Wall Street Money Machine

On November 27, Bloomberg News reported the results of its successful case to force the Fed to reveal the lending details of its 2008-09 bank bailout. In 29,000 pages of documents, the Fed revealed that by March 2009, it had committed $7.77 trillion in below-market loans and guarantees to rescuing the financial system; and that these nearly interest-free loans came without strings attached. The Fed insisted that the loans were repaid and there have been no losses, but the banks reaped a $13 billion windfall in profits; and “details suggest taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger.”

The revelations provoked shock and outrage among commentators. But the Fed was doing only what banks and the money market do for each other under normal conditions every day: making “liquidity” available at very low interest rates. In 2008, bank liquidity dried up after Lehman Brothers collapsed, and the banks could not get the cheap, ready credit on which their lending scheme depends; so the Fed therefore stepped in as “lender of last resort.”

The Banking Shell Game

When banks make loans, they extend credit FIRST, then rely on cheap loans of reserves from each other to clear their checks. Central banks engage in a similar scheme at an international level. Chris Martenson compares this sleight of hand to check kiting, defined in Barron’s Business Dictionary as:

[An] illegal scheme that establishes a false line of credit by the exchange of worthless checks between two banks. For instance, a check kiter might have empty checking accounts at two different banks, A and B. The kiter writes a check for $50,000 on the bank A account and deposits it in the bank B account. If the kiter has good credit at bank B, he will be able to draw funds against the deposited check before it clears, that is, is forwarded to bank A for payment and paid by bank A. Since the clearing process usually takes a few days, the kiter can use the $50,000 for a few days and then deposit it in the bank A account before the $50,000 check drawn on that account clears.

The international game is explained by Martenson like this:

. . . Central Bank A prints up a bunch of money and buys the debt of Country B. Then the central bank of Country B prints up a bunch of money and buys the debt of Country A.

Both enjoy the appearance of strong demand for their debt, both governments get money to use, and nobody is the wiser. Except that the world's total stock of central bank reserves keep on growing and growing and growing, . . . which will someday result in thoroughly unserviceable amounts of debt, an unmanageable flood of money, or both.

If this strikes you as a scam, congratulations; you get it.

Commercial banks engage in a similar shell game. Loans aren’t created from deposits, as most people think. Loans CREATE deposits. Bank A creates money in the form of “bank credit” in the account of its borrower, who then writes a check that is deposited in Bank B. The loan thus creates a deposit in a second bank. The check has to clear through Bank A’s reserve account at the Federal Reserve; but if Bank A doesn’t have the reserves, it can borrow them from another bank at the Fed Funds rate (the interbank lending rate). And another bank WILL have excess reserves in the required sum, because the reserves debited from Bank A just got credited to the reserve account of Bank B. So Bank A creates money in the form of “bank credit,” lends it at 5% or more to its customer, borrows that sum back at the Fed Funds rate of 0.25%, and pockets the difference. If the system as a whole is short of reserves, the banks that are short borrow directly from the discount window at the Fed, which creates the reserves on its books.

Setting Things Right

Only the Fed and the banking system have the power to create credit with accounting entries; but the fact that banks create credit on their books is not actually what is wrong with the system. The economy needs an expandable credit system and suffers recessions without it; and an expandable credit system needs a lender of last resort. What is wrong with the current scheme is that the profits are siphoned off to the 1% at the expense of the 99%. To fix the system, the profits need to be returned to the 99%.

How that could be done was suggested by Thom Hartmann in a recent editorial:

Have the central bank owned by the US government and run by the Treasury Department, so all the profits . . . go directly into the Treasury and you and I pay less in taxes . . . .

For a model, he pointed to the Bank of North Dakota:

The good people of North Dakota . . . established something very much like this—the Bank of North Dakota—and it's kept the state in the black, and kept its farmers, manufacturers and students protected from the predations of New York banksters for nearly a century. It's time for every state to charter their own state bank, just like North Dakota did, and for the Treasury Department to either buy the Fed from the for-profit banks that own it, or simply nationalize it.

We have been distracted here and in Europe by a sudden panic over our “sovereign debt” crises, when the real crisis is that our debt is NOT sovereign. We are indentured to a Wall Street money machine that creates our money and lends it back to us at interest, money our sovereign government could be creating itself, with full democratic oversight and accountability to the people.

We have forgotten our roots, when the American colonists thrived on a system of money created by the people themselves, debt-free and interest-free. The continued dominance of the Wall Street money machine depends on that collective amnesia. The fact that this memory is surfacing again may be the machine’s greatest threat—and our greatest hope as a nation.