Sovereign Debt, Sovereign Bank Runs
by Gary North: My
Proposed 9-11 Research Project
"sovereign debt" has become popular. I used Google to search for
debt" and got over six million hits. Yet I cannot recall hearing
the phrase as recently as 2007. If I ever did hear it, I did not
pay attention to it. It was called "government debt" back then.
"sovereign" refers to legal sovereignty, a characteristic of civil
governments. It is applied to national governments. What does it
mean? It means that a private citizen or a lower civil government
cannot sue a government agency in a national court without the consent
of that court, because the national level of civil government contains
the nation's supreme court. The nation answers to no higher sovereignty.
The call for
the establishment of a world government is a call to establish a
higher sovereignty: a supreme court that determines who may or may
not bring a lawsuit in its jurisdiction.
In the seventeenth
century, the phrase "divine right of kings" referred to the king
as immune to lawsuits. The theory insisted that there was no court
which could lawfully impose sanctions on the king, other than God's
court. As an agent of God, the theory asserted, the king was supreme
in matters political.
Then came the
beheading of Charles I by Parliament in 1649. The theory of the
judicial immunity of the king was no longer taken seriously by kings.
While it took over a century to sort out the judicial issues, Parliament
appropriated the divine right doctrine, although increasingly the
term "divine right" faded. Residents of the British empire might
or might not believe in God, but they were supposed to believe in
Then came the
American Revolution. That ended Parliamentary sovereignty in North
America. The colonials established a higher court.
is a legally recognized option, lack of citizens' faith in a nation's
sovereignty faith in the right of revolution is allowed
only in theory. To deny in public that the national government is
beyond the sanctions imposed by a higher institutional authority
is heresy. When exercised in wartime, it is treason.
IS AS SOVEREIGNTY DOES"
This is the
gospel according to Sally Field, who played Forrest Gump's mother.
She applied the principle to stupidity, but it is an all-purpose
are always under the authority of economic law. They cannot impose
their will irrespective of what investors think. That insight was
Bill Clinton's moment of truth as President.
In early 1993,
Clinton presented to his advisers his plans for reforming the economy.
Robert "Goldman Sachs" Rubin, his future Secretary of the Treasury,
of spending on education, public works and a middle-class tax
cut fell by the wayside as advisers led by Robert Rubin, who later
became Treasury secretary, convinced the new president the best
thing he could do for the economy was to show investors his resolve
on fiscal discipline.
to tell me that the success of the economic program and my re-election
hinges on the Federal Reserve and a bunch of risk-averse bond
He did not
actually say "risk-averse." His adjective was closer to what he
later insisted that he had not done with that woman, Miss Lewinsky.
But it was clear from what he was able to accomplish over the next
eight years that he was more constrained by the bond traders than
he was by Newt Gingrich and the Republican House. The only thing
that most people remember about his Administration is Miss Lewinsky
and Mrs. Clinton's reaction to Miss Lewinsky. When you think about
it, the main thing he did economically was to run budget surpluses
in his second term, something that no President had achieved since
Nixon in 1969. Bond traders rejoiced.
can attempt to change the economy, but he cannot do so at zero price.
That is the effect of scarcity. At zero price, there is greater
demand than supply.
right of kings ended unofficially on a scaffold in 1649. The divine
right of Parliament ended unofficially in 1694, when it granted
to a privately funded bank a sovereign monopoly over the control
of money and commercial banking in the British Isles. The Bank of
England still operates as a check on Parliament, or, more accurately,
a cheque. Under the Labor government in 1946, Parliament nationalized
the Bank. That lasted half a century. Labor taketh, and Labor giveth
back . . . with interest. This
is from the Bank of England's site.
in 1694, nationalised in 1946 and gaining operational independence
in 1997, the Bank of England stands at the centre of the UK's financial
system as the central bank of the United Kingdom. The Bank continues
to be committed to promoting the public good by maintaining a stable
and efficient monetary and financial framework as its contribution
to a healthy economy. The Bank is committed to increasing awareness
and understanding of its activities and responsibilities, across
both general and specialist audiences alike. Our Publication Scheme
builds upon that open and transparent foundation to provide a comprehensive
list of information classes accessible to members of the public.
yes! Or as Dudley Moore put it in a Cook-Moore routine in the 1960s,
"Stuff this for a laugh."
is as sovereignty does.
This is not
to say that central banking and governments are independent of each
other. In the United States, the nearly invisible Exchange Stabilization
Fund of the Treasury Department works closely with the Federal Reserve
Bank of New York, which is a private entity. Eric
deCarbonnel has done yeoman service in exposing this connection.
The government needs easy money when it runs massive deficits,
and the large commercial banks need a source of emergency loans
when bank runs threaten. This is what the Federal Reserve System
FED's $1.2 trillion in secret loans to major U.S. banks in late
2008 are indicative of how the system works behind the scenes. The
FED's behind-the-scenes activities were far more concealed in 2008
than today, for which we may thank Ron Paul.
When we think
of bank runs, we have a mental image of a long line of people in
front of a bank in the early 1930s. Or we have a mental image of
the scene in "It's a Wonderful Life," where depositors want their
money, and Jimmy Stewart hands out we never quite got this
$33,000 in honeymoon money to calm them. Yes, $33,000, which
was what $2,000 was worth in 1932. Check the inflation
calculator of the Bureau of Labor Statistics. (There was something
endearing about Frank Capra's movies, but it wasn't his economics.)
In 1934, the
government created the Federal Deposit Insurance Corporation (FDIC)
and an equivalent agency for the savings & loan industry, which
lent mortgage money. The depositors received government-subsidized
insurance for their accounts, up to a limit that covered most depositors.
After that, there were no further long lines of depositors trying
to get their money out. So, we live in a mental world created by
textbooks. The economic theme of the textbooks is universal: the
New Deal saved American capitalism from itself. Most modern capitalists
In fact, the
FDIC and FSLIC merely shifted bank runs from the front door to the
back door. The large deposits are far above the insurance limit
set by the U.S. government. The official limit was raised by the
government from $100,000 to $250,000 during
the crisis week of October 3, 2008. This temporary measure was
made permanent in July 2010.
The big money
for large banks is not gained from depositors who walk in the door.
It is gained from pools of investment money that are not covered
by any form of insurance. This is short-term money, usually tied
up for no more than a few days. This is the heart of bank profits.
The banks are borrowed short days, not months and
lent long: years, not months. These are profitable arrangements
because, except at the start of traditional recessions, long-term
rates are above short-term rates: a positive yield curve. "Borrow
low-lend high" is the law and the prophets for fractional reserve
banks RIP in August 2008 did not have to deal with
the general public. They did not offer accounts to little people.
They made lots of money in the far less regulated capital markets
for very rich people.
But in March
2008, Bear Stearns tottered at the edge of bankruptcy. A rumor spread
that it could not roll over its debts. The rumor became reality
within three days. This was a self-fulfilling prophecy. Wikipedia
March 2008, the Federal Reserve Bank of New York provided an emergency
loan to try to avert a sudden collapse of the company. The company
could not be saved, however, and was sold to JP Morgan Chase for
$10 per share, a price far below the 52-week high of $133.20 per
share, traded before the crisis, although not as low as the two
dollars per share originally agreed upon by Bear Stearns and JP
The bank had
existed since 1923. It was highly respected, Wikipedia says:
2005-2007, Bear Stearns was recognized as the "Most Admired" securities
firm in Fortune's "America's Most Admired Companies" survey, and
second overall in the security firm section. The annual survey is
a prestigious ranking of employee talent, quality of risk management
and business innovation. This was the second time in three years
that Bear Stearns had achieved this "top" distinction.
In other words,
the financial community didn't have a clue as to how vulnerable
the company was. The experts were idiots. They were convinced that
to be borrowed short and lent long is smart business. That is to
say, they rejected Austrian School economics in general and Ludwig
von Mises' Theory
of Money and Credit (1912) in particular.
week of July 16, 2007, Bear Stearns disclosed that the two subprime
hedge funds had lost nearly all of their value amid a rapid decline
in the market for subprime mortgages." Lawsuits by investors began.
Still, the financial world shrugged its shoulders. "No problem."
But what of
the Securities and Exchange Commission, which regulated the investment
banks. It was blind right to the end?
March 20, Securities and Exchange Commission Chairman Christopher
Cox said the collapse of Bear Stearns was due to a lack of confidence,
not a lack of capital. Cox noted that Bear Stearns's problems escalated
when rumors spread about its liquidity crisis which in turn eroded
investor confidence in the firm. "Notwithstanding that Bear Stearns
continued to have high quality collateral to provide as security
for borrowings, market counterparties became less willing to enter
into collateralized funding arrangements with Bear Stearns," said
Cox. Bear Stearns' liquidity pool started at $18.1 billion on March
10 and then plummeted to $2 billion on March 13. Ultimately market
rumors about Bear Stearns' difficulties became self-fulfilling,
This was indeed
the heart of the matter: a lack of confidence. When you are running
a confidence game which is what "borrowed short and lent
long" is inherently you always face the threat of a crisis
of confidence by your lenders.
lack of capital? Ha! The essence of capital for all fractional reserve
banking is lenders' confidence. Lose it, and the end is nigh.
short-term debt matures in days and must be re-financed when it
matures. If there is no one ready to buy the next round of debt,
the bank is busted. This does not take weeks. It takes days.
The bank runs
that we have in our mind rest on an image of depositors asking for
currency. That image is wrong, and has been wrong since 1934. The
correct image is that of a man in a suit looking at a computer screen.
He sees that the deadline for repayment of a loan with many zeroes
is due today. He contacts the bank to which his firm has made the
loan. "Please transfer our money to our bank."
Nothing else. No lining up. No presenting of a savings passbook.
No exchange of pieces of paper. Just a notification by email that
the loan will not be rolled over, so please send a bank wire of
the funds. It's all very clean. It's all very fast. It takes one
working day to complete the transaction. The words, "your check
is in the mail," is not applicable.
mid-September, Lehman Brothers, another investment banking firm,
went through the same experience. In this case, however, the U.S.
government and the New York Federal Reserve Bank refused to assist
the firm. Henry "Goldman Sachs" Paulson, the Secretary of the Treasury,
was seized by a fit of debt ceiling fever. He was the man who had
nationalized Fannie Mae and Freddie Mac on September 7. Over
the weekend of September 13, no one came to the rescue of Lehman
Brothers. On September 15, it filed for bankruptcy. It was the largest
bankruptcy in U.S. history.
That sent a
message to the other investment bankers. We read in the Wiki entry
for Morgan Stanley,
Stanley and Goldman Sachs, the last two major investment banks in
the US, both announced on September 22, 2008 that they would become
traditional bank holding companies regulated by the Federal Reserve.
The Federal Reserve's approval of their bid to become banks ended
the ascendancy of securities firms, 75 years after Congress separated
them from deposit-taking lenders, and capped weeks of chaos that
sent Lehman Brothers Holdings Inc. into bankruptcy and led to the
rushed sale of Merrill Lynch & Co. to Bank of America Corp.
Can you imagine
the lawyers? They had to complete the restructuring of these banks
in one week. They did it. And then, lo and behold, the
FED tossed the lifelines: $107 billion for Morgan Stanley, $69
billion for Goldman Sachs. All of this was done in complete secrecy.
Nothing about it appeared on the FED's balance sheets.
IT'S GOVERNMENTS' TURN
is now paying 43% per annum on 2-year bonds. This is very close
to the end of the road. This is a loan shark interest rate, but
it is not the Mafia that is acting as the lender of last resort.
It is Europe's most sophisticated investors. It is also the European
Central Bank. The
London Telegraph reports:
Monetary Fund's partner in the recent international bail-out missions
is itself in danger of becoming a liability, Open Europe has argued.
a report published on Monday entitled "A House Built on Sand?",
Open Europe has calculated that the ECB has a total exposure of
about €444bn (£397bn) to "struggling eurozone economies".
is now "23 to 24 times levered" as a result of bailing out Greece,
Ireland, Portugal and Spain.
think tank argued: "Should the ECB see its assets fall by just
4.23pc in value . . . its entire capital base would be wiped out."
are desperately trying to conceal the thinness of the ice they are
skating on. Legally, they are skating on behalf of the voters. Operationally,
they are skating on behalf of the largest commercial banks. Their
sovereign status makes them immune to lawsuits. But the market is
imposing sanctions: 43% interest.
avoided this, because he took Robert Rubin's advice. The bond traders
did not get him.
They are going
to get Greece. They are going to get Portugal, Spain, and Italy.
Who will bail
out the banks? How much money will it take?
You might imagine
that very smart experts would have seen this coming. They did not,
any more than they saw the Bear Stearns/Lehman Brothers crisis coming.
The best and the brightest respect each other. They see their peers
borrowing short and lending long, and they conclude that their peers
are the smartest guys in the room.
These are people
who thought Bernie Madoff was an investment genius. They thought
the same of Bernie Cornfeld a generation earlier.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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