July 31, 2012

The Fed On Gold Price Manipulation

Lately various media outlets have been swamped with stories and allegations of precious metal manipulation ranging from the arcane, to the bizarre to the outright ridiculous. At issue is not that these claims of price fraud are unfounded - they very well may be completely true - but without a notarized facsimile of an actual trade ticket signed by Brian Sack, or his replacement Simon Potter, or any of the BIS traders confirming they are indeed selling gold on behalf of the Fed, BOE, ECB, SNB or BOJ simply to keep the price of the metal down, what such constant factless accusations (and no, sorry, a chart showing that the price of gold may go up or go down sharply indicates merely that and nothing about the underlying factors for such a move) do is to habituate the broader public to the real issues surrounding precious metal, and other asset class, manipulation. So instead of searching for circumstantial evidence which one can easily find everywhere, we decided to go straight to the source. To do that we go back to a post we wrote back in September of 2009, based on an internal previously confidential Fed document, which conveniently enough explains everything vis-a-vis gold manipulation and leaves nothing to speculation or misinterpretation. Zero Hedge presents the smoking gun that may provide responses to all the various open questions regarding the Fed's Modus Operandi in the gold arena which answer the core question - motive - courtesy of a declassified memorandum, written by none other than the then Fed Chairman, and addressed to the president of the United States.

Zero Hedge has recently presented several declassified documents from the pre-1971 "Nixon Shock" days, that endorse the case for gold as a major historical factor in US monetary and foreign policy, as demonstrated by State Department and CIA disclosure. Gold's special status in policy and administrative decision-making was a direct factor in Nixon's choice to abolish the gold reserve at a time of an exploding budget deficit.

Yet what about the days after 1971, and specifically, how did that critical "behind the scenes" organization, the Federal Reserve, perceive and manipulate gold in the post Bretton-Woods world? Was gold, freed from its shackles to the dollar, once again merely a symbolic representation for money?

Zero Hedge presents the smoking gun that may provide responses to all the various open questions, courtesy of a declassified memorandum, written by none other than the then Fed Chairman, addressed to the president of the United States.

On June 3, 1975, Fed Chairman Arthur Burns, sent a "Memorandum For The President" to Gerald Ford, which among others CC:ed Secretary of State Henry Kissinger and future Fed Chairman Alan Greenspan, discussing gold, and specifically its fair value, a topic whose prominence, despite former president Nixon's actions, had only managed to grow in the four short years since the abandonment of the gold standard in 1971. In a nutshell Burns' entire argument revolves around the equivalency of gold and money, and furthermore points out that if the Fed does not control this core relationship, it would "easily frustrate our efforts to control world liquidity" but also "dangerously prejudge the shape of the future monetary system."

Furthermore, the memo goes on to highlight the extensive level of gold price manipulation by central banks even after the gold standard has been formally abolished. The problem with accounting for gold at fair market value: the risk of massive liquidity creation, which in those long-gone days of 1975 "could result in the addition of up to $150 billion to the nominal value of countries' reserves." One only wonders what would happen today if gold was allowed to attain its fair price status. And the threat, according to Burns: "liquidity creation of such extraordinary magnitude would seriously endanger, perhaps even frustrate, out efforts and those of other prudent nations to get inflation under reasonable control." Aside from the gratuitous observation that even 34 years ago it was painfully obvious how "massive" liquidity could and would result in runaway inflation and the Fed actually cared about this potential danger, what highlights the hypocrisy of the Fed is that when it comes to drowning the world in excess pieces of paper, only the United States should have the right to do so.

Another notable observation is that despite a muted antagonism between the Fed and the US Treasury persisting for decades, the fuse is and always has been short, and the conflict can promptly hit a crescendo, with the Fed ultimately always getting the upper hand. In the case of the Burns memo, the Fed's position was diametrically opposed to what the Treasury proposed was the proper approach. The result: full on assault by the Federal Reserve over the Treasury's credibility and even then, more than three decades ago, a veiled threat by the Fed involving escalating problems if the recommendation of the Treasury was picked over that of the Fed. "Severe criticism on the part of prominent and influential financiers would inevitably follow if the Treasury's present position prevailed." It is not surprising that the Fed's modus operandi has not changed one bit since 1975: it is our way or virtually assured destruction/embarrassment way.

Additionally, a curious tangent of the Burns memo is the fact that gold was explicitly used as an engine to enact political doctrine: "If the United States took a stand on the gold question that failed to satisfy the French in current international negotiations, would there be adverse economic or political consequences? I doubt it... If we do ever accede to French views on gold, we should at least use our bargaining leverage to achieve some major political advantage." And while gold as a policy mechanism was unable to satisfy its role this time, one wonders on how many subsequent occasions was global democracy trampled over in order to placate the US Federal Reserve:

"I have consulted Henry Kissinger as to whether there is some political quid pro quo we might want to extract from the French in exchange for acceding to some part or all of their desired position on gold. But Henry tells me there is none at this time."

At some point governments of advanced nations will say "enough" to the covert domination of their controlling bodies by the Federal Reserve, which through manipulation of its gold and money interests, effectively has control over not just the French, but every government which has a monetary basis to its respective economy and a relationship to the US "reserve" currency... Which means virtually every country in the world. The backlash, if and when it occurs, will be memorable.

Lastly, the memo presents a useful snapshot into the cloak-and-dagger, and highly nebulous world of Central Bank negotiations and gold price manipulation:

"I have a secret understanding in writing with the Bundesbank that Germany will not buy gold, either from the market or from another government, at a price above the official price."

So to all conspiracy theorists claiming that gold is being manipulated on a daily basis by the Federal Reserve: when it occurs over and over, and is so well documented, it is no longer a theory, it is merely sad. And the fact that the US government goes to great lengths to hide the illicit dealings of the Federal Reserve, which through its monetary tentacles, has prima facie control over not just US policy but also over sovereign governments, is an unprecedented failure in the checks and balances system that the founding fathers had planned when they created the United States of America. Yet saddest is that the United States no longer pursues strategic goals that are in the best interest of the majority of its citizens, but merely manipulates other, less powerful nations into a servile existence that only provides gain to a very limited subset of the American financial oligarchy. It is time for the Fed's unprecedented control over affairs, both global and domestic, to end.

Full memo from Arthur Burns presented, compliments of Geoffrey Batt who collaborated in the creation of this post.

July 30, 2012

Germans Getting Even More Opposed to Being in the Eurozone

Over the weekend, the newspaper Bild released the results of a new poll on German sentiment on the Euro. It found that 51% thought Germany would do better by leaving the Eurozone with 29% saying Germany would fare worse. In addition, 71% of the respondents said Greece should be expelled from the Eurozone if it could not live up to its austerity commitments.

These results aren’t particularly novel; a large cohort of Germans have been vocally opposed to Eurorescues for some time. What is new about this poll is how low the percentage is that sees being in the Euro as good for Germany. And some respondents don’t seem to understand that expelling Greece is probably fatal to the Euro project. While Greece by itself is almost certainly enough to impair the Eurozone, a Greek exit is likely to escalate the crisis in Spain and Italy. Remember, Spain just quietly asked for €300 billion Euros and was rebuffed. And no wonder. The EFSF has less than €250 billion remaining, and the ESM has yet to be launched.

Reuters reports that a separate Bild-sponsored poll found support for Merkel’s handling of the crisis to be cratering:

Only one third of Germans still believe Angela Merkel is making the right decisions over the euro zone debt crisis, according to a survey published on Sunday, pointing to a steep erosion in domestic support for the chancellor over the last weeks.

The survey by YouGov, due to be printed in Monday’s edition of Bild newspaper, found 33 percent in favor of her stance but 48 percent against, a setback for the chancellor who is to seek a third term in a 2013 federal election, which she has vowed to make a vote on Europe.

Asked in the survey whether they feared for their savings, 44 percent of Germans said that they did.

In mid-July, a poll by ZDF-Politbarometer showed 63 percent of Germans backed Merkel’s handling of the crisis, although a majority thought she should explain her policies better.

Another poll at the start of July by Infratest-ARD put support for Merkel’s crisis policies at 58 percent, although 85 percent of those polled also expected the crisis to get worse.

On the one hand, the usual response to crises is for the populace to turn more conservative and parochial. Grand ideals seem besides the point if you are under financial stress. On the other, the increasing hostility of Germans to the Eurozone is a massive failure of leadership and communication.

As numerous commentators and economists have pointed out, German is the big beneficiary of the Eurozone. Its large, sustained trade surpluses are to its benefit and are also what is breaking the monetary union. But the problem, as Josh Rosner indicated in a recent paper, the “Germany” that is benefiting is not ordinary citizens, but its corporations. And they prospered by squeezing wages, using the fact that Germany entered the EMU at an overvalued exchange rate as the pretext for labor “reforms”:

Of course, it’s much easier to play to stereotypes and demonize lazy Southern Europeans, rather than ‘fess up that the rescues have been to save the hides of French and German banks. Yanis Varoufakis reminds us that not a drachma of funding from the next tranche to be released to Greece would actually go to Greece:

On 20th August, the Greek government will have to borrow 3.2 billion from one arm of the Eurozone (from the EFSF) in order to repay another (the ECB). Yet Greece is insolvent. The very idea of an insolvent entity borrowing more from a community, like the Eurozone, in order to repay that same community is obscene. All it does is to shift the burden from the Central Bank to the taxpayers of Germany, Holland, Austria and Finland. This is not an act of solidarity with Greece. It is an act of irresponsible kicking-the-can-up-a-steep-hill.

But it’s much more convenient to have Germans mad at Greece rather than their own leaders for throwing German workers under the bus once, by failing to come up with better ways to share the economic pain of adjustment in the early 2000s, and again, by failing to get tough with banks. And the worse is, as Rosner and others have stressed, that while every way forward will impose costs on the German population, a Eurobreakup or German exit will be far more detrimental to German citizens. ING estimates GDP would fall 9.2% in a full breakup scenario, and unemployment would rise to 9.3%. And if Germany were to leave (as some readers suggest), its currency would skyrocket, leading to an erosion of its trade surplus and rising unemployment, as well as losses to its banks on Euro denominated obligations, necessitating more costly bailouts.

So this situation is ugly indeed. And it appears German leadership is unwilling to try to change the hearts and minds of the public because they are too deeply invested in the story they’ve been telling to change course. The German people are almost certain to wind up poorer as a result.

Update 12:40 AM: The Telegraph reports that the ECB and other central banks may take a haircut on Greek debt as a way to finesse the next round of funding. Notice the continued failure to ‘fess up that this “funding” is merely moving money among parties outside Greece. Reader George P. nevertheless anticipates that the Germans will be apoplectic. From the article:

Intensive discussions now under way among EU policy-makers involve the European Central Bank and a number of central banks taking a significant write-down on their Greek bonds as the price for avoiding a eurozone break-up and losing its weakest link.

France’s central bank, the most heavily exposed, may need to be recapitalised because of the scale of its potential losses. The central banks of Malta and Cyprus are also in the firing line, as well as clearing banks and eurozone governments.

The latest rescue package for the stricken Greek economy is aimed at reducing the country’s debts by another €70bn (£54.6bn) to €100bn, cutting the total to what is regarded as a more manageable level.

July 27, 2012

A Once Prominent Leader In The Two Big To Fail Banking System Now Reverses His Opinion

In a stunning reversal, a former big bank CEO who crusaded for policies that helped create the so-called "too-big-to-fail" banks now says we need to break up the banks.

"What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, and have banks do something that's not going to risk the taxpayer dollars, that's not going to be too big to fail," former Citigroup Chairman and CEO Sanford "Sandy" Weill told CNBC on Wednesday morning.

It's a shocking statement coming from Weill, who was responsible for turning Citi into one of the largest banks in the world. During his tenure, he bought up one financial institution after another and orchestrated the merger of Travelers Group and Citibank in 1998--at the time, the largest merger in history. He retired as CEO of Citigroup in 2003 and stepped down as chairman in 2006.

A "stunning reversal" is absolutely "stunning" coming from a man that created one of the first "Too Big To Fail" banks in our country.

However, history does repeat itself and as grown men grow older, their views and outlooks begin to come back to reality. As one gets older, the need for greed reduces -especially for some who have all the wealth they will ever need or want.

Back in the late 1960's, Mergers and Acquisitions (M & A) were the business model of the day. It was a time where companies acquired other companies and became known as "conglomerates" - companies who owned many other companies especially in non related fields. A prime example of a conglomerate back then was a company called Gulf + Western - originally a company called Michigan Plating and Stamping - from which its owner began his comglomerate. Best known of all acquisitions by G+W was Paramount Pictures. For those of you who can remember, underneath the words Paramount Pictures in every movie were the words - " A Gulf + Western Company". A complete history of the company and its many acquisitions from Wikipedia...click here.

Then again in the early 1980's, Mergers and Acquisitions again became the business rage of the day. This time, much of it was done by a concept known as "leveraged buyouts". A business model coming back into popularity today whereby a company was purchased (acquired by another) using that companies assets to purchase itself. Or, where the company being acquired was worth more by selling off its components thereby creating the cash to complete the purchase.

During this period - which I call the original period of "Too Big To Fail" - many of our venerable and well known companies participated in this game. Companies such as that venerable paint company Sherwin Williams who acquired among others a non related business Drug Fair, a national retail drug store company.

Others in the game at the time was a company still very much alive and well today - Kohlberg, Kravits and Roberts (KKR) - leveraged buyout experts whose largest and most popular acquisition was RJR Nabisco. A conglomeration of companies comprised of aluminum, tobacco and food.

Now as history has shown us, bigger is not better! What many of these companies began to learn is that owning many other companies became a management nightmare. Many found it very difficult to operate in areas they had no expertise in and business they thought would flourish under one "umbrella" began to decline.

After the big push for M & A the next business cycle became the M & A divestiture. These large conglomerates as those created in the 60's began to divest themselves of all "non core" companies. The great sell off of the 1990's began. These companies realized that they needed to focus on their "core" business - the business that they were in business for and knew well. You can compare this to a butcher becoming a surgeon or banker becoming a Realtor.

As we have watched the banking industry consolidate through Mergers & Acquisitions to become larger and as we have watched Commercial Banks become Investment Banks and Investment Banks become Commercial Banks we are seeing what those back in the 60's and 80's saw. Difficult management of all components, reduced profits and non consumer friendly institutions on all levels. What I have personally experienced in these now Too Big To Fail conglomerates is a drastic decline in customer service - a very non consumer friendly environment with attitudes from management as big as their institutions who don't give a dam about the consumer anymore. Dictating their business by size alone with no consumer (customer) consideration, no customer relations morality or no business ethics whatsoever as they feel they have the control and ability to do what they want, how they want as even our government regulators are controlled by them..

But do not despair my friends, as people like Sandy Weill are coming forward to say this Too Big To Fail stuff is "not working" and needs to be broken up, we will see an eventual break up of these conglomerates because as history has proven, they do not work long term. There are others who see the reality of the banks "going back to their core business models" such as Sheila Bair.

Sheilla Bair, former head of FDIC, also has been a long time proponent of breaking up these Too Big To Fail institutions. She did so while active as FDIC chairperson and still does so today.

Eventually, I will predict, the banks will be broken up. Glass - Steagall made sense back in 1933 and makes even more sense today in the 21st century. There can be no greater evidence of Too Big To Fail does not work then the massive global financial meltdown and crisis that occurred just a few short years ago. History does repeat itself. Things that have not worked in the past do not work in the present and the corrections back to sanity will eventually come.

July 26, 2012

Keynesian Dialogue Symptom of Larger Monetary Upeaval

Weimar solution beckons as manufacturing crashes in US Fifth District? ... Worker at General Motors. The collapse in US manufacturing is worrying ... If so, we can all have a ferocious argument – yet again – about what to do next to avoid a global depression (if we are not in a "contained" variant already). Needless to say, I will be advocating 1933 monetary stimulus à l'outrance, or trillions of asset purchases through old fashioned open-market operations through the quantity of money effect (NOT INTEREST RATE 'CREDITISM') to avert deflation – and continue doing so until nominal GDP is restored to its trend line, at which point the stimulus can be withdrawn again. And the Austro-liquidationists (whom I love during bubbles, and hate during busts) can all hurl shoes at me. – UK Telegraph

Dominant Social Theme: Money printing is a necessity.

Free-Market Analysis: Ambrose Evans-Pritchard is feeling the heat from his suddenly affirmed Keynesian tendency and has mentioned it in this article appearing in the UK Telegraph (see above).

What might seem an unimportant conversation between a journo and his readers is much more important than that, in our humble opinion. The conversation is actually breathtakingly sophisticated compared to the kinds of monetary discussions that occurred in the 20th century.

It shows us how far what we call the Internet Reformation has travelled in a short ten years. In fact, the interplay is equivalent to what might have been found in a Mises Foundation free-market journal in the 20th century, written by a handful of idiosyncratic outsiders on cheap paper and distributed to a tiny audience of aficionados.

But in the 21st century, this conversation takes place on the Internet within the context of literally millions of readers. Evans-Pritchard discusses his Keynesian sympathies and readers fire back. Here's some more from the article:

As Britain tanks by 0.7pc in the second quarter (much worse than Spain at 0.4pc), it is worth keeping a close eye on the very ominous turn of events in the US. The Richmond Fed's twin indices of manufacturing and services – a very good indicator at the onset of the Great Recession – collapsed this month.

They are now falling at a steeper pace than in early 2008. Current activity in manufacturing fell 16 points from -1 to -17. That is a major shock. We will find out soon what the US GDP numbers are for Q2. The preliminary reading will no doubt be positive, creating a false sense of relief.

But remember, the GDP data was massively wrong at the inflection point in early- to mid-2008. The first read of Q2 2008 was solid growth of 1.9pc. Only later did it become clear that the US recession began in late 2007, and was much deeper than originally thought. Now it really gets dirty. Weimar without Weimar, so to speak; a victimless crime.

What Evans-Pritchard is referring to here, of course, is the great inflationary depression of the Weimer Republic early this past century. The Weimer inflation is often trotted out as a terrible inevitability but in fact it was a raging inflation in a circumscribed area with unique causes and consequences.

It may not serve as a model for the entire Western world, or even America, in the 21st century. In any event, there is a good deal of irony in its use of the Weimer anecdote, as he is arguing for the kind of monetary stimulation that certainly makes hyperinflation a possibility.

On a deeper level, Evans-Pritchard is adopting the language and promotional elements of the power elite that sponsors both central banking and its various justifications. We wrote about this intellectual tradition (if one can call it that) here:

"BBC's Hopeless Attempt to Elevate Keynes"

John Maynard Keynes was indeed in a sense "hired" by the power elite to justify the craziness of allowing a tiny handful of men to fix the value and volume of money around the world on a daily basis.

In the 21st century, the conversation as been fully exposed, and even when someone as financially savvy as Evans-Pritchard begins to make a monetarist argument, he gets a good deal of pushback.

The feedbacks basically debunk Evans-Pritchard's position that extraordinary money printing is necessary to avoid a deeper recession/depression. They point out that such a strategy is monetarily damaging and probably impotent in any case.

What is not discussed, however, is why Evans-Pritchard believes the current system is worth saving. We've written about this many times previously.

The current economic system is the outcome of a century's worth of fiat-money stimulation. Who knows what the larger economy would like if it had grown normally instead of via a series of manic central bank episodes.

China is a good case in point within this context. China's intractable poverty and lack of industrialization has been all but eradicated in the past 30 years. Centuries of impoverishment are being remedied.

At the same time, the economy of the post-war leader of the world, America, is collapsing. Fiat money printing is simply not the answer to economic woes. It is kind of the crack cocaine of monetary remedies. There is an initial rush, but once it wears off the old problems are still present, but only with renewed impetus.

Evans-Pritchard is wrong to argue for the faux-stimulation of paper money printing. The power elite that apparently wants to run the world has created the current monetary paradigm as well as the economies that react to it. But that does not make either state of affairs correct, only ubiquitous.

These kinds of articles and the feedbacks they elicit show us clearly that a new kind of monetary system is probably inevitable. The end result of such suasion as Evans-Pritchard wants to induce is not going to be stimulative but part of a larger crisis of confidence.

The import of these conversations lies not in their narrative but in the interaction itself and its sophistication. It leads us to believe significant changes may be closer than they seem.

Conclusion: And by significant, we mean fundamental.

July 25, 2012

David Stockman: "The Capital Markets Are Simply A Branch Casino Of The Central Bank"

A selected excerpt by David Stockman from his just released interview with Alex Daley of Casey Research:

This market isn't real. The two percent on the ten-year, the ninety basis points on the five-year, thirty basis points on a one-year – those are medicated, pegged rates created by the Fed and which fast-money traders trade against as long as they are confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten-year bond at a two percent interest rate. But they're doing it because they can borrow overnight money for free, ten basis points, put it on repo, collect 190 basis points a spread, and laugh all the way to the bank. And they will keep laughing all the way to the bank on Wall Street until they lose confidence in the Fed's ability to keep the yield curve pegged where it is today. If the bond ever starts falling in price, they unwind the carry trade. Then you get a message, "Do not pass go." Sell your bonds, unwind your overnight debt, your repo positions. And the system then begins to contract... The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an "interest rate." That isn't a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he's still in a positive spread. And you can't have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That's essentially what we have today.

From Casey Research

The New Economic Collapse Video: It makes uncomfortable but urgent viewing.

When Casey Research Chief Technology Investment Analyst Alex Daley met former Reagan Budget Director David Stockman to talk about the economy and where he sees it leading taxpayers investors and savers in the near future, he got some very intriguing insights from a man who served right at the heart of the US federal government.

True, some if it makes for uncomfortable watching, but the message is critical if you want to keep your assets safe in what David calls calls "the great unwind."

Watch the video and secure your money.

Full Transcript:

Interviewed by Alex Daley, Chief Technology Investment Strategist, Casey Research

Alex Daley: Hello. I'm Alex Daley. Welcome to another edition of Conversations with Casey. Today our guest is former Reagan Budget Director and Congressman David Stockman. Welcome to the show, David.

David Stockman: Glad to be here.

Alex: So we're here in Florida talking at the Recovery Reality Check Casey Summit. What do you think: is the United States economy on the road to recovery?

David: I don't think we are at the beginning of the recovery. I think we are at the end of a disastrous debt supercycle that has gone on for the last thirty or forty years, really. It started when Nixon defaulted on our obligations under Bretton Woods and closed the gold window. Incrementally, year after year since then, we have been going in a direction of extremely unsound money, of massive borrowing in both the private and the public sector. We now have an economy that is saturated with debt: $54 trillion or $53 trillion – 3.5 times the GDP – way off the charts from where it was for a hundred years prior to the beginning of this. The idea that somehow all of that debt is irrelevant, as the Keynesians would tell us, is fundamentally wrong – and the reason why the economy can't get up off the mat.

We're doing all the wrong things. We're adding to the problem, not subtracting. We are not allowing the debt to be worked down and liquidated. We're not asking people to save more and consume less, which is what we really need to do. And so therefore I think policy is just making it worse, and any day now we will have another recurrence of the kind of economic crisis we had a few years ago.

Alex: You paint a very stark picture, but if people just stop spending, start saving, won't companies like Apple see their earnings hurt? Won't the stock market then start to tumble, people's net worth fall? Isn't that a negative cycle that feeds on itself?

David: Sure it does, but you can't live beyond your means because it's pleasant. It's not sustainable. Clearly the level of debt that we have is not sustainable. We have a whole generation – the Baby Boom – that's about ready to retire, and they have no retirement savings. We have a federal government that is bankrupt, literally. Its [debt is] $16 trillion and growing by a trillion a year. Something's going to give. We can't pay for all these entitlements. There won't be the revenue generation in the economy to do it.

So as a result of that, we are deluding ourselves if we think we can just continue to spend. Look at the GDP that came out in the first quarter of this year. It was only 2.2%. Most of it was personal consumption expenditure, and half of that was due to a drawdown of the savings rate, not because the economy was earning more income or generating more real output. It was because of a drawdown of savings. That is exactly the wrong way to go – an indication of how severe the crisis is going to be.

I'm not saying the economy should stop spending entirely. I'm only saying you can't save 3% of GDP and spend 97% if you are going to get out of this fix. As the savings rate goes up both in the public sector (which means reduction of spending and the deficit) and the household sector (to seriously reduce debt burden, which has not really happened) we are going to, on the margin, spend less, save more. It will slow down the economy. It will undermine profits, I agree. But profits today are way overstated. They're based on a debt-bloated economy that isn't sustainable.

Alex: So we can only live beyond our means for so long, as any family knows.

David: Yes.

Alex: Now, the government can reduce its expenses at any time by simply reducing spending, and it can reduce debt if it brings in more tax revenue. That's austerity – I think that's how they refer to it. But won't austerity cause massive joblessness? Won't there be millions more people in this country not receiving a paycheck?

David: Yes, but the critique, the clamoring and clattering that you hear from the Keynesians (or even mainstream media, which is pretty clueless economically) that austerity is bad forgets the fact that austerity isn't an elective course. Austerity is something that happens to you when you're broke. And yes, it is painful and spending will go down and unemployment will go up and incomes will be impaired, but that is a consequence of the excess debt creation that we've had for the last thirty years. So austerity is what happens when you break the rules.

And somehow we have this debate going on. They're making a mistake. They chose the wrong strategy. Do you think Greece chose the wrong strategy with austerity? No. No one would lend them money. That's why they ended up in the place they were. Do you think that Spain today is teetering on the brink because they said, "Oh, wouldn't it be a good idea to have austerity?" No, they had a gun to their head. They were forced to do this because the markets would not continue to lend, and even now their interest rate is again rising. The markets are losing confidence, and unless the ECB prints some more money and bails them out some more, they are going to have austerity. So the austerity upon us is the backside of the debt supercycle we had for the past thirty years. It's not discretionary.

Alex: Austerity hasn't been forced upon us yet. The dollar is up, people are continuing to buy Treasuries – both nations and banks are buying Treasuries. To all extents and purposes, people are continuing to show massive confidence in the US government, lend it money at extremely cheap interest rates, and letting it build up its debt.

So you are advocating that, unlike Greece or Spain taking it to the edge and having austerity forced on them, we should volunteer for austerity today? Instead of just kicking the can down the road and living high a little bit longer, until the bill collectors finally come knocking? Why go today, why start austerity now instead of doing what Greece did and going as long as you possibly can?

David: Because Greece is a $300 billion economy. Tiny. A rounding error in the great scheme of things. It's – last time I checked – about eight and a half months' worth of Walmart sales. Okay? That's a little different than when you have the $15 trillion heartland of the world economy, and the $11 trillion Treasury market which is at the center of the whole global financial system buckle and falter. That's the risk you're taking if you say, "Mañana. Kick the can; let's just wait for something good to happen."

This market isn't real. The two percent on the ten-year, the ninety basis points on the five-year, thirty basis points on a one-year – those are medicated, pegged rates created by the Fed and which fast-money traders trade against as long as they are confident the Fed can keep the whole market rigged. Nobody in their right mind wants to own the ten-year bond at a two percent interest rate. But they're doing it because they can borrow overnight money for free, ten basis points, put it on repo, collect 190 basis points a spread, and laugh all the way to the bank. And they will keep laughing all the way to the bank on Wall Street until they lose confidence in the Fed's ability to keep the yield curve pegged where it is today. If the bond ever starts falling in price, they unwind the carry trade. They unwind the repo, because then you can't collect 190 basis points.

Then you get a message, "Do not pass go." Sell your bonds, unwind your overnight debt, your repo positions. And the system then begins to contract – exactly what happened in September and October of 2008. Only, that time it was an unwind to the repo on mortgage-backed securities and CDOs and so forth. That was a minor trial run for the great unwind that is going to happen when the Treasury market is finally shattered with a lack of confidence because, on the margin, no one owns a Treasury bond: they just rent it on borrowed money. If the price starts falling, they'll get out of that trade as fast as they got out of toxic CDOs.

Alex: So when people run away from the US, they will run away all at once.

David: Well, if they run away from the Treasury, it sends compounding forces of contagion through the entire financial system. It hits next the MBS and the mortgage market. The mortgage market then scares the hell out of people about the housing recovery, which hasn't happened anyway. And if there isn't a housing recovery, middle-class Main-Street confidence isn't going to recover, because it is the only asset they have, and for 25 million households it's under water or close to under water.

Alex: We saw something much like that in 2008. All the markets correlated. Stocks went down. Bonds went down. Gold went down with them. It sounds like what you're saying is that the Fed is effectively paying bankers to stay confident in the Fed, and that the moment that stops – either because the Fed stops paying them or something else shakes their confidence – this all goes down in one big house of cards?

David: Yes, I think that's right. The Fed has destroyed the money market. It has destroyed the capital markets. They have something that you can see on the screen called an "interest rate." That isn't a market price of money or a market price of five-year debt capital. That is an administered price that the Fed has set and that every trader watches by the minute to make sure that he's still in a positive spread. And you can't have capitalism if the capital markets are dead, if the capital markets are simply a branch office – branch casino – of the central bank. That's essentially what we have today.

Alex: Last night you told our audience that if you were elected president, the first thing you would do is quit. Or at least demand a recount, I believe were your words, which I thought was telling. Are you saying there are no policy changes we could make today that would get us out of this? Or at least that wouldn't get you assassinated?

David: Yeah, there is a paper blueprint. People who believe in sound money and fiscal responsibility, that you create wealth the old-fashioned way through savings and work and effort and not simply by printing money and trading pieces of paper – there is a plan that they could put together. One would be to put the Fed out of business. You don't have to "end the Fed," although I like Ron Paul's phrase. You have to get them out of discretionary, active, day-to-day meddling in the money markets. Abolish the Open Market Committee.

The Fed has taken its balance sheet to $3 trillion. That's enough for the next 50 years. They don't have to do a damn thing except maybe have a discount window that floats above the market, and if things get tight, let the interest rate go up. People who have been speculating will be carried out on a stretcher. That's how they used to do it. It worked prior to 1914. That's the first step: abolish the Open Market Committee. Abolish discretionary monetary policy.

Let the Fed, if you're going to keep it – I don't even know that you need to do that, but if you are going to keep it – be only a standby source. As Badgett said (Walter Badgett, the great 19th-century British financial thinker): provide liquidity at a penalty rate to sound collateral.

Now, that's what J.P. Morgan did in 1907, in the great crisis of 1907, from his library. He didn't have a printing press. He didn't bail out everybody. He didn't do what Bernanke did and say: "Stop the presses, freeze everybody, and prop up Morgan Stanley and Goldman Sachs and all the rest of the speculators." The interest rate, the call-money interest rate, which was the open-market interest rate at the time, some days went to 30, 40, 70% – and they were carrying out the speculators left and right, liquidating margin debt, taking out the real estate speculators. Eight or ten railroads went bankrupt within a couple of months. The copper magnates got carried out on their shields.

This is the only way a capital market can work, but it needs an honest interest rate. And we have no interest rate, so therefore we solve nothing and we have the kind of impaired, incapacitated markets that we have today. They're very dangerous, because they're all dependent on twelve people. It is what I call "the monetary Politburo of the Western world," and they are just as dangerous as the Politburo in Beijing or the Politburo of memory in Moscow.

Alex: A twelve-person Open Market Committee determining the future of our economy by manipulating rates. Sounds like central planning to me.

David: It is. They are monetary central planners who are attempting to use the crude instrument of interest-rate pegging and yield-curve manipulation and essentially buying debt that no one else would buy, in order to keep this whole system afloat. It's Ponzi economics. Anybody who had financial training before 1970 would instantly recognize this as Ponzi economics. It is only because of the last twenty years we got so inured to prosperity out of the end of a printing press and massive incremental debt that people lost sight of the fundamental principles of sound money, which, there's nothing arcane about it. It's just common sense. It is not common sense to think that 50, 60, 70% of all the debt that's being created by the federal government can be bought by the Federal Reserve, stuffed in a vault, and everybody can live happily ever after.

Alex: So the government has certainly put us in a precarious position, but I don't think they alone have put America in this position, have they? You mentioned consumer debt becoming a major burden on the economy. How do we shed ourselves of that? I mean, the federal government can repudiate its debts if we walk away from it. We might see a few wars or something from that. It could inflate its way out of it. It can tax its way out of it. But how do households get out from under the debt burden that they have today?

David: Well, it's very tough, and they were lured into it by bad monetary policy when Greenspan panicked in December 2000. The interest rate was 6.5%; we had an economy that was threatened by competitors around the world. We needed high interest rates, not low. He panicked after the dot-com crash, and as you remember in two years they took the interest rate all the way down to 1%, and they catalyzed an explosion of mortgage borrowing, which was crazy.

When they cut the final rate down to 1% in May, June 2003, in that quarter – the second quarter of 2003 – the run rate of mortgage borrowing was $5 trillion at an annual rate. That was nuts! There had never been even a trillion-dollar annual rate of mortgage borrowing previously. In that quarter the run rate was $5 trillion, 40% of GDP. Why? Because the Fed took the rate down to 1%. Floating-rate product got invented everywhere. Anybody that had a pulse was being given mortgage loans by the brokers. The mortgage brokers didn't have any capital or funding. They went to Wall Street. They got warehouse lines, and the whole thing got out of control. Millions of households were lured into taking on debt that was insane, and now we have a generation of debt slaves.

There are 25 million households in America who couldn't move if they wanted to, because their mortgages are under water. They cannot generate a down payment and the 5% or 6% broker fee that you need to move. So we've got 25 million households immobilized, paralyzed, and worried every day about when they are going to lose property, because of what the Fed did. It's a terrible indictment.

Alex: Mobility itself is the American dream, isn't it? It's the ability to pick up and find work and then move and do all that. So now we have people who are slaves to their debt. How do we get ourselves out of this? Is this just a matter of personal financial discipline? Is there a policy move that can happen?

David: It's policy. If we don't do something about the Fed, if we don't drive the Bernankes and the Dudleys and the Yellens and the rest of these lunatic money-printers out of the Federal Reserve and get it under the control of people who have at least a modicum of sanity, we are just going to bury everybody deeper.

It's unfortunate. The American people are as much a victim of the Fed's massive errors as anything else. People were not prudent when they took on debt at 100% of the peak value of their property at some moment in 2004 and 2005. They were lured into it. But now we're stuck with something that didn't need to happen.

Alex: The Federal Reserve was founded in 1914, and it saw America through World War I, World War II. It saw America through Vietnam, saw America through the biggest boom in the economic history of the world. Yet now, today, you are calling for the abolishment of the Fed. Wasn't the Fed here the entire time that America was a prosperous, growing, wealthy, technology-driven nation? What's changed?

David: The greatest period of growth in American history was 1870-1914 – the Fed didn't exist. Right after 1870, when we recovered from the Civil War we went back on the gold standard. It worked pretty well. World War I was a catastrophe for the financial system. The Fed financed it, but I don't give them any credit for that, okay? We shouldn't have been in that war. It was a stupid thing to get involved in. But once we got involved in it, the Fed printed money like crazy, it facilitated borrowing, set the groundwork for the boom of the 1920s and the collapse of the 1930s.

Even then though, we had great minds who coped with reality in a pragmatic way in the Fed. Even Marriner Eccles wasn't all that bad. He stood up to Truman in 1951, when Truman wanted to force the Fed to continue to peg interest rates at 2% or 2.5% when inflation was 5%. Then we had William McChesney Martin: brilliant, pragmatic. He wasn't some kind of gold-standard guy in a pure sense, but a pragmatic guy who understood that prosperity had to come out of private productivity, out of investment, out of risk-taking, and the Fed had to be very careful not to allow speculation to start or inflation to get ignited. In 1958, he invented the phrase, "The job of the Fed is to take the punchbowl away." And we had a small recession. Six months after the recession was over he was actually raising the margin rate on the stock-market loans in order to quell speculation, and raising interest rates so that the economy didn't start to inflate again.

Now that was the regime we had until, unfortunately, Lyndon Johnson came along with his "guns and butter," took William McChesney Martin down to the ranch, and beat the hell out of him and forced him to capitulate. But here's the point I would make: In 1960, at the peak of what I call the golden era – the twilight of fiscal and financial discipline – we had $30 billion on the balance sheet of the Fed. It had taken 45 years to build that up. Then, as they began to rapidly expand the balance sheet of the Fed during the inflation of the '70s and the '80s, even then it took us until September 2008 – the Lehman collapse – to get to $900 billion. Had the balance sheet only grown at 3%, which is what the capacity of the economy to grow, I think, really is, it would have been $300 billion, so they were overshooting.

Alex: We're three times where we should be.

David: Where we should have been by the Lehman crisis event. In the next seven weeks, this crazy lunatic who's running the Fed increased the balance sheet of the Fed by $900 billion, in seven weeks. In other words, they expanded the balance sheet of the Fed as rapidly in seven weeks as it had occurred during the first 93 years of its existence. And that's not all, as they say on late night TV: in the next six weeks they added another $900 billion. So in thirteen weeks they tripled the balance sheet of the Fed.

Alex: Wow, that's an incredible…

David: So no wonder we are in totally uncharted waters, and it's being run by people who are clueless as to how to get out of the corner they've painted this country into. They really ought to be run out of town on a rail.

Alex: I think you'd find that a lot of our viewers would agree with you on that one. You know, the average American is suffering. It looks like the average American is going to have to suffer more to get us out of this, but it seems like the only thing the Fed is interested in these days is propping up the stock market. Why is that? Where does that come from?

David: The Fed has taken itself hostage with this whole misbegotten doctrine of wealth effects, which was created by Greenspan. In other words, if we get the stock market going up and we get the stock averages going up, people feel wealthier, they will spend more. If they spend more, there is more production and income and you get a virtuous circle. Well, that says you can create wealth through speculation. That can't be true, because if it is true, we should have had a totally different kind of system than we've had historically.

So they got into that game, and then the crisis came in September, 2008. They panicked and pulled out the stops everywhere. As I said, tripled the balance sheet in thirteen weeks, [compared to what] they had done in 93 years. They are now at a point where they don't dare begin to reduce the balance sheet, begin to contract, or they'll cause Wall Street to go into a hissy fit. They are afraid to death of Wall Street going into a hissy fit, so essentially, the robots and the boys and girls and the fast-money traders on Wall Street run the Fed indirectly.

Alex: So, in the 1960s, the Fed is taking away the punchbowl. Sounds like in 2010 the Fed is the one adding the alcohol. They are afraid to stop, lest everybody riot.

David: Yes, they got the party going, and they're afraid to stop it. As a result of that you have a doomsday machine.

Alex: At some point we are going to be forced to stop. Market forces will kick in and Europe and China and India will stop lending us money.

David: Yes. As I say, when the crisis comes in the Treasury market, it will be the great margin call in the sky. They'll start unwinding all of the carry trades, all of the repo. Asset prices generally will be affected, because this will ricochet and compound through the system.

Alex: When does this happen?

David: People looked at the housing market and the mortgage market way back in 2003 – there were some smart people looking at this. They looked at the run rate of gross mortgage issuance, the $5 trillion I was talking about, and said: "This is insane, this is off the charts, this is so far beyond anything that has ever happened before, something bad is going to come of this." It's obvious, if you pour debt into markets… I mean a lot of people leveraged 98%, or whatever they were doing at the time with so-called mortgage insurance, and just high loan to value ratios. They were driving up prices, and so there was a housing-price boom going on. It was sucking the whole middle class into speculation. So that's the nature of the system, and now they don't know how to unwind it.

Alex: That's a pretty stark picture. So as an individual investor, what are we to do? How do we protect ourselves in this type of situation? Should I be owning bonds and staying out of stocks? Should I be owning stocks?

David: No, I would stay out of any security markets. These are unsafe markets at any speed. It's all tied together. As I was saying when the great margin call comes and they start selling the Treasury bond, they'll take everything else with it. Real estate is priced off Treasuries. Mortgaged-backed securities are priced off Treasuries. Corporates are priced off Treasuries. Junk bonds are priced off Treasuries. Everything. The stock market will go into a panic. We don't know when the timing will come – we've never been in a world where there is $15 trillion worth of central-bank balance sheets, like we have today. The only thing I think you can conclude is preservation is the only thing you are about as an investor. Forget about yield. Forget about return. Just keep yourself liquid and preserve your capital, because you can't predict the day when, as I say, the great margin call in the sky comes down.

Alex: So if it's not about coming out ahead, it's about coming out not behind everybody else. It's just losing a little less. What's the most effective way to do that? Do you want to hold cash? Alternative options?

David: Yes. I don't even think there's nothing wrong with owning Treasury bills. I mean, if you want to get, for a one-year Treasury, what is the thing now? Twenty basis points or something?

Alex: So when the great Treasury crash comes, I should own Treasury bills?

David: Well, it doesn't mean the price of the Treasury is going to crash, no.

Alex: Okay, so we are just going to see interest rates skyrocket on new issues. The US government is not going to be able to borrow.

David: That's why you're short. If you're in a thirty-day piece of paper, you're not going to lose principal.

Alex: What happens to the dollar in all of this? If I'm holding dollar denominated assets –?

David: Well, the dollar, in theory, people would think is going to crash. I don't think it is because all the rest of the currencies in the world are worse.

Alex: So once again, America is not that bad off.

David: Well, we're bad off because when the financial markets reprice drastically, it's going to have a shocking effect on economic activity. It's going to paralyze things. It's going to finally cause consumption to come down. It's going to cause government spending to be retracted.

You know, the Keynesians are right. Borrowing does add to GDP accounts. But it doesn't add to wealth. It doesn't add to real productivity, but it does add to GDP as it's calculated and published – because GDP accounts were designed by Keynesians who don't believe in a balance sheet. So they said, "If the public sector and the household sector are borrowing, let's say, $10 trillion next year, run it though GDP, you'll get a big bump to GDP." But sooner or later your balance sheet will collapse. They forgot about that one. So my point is that we've gone through a thirty-year expansion of the balance sheet, an artificial growth in GDP; now we're going to have to be retracting the collective balance sheets. That means that GDP will not grow. It may even contract, and no one's prepared for that.

Alex: So the economy will collapse. The dollar will be okay, because we still need a medium of exchange and the dollar is the least-bad currency in the world. How does gold fit into the picture? Do you think that gold is a good asset?

David: Yes, I think that gold is a good asset. It's the only currency that anybody is going to believe in after a while.

Alex: Okay, so maybe hold that as an insurance policy. Do you own gold yourself?

David: Yes, as an insurance policy.

Alex: Where else do you invest in today?

David: I'm preserving capital. I'm in cash. I don't think the risk of the system is worth it.

Alex: So you are practicing what you preach, 100%?

David: Yes.

Alex: That's great. It's good to hear. This is excellent advice for our subscribers as well, to consider that there's a lot of potential energy built up in the system. You've articulated it well, a lot of painful policy moves ahead of us, and probably something that makes 2008 look like a preview, if you will.

David: It was just a warm-up.

Alex: Just a warm-up. Thank you very much.

David: Thank you.

July 24, 2012

Titanic banks hit Libor 'berg

At one time, calling the large multinational banks a "cartel" branded you as a conspiracy theorist. Today the banking giants are being called that and worse, not just in the major media but in court documents intended to prove the allegations as facts.

Charges include racketeering (organized crime under the US Racketeer Influenced and Corrupt Organizations Act, or RICO), antitrust violations, wire fraud, bid-rigging, and price-fixing. Damning charges have already been proven, and major damages and penalties assessed. Conspiracy theory has become established fact.

In an article in the July 3 Guardian titled "Private Banks Have Failed - We Need a Public Solution", Seumas Milne writes of the London Interbank Offered Rate (Libor) rate-rigging scandal admitted to by Barclays Bank:

It's already clear that the rate rigging, which depends on collusion, goes far beyond Barclays and indeed the City of London. This is one of multiple scams that have become endemic in a disastrously deregulated system with in-built incentives for cartels to manipulate the core price of finance.

... It could of course have happened only in a private-dominated financial sector, and makes a nonsense of the bankrupt free-market ideology that still holds sway in public life.

... A crucial part of the explanation is the unmuzzled political and economic power of the City ... . Finance has usurped democracy. [1]

Bid-rigging and rate-rigging

Bid-rigging was the subject of the US v Carollo, Goldberg and Grimm, a 10-year suit in which the US Department of Justice obtained a judgment on May 11 against three GE Capital employees. Billions of dollars were skimmed from cities all across America by colluding to rig the public bids on municipal bonds, a business worth $3.7 trillion.

Other banks involved in the bidding scheme included Bank of America, JPMorgan Chase, Wells Fargo and UBS. These banks have already paid a total of $673 million in restitution after agreeing to cooperate in the government's case.

Hot on the heels of the Carollo decision came the Libor scandal, involving collusion to rig the inter-bank interest rate that affects $500 trillion worth of contracts, financial instruments, mortgages and loans. Barclays Bank admitted to regulators in June that it tried to manipulate Libor before and during the financial crisis in 2008. It said that other banks were doing the same. Barclays paid $450 million to settle the charges.

The US Commodities Futures Trading Commission (CFTC) said in a press release that Barclays Bank "pervasively" reported fictitious rates rather than actual rates; that it asked other big banks to assist, and helped them to assist; and that Barclays did so "to benefit the bank's derivatives trading positions" and "to protect Barclays' reputation from negative market and media perceptions concerning Barclays' financial condition." [2]

After resigning, top executives at Barclays promptly implicated both the Bank of England and the Federal Reserve. [3] The upshot is that the biggest banks and their protector central banks engaged in conspiracies to manipulate the most important market interest rates globally, along with the exchange rates propping up the US dollar.

CFTC did not charge Barclays with a crime or require restitution to victims. But Barclays' activities with the other banks appear to be criminal racketeering under federal RICO statutes, which authorize victims to recover treble damages; and class action RICO suits by victims are expected.

The blow to the banking defendants could be crippling. RICO laws have taken down the Gambino crime family, the Genovese crime family, Hell's Angels, and the Latin Kings. [4]

The payoff - in interest rate swaps

Bank defenders say no one was hurt. Banks make their money from interest on loans, and the rigged rates were actually lower than the real rates, reducing bank profits.

That may be true for smaller local banks, which do make most of their money from local lending; but these local banks were not among the 16 mega-banks setting Libor rates. Only three of the rate-setting banks were US banks - JPMorgan, Citibank and Bank of America - and they slashed their local lending after the 2008 crisis. In the following three years, the four largest US banks - Bank of America, Citi, JPMorgan and Wells Fargo - cut back on small business lending by a full 53%. The two largest - Bank of America and Citi - cut back on local lending by 94% and 64%, respectively. [5]

Their profits now come largely from derivatives. Today, 96% of derivatives are held by just four banks - JPMorgan, Citi, Bank of America and Goldman Sachs - and the Libor scam significantly boosted their profits on these bets. Interest-rate swaps compose fully 82% of the derivatives trade. The Bank for International Settlements reports a notional amount outstanding as of June 2009 of $342 trillion. [6] JPMorgan - the king of the derivatives game - revealed in February 2012 that it had cleared $1.4 billion in revenue trading interest-rate swaps in 2011, making them one of the bank's biggest sources of profit.

The losers have been local governments, hospitals, universities and other non-profits. For more than a decade, banks and insurance companies convinced them that interest-rate swaps would lower interest rates on bonds sold for public projects such as roads, bridges and schools.

The swaps are complicated and come in various forms; but in the most common form, counterparty A (a city, hospital, and so forth) pays a fixed interest rate to counterparty B (the bank), while receiving a floating rate indexed to Libor or another reference rate. The swaps were entered into to insure against a rise in interest rates; but instead, interest rates fell to historically low levels.

Defenders say "a deal is a deal"; the victims are just suffering from buyer's remorse. But while that might have been a good defense if interest rates had risen or fallen naturally in response to demand, this was a deliberate, manipulated move by the Fed acting to save the banks from their own folly; and the rate-setting banks colluded in that move. The victims bet against the house, and the house rigged the game.

Lawsuits brewing

State and local officials across the country are now meeting to determine their damages from interest rate swaps, which are held by about three-fourths of America's major cities. Damages from Libor rate-rigging are being investigated by Massachusetts Attorney General Martha Coakley, New York Attorney General Eric Schneiderman, officers at CalPERS (California's public pension fund, the nation's largest), and hundreds of hospitals.

One victim that is fighting back is the city of Oakland, California. On July 3, the Oakland City Council unanimously passed a motion to negotiate a termination without fees or penalties of its interest rate swap with Goldman Sachs. If Goldman refuses, Oakland will boycott doing future business with the investment bank. Jane Brunner, who introduced the motion, says ending the agreement could save Oakland $4 million a year, up to a total of $15.57 million - money that could be used for additional city services and school programs. Thousands of cities and other public agencies hold similar toxic interest rate swaps, so following Oakland's lead could save taxpayers billions of dollars.

What about suing Goldman directly for damages? One problem is that Goldman was not one of the 16 banks setting Libor rates. But victims could have a claim for unjust enrichment and restitution, even without proving specific intent:

Unjust enrichment is a legal term denoting a particular type of causative event in which one party is unjustly enriched at the expense of another, and an obligation to make restitution arises, regardless of liability for wrongdoing ... [It is a] general equitable principle that a person should not profit at another's expense and therefore should make restitution for the reasonable value of any property, services, or other benefits that have been unfairly received and retained.

Goldman was clearly unjustly enriched by the collusion of its banking colleagues and the Fed, and restitution is equitable and proper.

Rico claims on behalf of local banks

Not just local governments but local banks are seeking to recover damages for the Libor scam. In May 2012, the Community Bank & Trust of Sheboygan, Wisconsin, filed a Rico lawsuit involving mega-bank manipulation of interest rates, naming Bank of America, JPMorgan Chase, Citigroup, and others. [7] The suit was filed as a class action to encourage other local, independent banks to join in. On July 12, the suit was consolidated with three other Libor class action suits charging violation of the anti-trust laws.

The Sheboygan bank claims that the Libor rigging cost the bank $64,000 in interest income on $8 million in floating-rate loans in 2008. Multiplied by 7,000 US community banks over 4 years, the damages could be nearly $2 billion just for the community banks. Trebling that under Rico would be $6 billion.

Rico suits against banking partners of Mers

Then there are the Mers lawsuits. In the State of Louisiana, 30 judges representing 30 parishes are suing 17 colluding banks under Rico, stating that the Mortgage Electronic Registration System (Mers) is a scheme set up to illegally defraud the government of transfer fees, and that mortgages transferred through Mers are illegal. A number of courts have held that separating the promissory note from the mortgage - which the Mers scheme does - breaks the chain of title and voids the transfer. [8]

Several states have already sued Mers and their bank partners, claiming millions of dollars in unpaid recording fees and other damages. These claims have been supported by numerous studies, including one asserting that Mers has irreparably damaged title records nationwide and is at the core of the housing crisis. What distinguishes Louisiana's lawsuit is that it is being brought under Rico, alleging wire and mail fraud and a scheme to defraud the parishes of their recording fees.

Readying the lifeboats

Trebling the damages in all these suits could sink the banking Titanic. As Seumas Milne noted in The Guardian:

Tougher regulation or even a full separation of retail from investment banking will not be enough to shift the City into productive investment, or even prevent the kind of corrupt collusion that has now been exposed between Barclays and other banks ... .

Only if the largest banks are broken up, the part-nationalized outfits turned into genuine public investment banks, and new socially owned and regional banks encouraged can finance be made to work for society, rather than the other way round. Private sector banking has spectacularly failed - and we need a democratic public solution.

If the last quarter century of US banking history proves anything, it is that our private banking system turns malignant and feeds off the public when it is deregulated. It also shows that a parasitic private banking system will not be tamed by regulation, as the banks' control over the money power always allows them to circumvent the rules.

We the people must transparently own and run the nation's central and regional banks for the good of the nation, or the system will be abused and run for private power and profit as it so clearly is today, bringing our nation to crisis again and again while enriching the few.

Notes: 1. Private Banks Have Failed - We Need a Public Solution
2. See here.
3. See here.
4. See here.
5. See here.
6. See here.
7. See here. 8. See here.

July 23, 2012

The Cost of the Left-wing’s Ongoing Vendetta Against Reagan

What causes some people to feel compelled to make uninformed digs at President Reagan? Is it just that they are brainwashed or, if they are thoughtful people, just too involved with other matters to be well informed about Reagan? How many of the digs at Reagan are deflective activity by Clinton/Bush/Cheney/Obama shills diverting attention from the real causes of our woes?

Reagan and his administration are not above criticism, but Reagan most certainly is not to blame for the financial crisis or for the neoconservative wars for American hegemony.

The Reagan administration’s interventions in Grenada and Nicaragua were not, as is sometimes claimed, precursors to Clinton’s war on Serbia and the Bush and Obama wars on Iraq, Afghanistan, Libya, and Syria, with more waiting in the wings. Reagan saw his interventions in the context of the Monroe Doctrine, not as an opening bid for world hegemony.

The purpose of Reagan’s interventions was to convince the Soviets that there would be no more territorial gains for communism. The interventions were part of Reagan’s strategy of bringing the Soviets to the table to negotiate the end of the cold war. Reagan believed that getting the Soviets to negotiate would be more difficult if they were still making territorial gains or gains that the Soviets might perceive in that way. Possibly, Reagan’s advisers were wrong to put a Marxist interpretation on political events in Grenada and Nicaragua, but that is the way Reagan understood them.

When Reagan understood what the Israelis had lured him into in Lebanon, he pulled out. Reagan opposed war as an instrument of American hegemony. It is the neoconservatives who use war to achieve hegemony. Reagan was not a neoconservative.

The left-wing is more interested to blame Reagan for the financial crisis than to understand the crisis. The left-wing accuses Reagan of deregulating the financial system and of setting up a “Plunge Protection Team” to rig financial markets.

I have found that giving people information that they do not want to hear is a frustrating experience. Heaven forbid that anyone would have to overcome their ignorance or rethink their prejudices. But I keep trying.

First, however, I want to answer two questions: What is the source of the left’s animosity toward Reagan, and “why does Roberts keep defending Reagan?” The latter question is usually answered for me by people who know nothing of my motives but are nevertheless comfortable in answering for me: “He was part of it and can’t admit he was wrong.”

The left’s animosity toward Reagan is a mystery. Consider Reagan’s economic and foreign policies. The stagflation that Reagaonmics cured was hurting the poor, not the rich. The rich raise prices; the poor pay the higher prices. There is always a risk of a cold war going hot. Negotiating the end of the cold war did not please the military/security complex, and apparently not the leftwing peaceniks either.

The first business of the new Reagan administration was to complete the Carter administration’s plan to save autoworker jobs by imposing quotas on imports of Japanese cars. Reagan did this even though it demoralized his conservative free trade supporters. Reagan got no thanks from the left who denounced him instead for bailing out his Republican buddies in the auto business.

I still hear from Readers hostile to Reagan that Reagan’s firing of the illegally striking air traffic controllers is proof that he was a “union buster.” One sometimes feels sorry for people who have so little grasp of politics. For a new president to let himself be rolled up by a poorly-advised, illegally-striking public sector union would have rendered Reagan impotent and without the power to achieve his ambitious agenda of changing the economic and foreign policies of the US. Even Reagan’s court historians do not realize Reagan’s extraordinary achievements in economic and foreign policy.

It wasn’t Reagan’s agenda that was anti-left; it was the rhetoric Reagan used in order to keep the conservative base in line. Conservatives did not understand supply-side economics any better than did the economics profession and Wall Street. Conservatives wanted a balanced budget, which is their solution to every economic problem. Reagan was talking about a 30% reduction in marginal tax rates (the rate of tax applied to increases in income) and about faster depreciation schedules for capital investments.

What this meant to conservatives was more budget deficits. Wall Street never lobbied me to repeal Glass-Steagall, but Wall Street did lobby me to water down the Reagan tax rate reductions.

On the cold war front, conservatives were very suspicious of negotiating with the Soviets. Some conservatives put out the story that Gorbachev was the anti-christ, that he would take Reagan to the cleaners and we would all end up living under the red flag of communism.

All of this was over the heads of the left-wing. Being creatures of words, the left was moved by Reagan’s words, not by his actions. Whatever words David Stockman and others put in his speeches about cutting back government and the welfare state, the record is clear that Reagan did not cut back government or abolish the welfare state.

I defend Reagan because I am fair and believe people should be judged on their real record, not on a fabricated or demonized one. More importantly, although people seem unable to learn from history, a lack of understanding can lead to the wrong lessons being drawn from the past.

For example, by the time of George W. Bush’s presidency, jobs offshoring by US corporations had reduced US GDP growth and employment opportunities in manufacturing. The Bush administration’s solution was to reapply the Reagan solution–tax rate reductions. However, Reagan’s tax policy was directed at increasing the supply of goods and services relative to demand in order to stop the rise in inflation and unemployment. Supply-side economics is not a cure for declining employment opportunities and GDP growth due to jobs offshoring. From a policy standpoint, the Bush tax rate reduction was pointless, and it was ineffective as an answer to an economy in decline from jobs offshoring.

The Republicans, however, misreading the past, thought that tax reductions and de-regulation were the stimulus that the economy needed. Their mistake has left us with a hollowed out economy with the once prosperous middle class in decline and with an ongoing financial crisis that is held off with the Federal Reserve’s policy of negative rates of interest on overpriced bonds.

If all the uninformed people who ranted about “Reagan deficits” and “tax cuts for the rich” had bothered to educate themselves about the policy that they so desperately wanted to demonize, a wider understanding of the Reagan era might have created an audience among Washington policymakers for writings by myself and others who stressed, to no effect, the adverse impact of jobs offshoring on the economy. Instead, this cancer, masquerading as the benefits of free trade, has gone untreated for 20 years.

I agree that this is a lot of history in a few words, but it suffices to make the point. Now to get on with Reagan’s non-responsibility for the financial crisis and war on terror.

The Presidents Working Group on Financial Markets, created in the last year of the Reagan administration, was labeled the “plunge protection team” by the Washington Post. The Working Group consists of the Treasury Secretary, Federal Reserve Chairman, and the financial regulators.

I do not know the reason the Working Group was formed other than it appears to be a response to the October 19, 1987 stock market decline. I suspect that there was concern that speculators either drove down the market by short selling or took advantage of a decline in the market to make money by short selling that worsened the crisis. If speculators were indeed gaming the market at the expense of pension funds, IRAs, and long term investors, the government might have felt obliged to come up with new regulations or to use moral suasion or even direct intervention in order to protect legitimate investors from the greed of speculators. If speculators short the market and the Federal Reserve buys long, the shorts don’t pan out for the speculators.

How the Working Group has evolved since 1988 I do not know. The Treasury itself seldom has any money, especially these days when it lives hand-to-mouth from bond auction to bond auction. It is the Federal Reserve that can create money. It would be easy for the Federal Reserve to offset the effect of short sales on the market average by purchasing stock index futures.

Whatever the original purpose of the Working Group, it was not to help protect the foreign exchange value of the dollar from a low interest rate policy that the Federal Reserve regards as a necessary response to the 2008 financial crisis in order to maintain the solvency of banks too big to fail, and it was not to disguise the exit of investors from the stock market. The purpose of the Working Group was to prevent private speculators from gaming the market or to make them pay a price if they did.

The Federal Reserve’s use of the Working Group has probably evolved with the crisis, just as the Federal Reserve has used its balance sheet in new ways that go beyond its normal operations. However, it is absurd to blame Reagan for the Federal Reserve’s different use or misuse of the Working Group twenty-four years later, if that is indeed what is occurring.

What explains the left-wing’s obsession with Reagan to the neglect of the serious war crimes of the Clinton, Bush, and Obama regimes and to the neglect of the destruction of the civil liberties guaranteed by the Constitution? Reagan is not responsible for any of this. Reagan had no war on terror, no PATRIOT Act, and no police state. Reagan neither assassinated nor put in indefinite detention any US citizen.

As for financial deregulation, it began two presidents after Reagan with the Clinton administration’s repeal of Glass-Steagall.

By curing stagflation, Reagan gave the economy a new lease on life. By ending the cold war, Reagan made it possible to curtail Pentagon spending and to balance the budget. It is not Reagan’s fault that Washington responded to the Soviet collapse with a new militarism in pursuit of world hegemony. That goal appeared with the neoconservatives’ “Project for the New American Century” a decade after Reagan left office.

Yet, the left-wing remains obsessed with Ronald Reagan, wasting its energy in uninformed tirades against an administration that many leftists are too young to have experienced and know nothing about.

July 20, 2012

Chris Cook: Libor and Oil Market Manipulation – Rage Against the Dying of the Light

By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange

A generation of markets is dying and the era of the Middleman is coming to an end. The ‘Bezzle’ – as J K Galbraith described financial misbehaviour in a boom, revealed by a bust – is now coming to light.

We now see a wave of popular rage against the freshly revealed manipulation by banks of LIBOR, the London Interbank Offered Rate benchmark for interest rates which is the cornerstone of the money market.

This manipulation in the financial world is being augmented by a groundswell of protest against manipulation taking place in the real world. Here, the allegation is that the Brent/BFOE (Brent, Forties, Oseberg, Ekofisk) crude oil benchmark price, against which global crude oil prices are set, is the subject of routine manipulation by market participants, particularly investment banks and traders of physical oil.

In both cases, the popular outcry is based upon misconceptions as to what has actually been going on. The good news in the oil market at least is that the manipulation which is being revealed is nowhere near as serious in its effects on the general public as is believed. The bad news is that the true manipulation, as yet still concealed, is far more serious than anyone has yet conceived.

They Shoot Horses, Don’t They?

The current LIBOR pogroms are the regulatory equivalent of flogging a dead horse. The Interbank money market in wholesale lending had a heart attack in 2007 and essentially died in October 2008 with the collapse of Lehman Brothers. The money market is now on life support directly to central banks and to all intents and purposes there is no independent Interbank Market in money and there never will be again.

LIBOR is dead, and the markets are moving on.

The Brent/BFOE crude oil market benchmark, on the other hand, has been in failing health for a long time as the North Sea oil production upon which it is based has been in secular decline. Despite the best efforts of Platts – the Price Reporting Agency who are getting most of the flak – the market is at the point where if it were a horse it would be put down.

Market Manipulation

A regulator friend of mine used to joke that since excessive market manipulation is a US felony, the implication is that there is such a thing as ‘acceptable’ market manipulation. My response was that trading might be defined as ‘acceptable market manipulation’.

While producers desire a stable high price, and consumers desire a stable low price, for a trading intermediary who aims for transaction profit, price stability is Death, and the only bad news is no news at all.

I am not familiar enough with the endemic LIBOR manipulation to say much about the victims and their losses. But I can say that from its inception in the mid 1980s crude oil trading and the associated fun and games in the Brent/BFOE complex of contracts have taken place entirely among consenting adults. The outcome of the routine short term ‘micro’ manipulation by oil market participants has been pretty much a zero sum game between trading intermediaries.

Some of these middlemen are traders of physical oil like Vitol and some of them are the ‘Wall Street Refiner’ traders in investment banks such as Goldman Sachs. There have been no direct effects from these continuing trader games on the man in the street, but there are indirect effects such as the higher cost of energy investment arising out of unnecessarily high market price volatility.

Whenever producers or consumers can gain market power, through some kind of leverage, to either support or suppress prices in the medium and long term, then they will. The history of markets is full of examples of such ‘macro’ market manipulation and while LIBOR is among them, that is only now of historic interest, now that the market is dead. In crude oil, on the other hand, we are approaching the end of the greatest macro market manipulation in the history of commodity markets, by comparison to which Yasuo Hamanaka’s $2bn manipulation of the copper markets through Sumitomo is a car boot sale.

Cui Bono

Ask yourself who benefits from high oil prices? It’s the producers, stupid. From 2005 onwards a market bubble in crude oil has been deliberately created. This has been achieved opaquely through use of the Prepay funding used by Enron to sell commodities at a discount for cash now, and deliver them later.

Creditors and investors who were unaware of Enron’s ‘off-balance sheet’ liabilities were misled as to the true financial position and were thereby defrauded. Most oil market participants have been similarly misled as to the true position in the oil market through the use of prepays by producers, funded by passive investors.

In simple terms, risk averse investors have lent dollars to producers, and producers have lent oil to investors. None of the resulting changes of ownership of oil in the physical market were visible to other market participants, and the price has become a completely distorted and financialised bubble as a result.

The bubble first collapsed during the second half of 2008 from $147 to $35 per barrel and it was then re-inflated in 2009 through the use of prepays, facilitated by US investment banks to the benefit of producers. Oil prices have since been kept pegged as far as possible between levels which: (a) do not endanger US presidential re-election; and (b) enable producer populations to be financially anaesthetised.

A key element in the evolution of this macro manipulation has been that banks as financial intermediaries are no longer capitalised to take risks in the way that they could and did prior to the collapse of the banking system. The outcome has been that market risk – ie the risk that the oil price will fall – is no longer held by the banks but has been transferred to passive and risk averse investors.

The motive of passive investors is not the speculative desire of active investors to make a transaction profit, but its very opposite: the desire to avoid loss. So they invest in oil funds in order to offload the risk that the dollar will depreciate in value relative to oil. Unfortunately, they are blithely unaware that they have a massive market risk if the oil price falls in a market ‘bust’, as it did in 2008; has recently been doing; and will continue to do at least until the end of the year. This is a regulatory accident waiting to happen.


The direct ‘Peer to Peer’ connections between producers and consumers which were first demonstrated by the music file-sharing phenomenon Napster have also been evident in the financial markets for some time through Peer to Peer lending businesses such as Zopa, and the new phenomenon of ‘crowd-sourcing’ of investment and donations.

But it is not widely understood that in financial services, the transition of middlemen to a role as service providers managing risk, business platform and direct P2P relationships is actually in the interests of the middlemen themselves. The reason is that when credit or market risk is with end users, then the only capital needed by service providers is the limited amount necessary to cover operating costs.

This is precisely why investment banks starved of capital have since 2008 been originating and selling the new generations of funds responsible for the bubbles, where the market risk is with the investors, and not the banks. Unfortunately they have also been able to prey upon end users through their privileged ‘asymmetric’ access to markets and market data and through trading such as ‘High Frequency Trading’ (HFT).

Intermediaries are also responsible for short term micro manipulation, but they are not directly guilty of the macro manipulation of markets which has inflated the medium and long term market price because they simply do not have the capital to invest in this way any more, even if regulators allowed it.

The End Game

Once the current bubbles collapse, which is only a matter of time, I believe that we will see markets evolve to the next ‘adjacent possible’, which will be the widespread – and necessarily transparent – use of direct Peer to Peer relationships through a new generation of market instruments, of which Enron’s Prepay was the first.

This return to what is in fact an ancient form of financing and funding will complete a cycle which began some 300 years ago when modern money and capital markets began with the foundation of the first Central Banks and the wave of Joint Stock Companies which financed and funded the Industrial Revolution.

July 19, 2012

U.S. Is Building Criminal Cases in Rate-Fixing

As regulators ramp up their global investigation into the manipulation of interest rates, the Justice Department has identified potential criminal wrongdoing by big banks and individuals at the center of the scandal.

The department’s criminal division is building cases against several financial institutions and their employees, including traders at Barclays, the British bank, according to government officials close to the case who spoke on the condition of anonymity because the investigation is continuing. The authorities expect to file charges against at least one bank later this year, one of the officials said.

The prospect of criminal cases is expected to rattle the banking world and provide a new impetus for financial institutions to settle with the authorities. The Justice Department investigation comes on top of private investor lawsuits and a sweeping regulatory inquiry led by the Commodity Futures Trading Commission. Collectively, the civil and criminal actions could cost the banking industry tens of billions of dollars.

Authorities around the globe are examining whether financial firms manipulated interest rates before and after the financial crisis to improve their profits and deflect scrutiny about their health. Investigators in Washington and London sent a warning shot to the industry last month, striking a $450 million settlement with Barclays in a rate-rigging case. The deal does not shield Barclays employees from criminal prosecution.

The multiyear investigation has ensnared more than 10 big banks in the United States and abroad. With the prospects of criminal action, several firms, including at least two European institutions, are scrambling to arrange deals, according to lawyers close to the case. In part, they are trying to avoid the public outcry that stemmed from the Barclays case, which prompted the resignation of top executives.

The criminal and civil investigations have focused on how banks set the London interbank offered rate, known as Libor. The benchmark, a measure of how much banks charge one another for loans, is used to determine the borrowing costs for trillions of dollars of financial products, including mortgages, credit cards and student loans. Cities, states and municipal agencies also are examining whether they suffered losses from the rate manipulation, and some have filed suits.

With civil actions, regulators can impose fines and force banks to overhaul their internal controls. But the Justice Department would wield an even more potent threat by bringing criminal fraud cases against traders and other employees. If found guilty, they could face jail time.

The criminal investigations come at a time when the public is still simmering over the dearth of prosecutions of prominent executives involved in the mortgage crisis. The continued trouble in the financial sector, including the multibillion-dollar trading losses at JPMorgan Chase, have only further fueled the anger of consumers and investors.

But the Libor case presents a potential opportunity for prosecutors. Given the scope of the problems and the number of institutions involved, the rate-rigging investigation could provide a signature moment to hold big banks accountable for their activities during the financial crisis.

“It’s hard to imagine a bigger case than Libor,” said one of the government officials involved in the case.

The Justice Department has jurisdiction over the London bank rate because the benchmark affects markets in the United States. It could not be learned which institutions the criminal division is chasing next.

According to people briefed on the matter, the Swiss bank UBS is among the next targets for regulatory action. The Commodity Futures Trading Commission is pursuing a potential civil case against the bank. Regulators at the agency have not yet decided to file an action against the bank, nor have settlement talks begun. UBS has already reached an immunity deal with one division of the Justice Department, which could protect the bank from criminal prosecution if certain conditions are met. The bank declined to comment.

The investigation into the global banks is unusually complex and it could continue for years, and ultimately end in settlements rather than indictments, said the officials close to the case. For now, regulators are building investigations piecemeal because the facts of the cases vary widely. That could make it difficult to compile a global settlement, although some banks would prefer an industrywide deal to avoid the harsh glare of the spotlight, said a lawyer involved in the case.

American authorities face another complication as they build cases. Investigators still lack access to certain documents from big banks.

Before gathering some e-mail and bank records from overseas firms, the Justice Department and American regulators need approval from British authorities, according to the people close to the case. But officials in London have been slow to act, the people said. At times, British authorities have hesitated to investigate.

By contrast, the Justice Department and the Commodity Futures Trading Commission have spent two years building cases together. Lanny Breuer, head of the Justice department’s criminal division, has close ties with David Meister, the former federal prosecutor who runs the commission’s enforcement team.

In the Barclays case, the British bank was accused of reporting false rates to squeeze out extra trading profits and fend off concerns about its health. During the crisis, banks feared that reporting high rates would suggest a weak financial position.

Lawmakers in London and Washington are examining whether regulators looked the other way as banks artificially depressed the rates. On Friday, it was disclosed that a Barclays employee notified the Federal Reserve Bank of New York in April 2008 that the firm was underestimating its borrowing costs. Despite the warning signs, the illegal actions continued for another year.

But in April 2008, a senior enforcement official at the Commodity Futures Trading Commission, Vincent McGonagle, opened an investigation. He directed the case along with another longtime official, Gretchen Lowe.

At first the case stalled as the agency waited months to receive millions of pages of documents when Barclays pushed back against the American regulators, according to the officials close to the case. By the fall of 2009, the trading commission received a trove of information, providing a broad view into the wrongdoing.

A series of incriminating e-mail and instant messages, regulators say, laid bare the multiyear scheme. In one document, a Barclays employee said the bank was “being dishonest by definition.”

The case gained further traction in early 2010, when the agency’s enforcement team engaged the Justice Department. The department’s criminal division, led by Mr. Breuer, agreed that regulators had a strong case. The investigation continued until January 2012, when the trading commission notified Barclays lawyers that they were entering the final stages before deciding about an enforcement action.

As part of the deal, regulators pushed the bank to adopt new controls to prevent a repeat of the problems. Among other measures, the bank must now “implement firewalls” to prevent traders from improperly talking with employees who report rates.

The bank says that it provided extensive cooperation during the three inquiries, and has spent around $155 million on its own three-year investigation. Because it agreed to settle with British authorities, Barclays received a 30 percent fine reduction.

In the United States, Barclays offered to pay a fine of $200 million to the C.F.T.C., slightly below the initially proposed range, according to government officials close to the case. Mr. Meister’s team soon accepted the offer, securing the biggest fine in the commission’s history.

On June 27, British and American authorities announced the deal with Barclays, which agreed to pay more than $450 million total. “For this illegal conduct, Barclays is paying a significant price,” Mr. Breuer said then.

July 18, 2012

HSBC let drug gangs launder millions

HSBC moved huge sum from Mexico into the U.S. between 2007 and 2008

Provided services for Saudi Arabia's Al Rajhi Bank linked to financing terrorism

Senate investigation suggests they also moved money tied to Iran

Accuses bank of 'pervasively polluted' culture

Another hammer blow to the credibility of British banking system after Barclays was fined for allegedly rigging LIBOR interest rate

Britain's biggest bank allowed rogue states and drugs cartels to launder billions of pounds through its branches.

HSBC stands accused of fostering such a ‘polluted’ culture it became a conduit for criminal enterprises.

A top executive at the bank sensationally quit yesterday in front of a US Senate hearing that exposed the scale of the scandal.

Following the Barclays rate-fixing revelations, it deals another blow to the City of London’s reputation.

HSBC – one of the few UK banks to survive the financial crisis with its reputation intact – now faces up to £640million in penalties. A devastating 335-page Senate report accused HSBC of ignoring warnings and breaching safeguards that should have stopped the laundering of money from Mexico, Iran and Syria.

The bank failed to monitor a staggering £38trillion of money moving across borders from places that could have posed a risk, including the Cayman Islands and Switzerland. The failures stretched to dealings with Saudi Arabian bank Al Rajhi, which was linked to the financing of terrorism following 9/11.

HSBC’s American arm, HBUS, initially severed all ties with Al Rajhi. But it later agreed to supply the Saudi bank with US banknotes after it threatened to pull all of its business with HSBC worldwide.

According to the report, HBUS also accepted £9.6billion in cash over two years from subsidiaries without checking where the money came from.

In one instance, Mexican and US authorities warned HSBC that £4.5billion sent to the US from its Mexican subsidiary ‘could reach that volume only if they included illegal drug proceeds’.

Concerns over the bank’s links to Mexican drug dealers included £1.3billion stashed in accounts in the Cayman Islands. One HSBC compliance officer admitted the accounts were misused by ‘organised crime’.

London-based banker David Bagley, head of HSBC’s compliance division, which is meant to prevent breaches of the law, quit in front of the Senate committee. He had been with the bank for 20 years.

The affair is also an embarrassment for David Cameron, because his trade envoy Stephen Green chaired HSBC during the period covered by the allegations.

John Mann, a Labour MP on the influential Treasury committee, last night demanded that Lord Green resign or be sacked. ‘Someone whose bank has been assisting murdering drug cartels and corrupt regimes across the world should not be in charge of a government portfolio,’ he said.

A spokesman for the Prime Minister backed the peer – officially known as Baron Green of Hurstpierpoint – saying he was doing an excellent job and would play an important role during the Olympics. No 10 sources said Mr Cameron has not questioned Lord Green about his role in the scandal.

Labour MP Pat McFadden, a member of the Treasury select committee, stopped short of calling for Lord Green to resign over the affair, but said the trade minister should be quizzed over what he knew.

‘I don’t know the timeline of this, but if something was going on at the time anyone was chairman of the bank they should be expected to be asked questions about this,’ he said.

Evidence in the Senate report shows that HSBC staff sought to get round sanctions that prevent American firms doing business with Iran.

It said: ‘From 2001 to 2007, HSBC affiliates sent almost 25,000 transactions involving Iran worth over $19billion (£12billion) through HBUS and other US accounts, while concealing any link with Iran in 85 per cent of the transactions.’

The bank’s compliance division ‘allowed the HSBC affiliates to continue to engage in these practices, which even some within the bank viewed as deceptive, for more than five years without disclosing the extent of the activity to HBUS’.

Many of HSBC’s breaches relate to its use of so-called bearer share accounts, in which ownership of shares and the income they incur can be passed from person to person in secrecy.

Senator Carl Levin, a Michigan Democrat who is leading the investigation, said HSBC had been ‘pervasively polluted for some time’. He added: ‘Banks that ignore money laundering rules are a big problem for our country.

‘In an age of international terrorism, drug violence in our streets and on our borders, and organised crime, stopping illicit money flows that support those atrocities is a national security imperative.’

In a statement, HSBC said: ‘We will apologise, acknowledge these mistakes, answer for our actions and give our absolute commitment to fixing what went wrong.’

The bank says it has sharpened up its controls and doubled spending on compliance to £255million.

It also said it was closing 20,000 accounts in the Cayman Islands as a result of the investigation

Saudi terror links

terror funding? The probe has examined links between HSBC and the Saudi Arabian Al Rajhi Bank

The Senate probe also examined banking HSBC did in Saudi Arabia with Al Rajhi Bank, which the report said has links to financing terrorism.

Evidence of those links emerged after the Sept 11, 2001 attacks on the United States, the Senate report said, citing U.S. government reports, criminal and civil legal proceedings and media reports.

In 2004, Al Rajhi sued the Wall Street Journal, which had published an article about U.S. and Saudi authorities monitoring accounts. The article referenced Al Rajhi.

Al Rajhi said in response to a WSJ story that it 'unequivocally condemns terrorism'. Al Rajhi and the paper settled in 2004.

The paper did not pay damages and stated that it 'did not intend to imply an allegation that (Al Rajhi) supported terrorist activity, or had engaged in the financing of terrorism', the Senate report said.

In 2005, HSBC told its affiliates to no longer do business with the bank, the report said. Four months later, HSBC officials reversed course, allowing affiliates to decide whether to continue to do business with Al Rajhi.

A Middle Eastern unit of HSBC continued doing business with the bank, the report said. HSBC ultimately stopped helping the bank handle certain types of transactions, and HSBC compliance officials rebuffed other HSBC bankers seeking to maintain ties to the bank.

Then in late 2006, Al Rajhi threatened to yank all of its business with HSBC unless it regained access to using HSBC's bulk-cash transaction business, the Senate report said.

HSBC agreed to continue to provide the bank bulk shipments of U.S. dollars until 2010 when HSBC exited entirely the bulk-cash business.

Officials at Al Rajhi could not immediately be reached for comment.

Dealings with Iran

Some of the money that moved through HSBC was tied to Iran, the report said, which would violate U.S. prohibitions on transactions tied to it and other sanctioned countries.

To conceal the transactions, HSBC affiliates used a method called 'stripping,' where references to Iran are deleted from records. HSBC affiliates also characterized the transactions as transfers between banks without disclosing the tie to Iran in what the Senate report called a 'cover payment.'

HSBC 'failed to take decisive action to confront these affiliates and put an end to the conduct,' the report said.

Between 2001 and 2007, more than 28,000 transactions were identified by an outside auditor for HSBC that potentially could have run afoul of laws that prohibit transactions with sanctioned countries.

Of those, 25,000 involved Iran. A smaller number required additional analysis to determine if violations of U.S. regulations had occurred, the report said.

At the heart of HSBC's failings was the fact that it served as a hub for smaller financial firms needing access to the global banking system, the report said.

In one example detailed in the Senate investigation, HSBC continued to do business with one client that admitted to U.S. law enforcement that it had failed to maintain an effective anti-money laundering system.

The client, Sigue Corp, was a money processor in California, the report said. In 2008, the company agreed to a so-called deferred prosecution with the U.S. Justice Department and other U.S. agencies where it admitted to allowing millions of dollars of suspect transactions between 2003 and 2005.

Undercover U.S. officers, in a sting, even moved money through the company, explicitly telling Sigue agents they were moving illegal drug proceeds, the report said.