The banker view
No doubt nearly all bankers want the broad foundations of the existing banking system to be maintained. That system is their bread and butter and it has served them well.
All resources that are no longer unappropriated are owned by some person or persons, where ownership means having exclusive control. Who owns the central bank of the United States, which is the Federal Reserve or the Fed? Its stockholders are member banks. The most powerful of the 12 Federal Reserve banks is the New York Fed. Its ownership is concentrated among a few large banks such as Citibank and JP Morgan Chase.
The Fed’s incorporation or very existence is a form of capital to it, and that’s due to its being a creature of Congress. However, Congress makes no appropriations for it and lacks effective day-to-day control. The Fed’s actions are largely independent of Congressional direction.
The Fed is like a large publically-held corporation in which the effective control is actually in the hands of a very few people, like a CEO who sits before a passive board of directors.
The people who run the Fed or heavily influence those who run it are the owners. They include the Federal Reserve Board and the New York Fed, which the large New York banks influence. They include the Secretary of the Treasury. They include Timothy F. Geithner, who is the President and CEO of the Federal Reserve Bank of New York. It was he who is said to have devised and brought about the financing of JP Morgan Chase with regard to the bailout of the failing investment bank Bear Stearns and Company. They include the major banks and dealers who have lined up to exchange hundreds of billions of dollars of questionable collateral for the loan of U.S. Treasury securities that the Fed once held.
The leading bankers who own and operate the central bank not only want the system maintained, they want to increase its hold on the rest of the financial system — the remaining capital markets and their institutions. They want the Federal Reserve System (the Fed) to gain new powers. The subprime crisis is the catalyst for this augmentation in Fed power.
JP Morgan Chase is a key player at the apex of the banking system. Two of its analysts have made it crystal clear that greater Fed regulation lies ahead. What they say is so important that I quote the Reuters article at length:
"This looks like a recession caused by financial markets, which clearly policy makers are not going to take kindly to … There will be a lot of follow-up," Loeys said.
“This was a run on the securitized world. The bank regulation and the structure of the supervisory system was created for a banking world of taking deposits and making loans. That world has moved towards capital markets, which were regulated from the point of view of consumer protection, but not from a systemic stability point of view,” he said.
“Banks did not have the tools to try to protect the capital market from its own excesses.” As a result, central banks will be forced to take on more power as they are the entities extending support to the markets, Loeys said.
“Central banks’ extension of liquidity to broker-dealers and (the) securitized world is permanent, and will be followed by regulatory control,” the analysts wrote.
Notice the heavily bank-oriented (and slanted) world-view in these statements. To paraphrase them, the financial markets caused the recession, not the Fed, and not the banking system. The capital markets, although regulated for consumer protection, are not regulated enough. They are subject to excesses. They threaten the banking system’s stability, so they need to be controlled. The banks cannot do this, so the Fed must. The Fed is the good guy. It’s supporting the system now, and control of brokers and other financial intermediaries doing securitization must follow. Control follows support. The banks, including the central bank, have clean hands. They were passive players in this disaster. The capital markets were the bad guys. The good guys will now have greater power over the bad guys. The good guys will save the system.
The non-banker view
Well, maybe the banking system will be saved so that it may continue to profit bankers for another cycle or two. After all, there is a lot of ruin in a country, and the bankers can do a lot more damage to us. But if several hundred years of bank-induced panics in this nation alone (not to mention those around the world), at a time when our capital markets were in knee pants, do not show us where the problem is, we are either bankers or we are taking something.
Our current banking system has, from the viewpoint of the general public, three main ills. The first of these is that it produces economic instability, that is, a boom-bust cycle or expansion and recession (or depression). The second, which is related to the first, is that it produces a continuing loss in purchasing power of the dollar. Third is that the banking system provides support to ill-conceived and destructive spending policies of the State. These three ills retard a normal course of economic expansion and impoverish many persons in our country in a most unjust way.
Four separate elements are responsible for these failings of the banking system. One is that banks promise that demand deposits will be paid out on demand, but they cannot possibly meet this requirement for all depositors because they lend out the deposits. Furthermore, their lending results in a multiplied total of further deposits and further loans. Second is that the money used in these deposits is fiat money, that is, money declared to be money that has no sound backing or perceived intrinsic worth. Third is that the money in the banking system has been made legal tender by State law. This means that it must be accepted as a payment medium. Fourth is that deposits are insured by a State agency, the Federal Deposit Insurance Corporation.
We could reform the banking system and eliminate its major ills if we rid ourselves of these four elements. We could make demand deposits really be ready and available on demand. We could shift from fiat money to monies that users found acceptable because of their worth or backing. We could rescind the legal tender laws, and we could terminate the FDIC.
Many other regulations could also be thoroughly and completely eliminated while retaining, clarifying, and strengthening laws against various criminal and tortious behaviors. The current apparatus known as the Federal Reserve System could be ended, for example.
We have had one or more of these elements of the existing banking system in place almost from the start of the republic. They are the foundations of the banking system. Our banking system serves the interests of the bankers and politicians very well. That is why we see this system in place today with the form it has despite the ills it produces, for these ills only damage the interests of the general public and the general public does not control the banking system. That is why the bankers will patch up the system if they can. That is why the Fed may end up with even greater power.
Regulation and appearances
It is an interesting fact that the banking system is heavily regulated. This regulation provides the appearance that the banks are under public control. We observe that these regulations are changed from time to time as various banking crises occur. They are changing again now because of the subprime crisis and they will change more in the months ahead. Appearances will again be maintained. The appearance will be given that the politicians or regulators are bringing the bankers to heel.
We will hear about reform; we have heard that refrain before. And reform there will be, but it will not correct the system. It will be reform of certain aspects of the system while leaving that system in place; and those reforms will be designed to prolong and enlarge the privileged position of the bankers. Remedies will be applied whose aim is to resuscitate the banks so that they can continue to profit while inflicting untold harm. The fact is that the system cannot be reformed by any piecemeal regulation or deregulation, because the regulators are part of the system and help keep it alive. The system relies upon the four elements noted above, and until those are eliminated, the existing system will remain in place.
Maintaining the bank cartel
Bank regulation is actually in the interests of the banks, not the public. The banks are running an operation in which they print fiat money and lend it out. Their goal is to run that system as long as possible so as to make as much profit as possible for themselves. The goal of regulation is the survival of this arrangement and the sustenance of the banks’ ability to print fiat money and lend it out at interest indefinitely.
If crises occur, the bankers may undergo regulations of various sorts. These act to control the individual banks so that they do not bring down the system. If, for example, the banks were to print money without restraint, the system would quickly grind to a halt as hyperinflation proceeded. Collectively, the banks must have a means to prevent excessive note issue in order to continue their note issuance. Regulation and central banking achieve that purpose. There is an optimal rate of inflation so as to hold up bank profits while ensuring the survival of various interests including the government itself.
The State participates in the cartelization and prolongation of the fiat money bank system. In return, bankers contribute heavily to politicians at all levels of government. The kinds of regulations that occur, such as deposit insurance, are designed to prop up the system.
The bank cartel has its problems, as all cartels do. The Basel Accords take country cartels to an international level in order to prevent the banking system of any one country from gaining a competitive edge.
Bank regulation typically controls the risk levels of the assets that banks hold. If asset risk is not controlled from without, the individual banks have a tendency to ramp up their risk-taking, especially when their deposits are insured. This endangers the entire system. Lax regulation in the last few years accompanied higher leverage of banks, risky off-balance sheet entities, loans to hedge funds, investment in risky subprime loans, etc.
Unless the cartel is enforced through regulation of the individual banks, banks have a tendency to make an excessive amount of bad loans. The end result is systemwide destruction. In terms of insolvency of the banking system, this has already occurred. Each day a new bank makes headlines by an announcement that it is raising billions of dollars of new capital.
The Fed’s current rescue operation is buying time so that banks can obtain more capital and liquidate bad loans or ship them off to the Fed in return for Treasury bills. But its measures are designed not only to save the banking cartel but to bring investment bankers and broker-dealers under its control. Congress looks ready to cooperate in that endeavor by strengthening not only the Fed but also the SEC.
The best solution to the financial problems brought about by the Fed’s past bubblenomics is analogous to a "big bath": write the old system off and start up a new one with sound fundamentals. That means eliminating legal tender laws, doing away with monopoly government fiat money, and making institutions that claim to be depositories for money actually hold that money.
Instead, the U.S. is following its tried and false strategy of bandaging up the banking system at great cost to non-bankers. If the system survives, there is likely to be a prolonged period of economic underperformance but the Fed will be rewarded for its past bad behavior.
Amazingly enough, the Fed, whose behavior brought about this crisis, looks to be the big winner. Maybe they did not plan this result, but they certainly knew that they were in the driver’s seat.
Central banking must be destroyed before it totally destroys us.
Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York.