultra-​accommodative monetary policy in the form of near-​zero interest rates and quantitative easing (QE). Stocks thrived under these loose monetary policies. As long as the central bank was injecting liquidity into the economy as an emergency lending measure, the safety net was laid out for investors chasing all kinds of risk assets.

… The idea that the Fed will come to stocks’ aid in a downturn began under Fed Chair Alan Greenspan. What is now the “Fed put” was once the “Greenspan put,” a term coined after the 1987 stock market crash, when Greenspan lowered interest rates to help companies recover, setting a precedent that the Fed would step in during uncertain times.

But the “free money” era seems to be over:

The regime change has left markets effectively on their own and led risk assets, including stocks and cryptocurrencies, to crater as investors grapple with the new norm. It’s also left many wondering whether the era of the so-​called Fed put is over.

Killing the Parasite That Is Killing the Host

The Fed put favors the rich – investors in the stock market, the speculative real estate market, the multi-trillion dollar derivatives market. It favors what economist Michael Hudson calls the “financialized” or “rentier” economy – “money making money,” formerly called “unearned income” – which drives up prices without adding productive value to the “real” economy. Hudson calls it a parasite, which is sucking out profits that should be going toward building more factories and other economic development.

By backstopping the financialized economy, the Fed has been instrumental in widening the income gap of the last two decades, pushing housing prices to heights that are unaffordable for first-time home buyers, driving up rents and educational costs, and crushing entrepreneurs. DiMartino Booth explains:

Fed policy feeds passive investing … because you don’t have to carefully allocate your resources. You simply have to be long [in] the NASDAQ and sit there with your money. What does that feed? It feeds the monopolization of America. The largest companies, the companies such as Google and Microsoft … if there is a competitor in their world they simply absorb them. They acquire them, which quashes … the entrepreneurial spirit that made this country so great.… If the Fed succeeds, Main Street will be the main winner.

… [T]he trick here is for the Fed to not break anything big, and that’s the delicate balancing act, … if … they can slowly, methodically take the rot out of the system without breaking anything big that forces them to pull back.

The “rot” in the system is particularly evident in the housing market:

Since the financial crisis, there’s been a lot of private equity that’s entered the space and snapped up all these homes and they’re renting them … It’s definitely exacerbated this housing cycle. It’s added an element of speculation because so many of them are all cash buyers. Don’t get me wrong, they’re levered — it is borrowed money — but they’re coming in as all cash buyers, and that I think created a lot of these massive bidding wars …

DiMartino Booth discusses the risk of derivatives contagion using the example of AIG, a giant insurance company brought down by derivatives exposure in 2008:

During the financial crisis … we rescued AIG because we didn’t want to actually see what it looked like on the other side of that cliff had derivatives actually been unwound, and what that contagion might have looked like.… We never tested the derivatives market, so that risk continues to lurk out there…. I’m not a cheerleader for there being some kind of a systemic risk event, and I do hope again that the Fed succeeds in managing this unwind, in seeing risk pulled out of the system, but one company at a time, not something that makes the global financial system implode.

Financial blogger Tom Luongo takes this argument further. He maintains that Fed Chair Powell is out to break the offshore eurodollar market – the speculative, unregulated offshore money market where the World Economic Forum and “old European money” (including mega-funds Blackrock and Vanguard) get the cheap credit funding their massive spending power. That is a complicated subject, which will have to wait for another article; but the principle is the same. Without the backstop of the Fed’s virtually free dollars to satisfy a surge in demand for them, these highly-leveraged dollar investments will collapse. (“Leverage” is an investment strategy that uses borrowed capital to increase potential returns. The risk is that if the investment sours, losses are also increased.)

Pushing “Until Something Breaks”

Whether or not popping these raging speculative bubbles is the goal, the Fed’s interest rate hikes are having that effect. According to a November 25, 2022 article on CNBC.com, “Interest rate hikes have choked off access to easy capital ….” As a result, “Investors have lost roughly $7.4 trillion, based on the 12-month drop in the Nasdaq.”

House prices are also tumbling. The third quarter of 2022 saw the biggest home equity drop ($1.3 trillion) ever recorded. Fortune Magazine quotes Moody’s Analystics: “Before prices began to decline, we were overvalued [nationally] by around 25%. Now, this means prices will normalize. Affordability will be restored.”

In 2021, 25% of all real estate purchases were being made by institutional investors. In the third quarter of 2022, investor buying of homes tumbled 30%. Blackstone, a real estate income trust notorious for buying up homes and turning them into rentals, was reported on December 2 to be limiting withdrawals from its $125 billion property fund as investors rush for the exits. George Cipolloni, portfolio manager at Penn Mutual Asset Management, said the U.S. Federal Reserve’s sharp interest rate increases have not “worked all the way through the economy yet,” and that he expects to see “more Blackstone-type news events coming forward in the next year.”

n May 2022, BlackRock stock (BLK) was down 30% for the year. And by November, the cryptocurrency market cap had plummeted from $3 trillion to $900 billion, with Bitcoin, its largest component, down 77% year-over-year.

Currently featured in the news is the crypto exchange FTX and its 30-year-old billionaire owner Sam Bankman-Fried. FTX was exposed as a Ponzi scheme by the receding tide of dollar liquidity, catching Bankman-Fried and team “swimming naked when the tide went out.” According to Swiss bank UBS’ chief of investment, “FTX’s collapse shows Federal Reserve tightening is crushing speculative assets.” Outing FTX is thought to be only the beginning of a succession of exposures of financial frauds to come.

The Delicate Balancing Act

Looked at in that light, breaking the Fed put sounds like a good idea. But can it be done without breaking the whole economy? More reputable establishments than FTX are at risk. Rate hikes seriously impact local retailers and wholesalers. In September, risky leveraged bets brought UK pension funds near to collapse, forcing the Bank of England to reverse course and lower its interest rates. And there is the stress in the U.S. Treasury, which is dealing with an enormous interest tab on its debt.

Other disturbing outcomes are being envisioned. One podcaster posits that the economy is intentionally being driven to collapse, at which point the government will declare a “bank holiday” as Pres. Roosevelt did in 1933. When the banks reopen, he says, we will have a “currency reset” in the form of a central bank digital currency (CBDC). The concern is that it will be a “programmable” currency, one that can be regulated or turned off altogether based on the user’s “social credit” score, as is already happening in China.

Alarmed observers note that the New York Fed recently embarked on a pilot project for a CBDC (Central Bank Digital Currency). But defenders point out that it is a “wholesale” CBDC, used just for transfers between banks, particularly overseas transfers. Settlement times of foreign exchange transactions typically take two days. Project Cedar, the New York Innovation Center’s pilot project, found that settlement for foreign exchange transactions using distributed ledger technology can happen in 10 seconds or less, significantly reducing risks. Whether that technology will be developed and used by the Fed has not yet been determined. DiMartino Booth observes that Powell and other Fed officials have frequently questioned the need for a “retail” CBDC, in which Fed accounts would be opened directly with the public. In a Substack article titled “A Grand Unified Theory of the FTX Disaster,” author and educator Matthew Crawford lays out a darker possibility – that the end goal of the powerful network of players behind the FTX scheme is not just a U.S. CBDC but a “Global Digital Central Bank” run by international power brokers. Whether or not the Federal Reserve intended it, aggressive interest rate hikes could expose this sort of parasitic corruption and remove the money machine that is its power source.

Rising from the Ashes

Meanwhile, the supply-side issues inflating the prices of food, energy and other key resources need to be addressed. Those are matters for federal and state legislatures, not the Fed. In the 1930s, a federal financial institution called the Reconstruction Finance Corporation pulled the economy out of the Great Depression, put people back to work, and crisscrossed the country with new infrastructure, including the dams and power lines that brought electricity to rural America. (See my earlier article here.) The government acted quickly and decisively because times were desperate.

A bill for a National Infrastructure Bank modeled on the Reconstruction Finance Corporation is now before Congress, H.R. 3339. For a local government bank, a viable model is the publicly-owned Bank of North Dakota, which pulled that state out of a regional agricultural depression in the 1920s. (See here.) As an iconic Depression-era poster declared, “We can do it!” We just need to roll up our sleeves and get to work.

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First Published on Scheerpost.

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