The real bank problem is not in the subprime market but is in the credit market, which has dried up and stopped because of capital requirements. The banking scheme itself has failed. As was learned by painful experience during the Great Depression, the economy cannot be rescued by simply propping up failed banks. The banking system itself needs to be overhauled and fast.
A Litany of Failed Rescue Plans
Credit has dried up because many banks cannot meet the capital requirement that limits their ability to lend. A bank’s capital – the money it gets from the sale of stock or from profits – can be fanned into more than 10 times its value in loans; but this advantage also works the other way.
While using $80 as a base in capital will produce $1,000 in loans, an $80 loss from default wipes out $80 in capital, reducing the sum that is lent by $1,000. The more credit failures the fewer loans. Failure to repay lowers the banks ability to grant more loans.
Since the banks have experienced widespread credit loan defaults, their capital base has shrunk. Some are in favor of another option buried in the 2008 voluminous rescue package – using a portion of the $700 billion to buy stock in the banks directly.
Plan B represented a controversial move toward nationalization, but it was an improvement over Plan A, which would have reduced capital requirements only by the value of the bad debts shifted onto the government’s books. In Plan B, the money spent on bank stock, increasing the banks’ capital base, which could then be leveraged into ten times that sum in loans.
One problem with Plan B was that it did not really mean nationalization (public ownership and control of the participating banks). Rather, it came closer to what we call "crony capitalism" or "corporate welfare."
The bank stock bought would be non-voting preferred stock, meaning the government would have no say in how the bank is run. The Treasury would just be feeding the bank money to do with as it would. Management could continue to collect enormous salaries while investing in wildly speculative ventures with the taxpayers’ money.
The banks could not be forced to use the money to make much-needed loans but could just use it to clean up their derivative-infested balance sheets. In the end, the banks can still go bankrupt, wiping out the taxpayers’ investment altogether.
Even if $700 billion were fanned into $7 trillion, the sum would not come close to removing the $180 trillion in derivative liabilities from the banks’ books. Shifting those liabilities onto the public purse would just empty the purse without filling the derivative black hole.
Plan C, the plan du jour, does impose some limits on management compensation. However, the more significant feature of this plan is the Fed’s new "Commercial Paper Funding Facility," which is now operational. The facility would open the Fed’s lending window for short-term commercial paper, the money all corporations need to fund their day-to-day business operations.
The Federal Reserve Bank of New York justified this extraordinary expansion of its lending powers by stating: "The CPFF is authorized under Section 13(3) of the Federal Reserve Act, which permits the Board, in unusual and exigent circumstances, to authorize Reserve Banks to extend credit to individuals, partnerships, and corporations that are unable to obtain adequate credit accommodations.
"The U.S. Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the New York Fed in support of this facility."
That means the government and the Fed are now committing money that is even more public and taking on even more public risk. The taxpayers are already tapped out, so the Treasury’s "special deposit" will no doubt come from U.S. bonds, meaning more debt on which the taxpayers have to pay interest.
The federal debt is winding up and running so high that the government stands to lose its own triple-A rating. The U.S. could be reduced to Third World status, with "austerity measures" being imposed as a condition for further loans, and hyperinflation running the dollar into oblivion. Rather than solving the problem, these "rescue" plans seem destined to make it worse.
The Collapse of a 300-Year Ponzi scheme
Not all the king’s men can put the private banking system together again, for the simple reason that it is a Ponzi scheme that has reached its mathematical limits. A Ponzi scheme is a form of pyramid scheme in which new investors must continually be sucked in at the bottom to support the investors at the top. In this case, new borrowers must continually be sucked in to support the creditors at the top. The Wall Street Ponzi scheme is built on "fractional reserve" lending, which allows banks to create "credit" (or "debt") with accounting entries.
Banks are now allowed to lend from 10 to 30 times their "reserves," essentially counterfeiting the money they lend. Over 97 percent of the U.S. money supply (M3) has been created by banks in this way. The problem is that banks create only the principal and not the interest necessary to pay back their loans.
Since bank lending is essentially the only source of new money in the system, someone somewhere must continually be taking out new loans just to create enough "money" (or "credit") to service the old loans composing the money supply.
This spiraling interest problem and the need to find new debtors has gone on for over 300 years -- ever since the founding of the Bank of England in 1694 – until the whole world has now become mired in debt to the bankers’ private money monopoly. As British financial analyst, Chris Cook observes:
"Exponential economic growth required by the mathematics of compound interest on a money supply based on money as debt must always run up eventually against the finite nature of Earth’s resources."6
The parasite has finally run out of its food source. However, the crisis is not in the economy itself, which is fundamentally sound – or would be with a proper credit system to oil the wheels of production. The crisis is in the banking system, which can no longer cover up the shell game it has played for three centuries with other people’s money.
We do not need the credit of private banks. A sovereign government can create its own. Now enter Obama and his 2010 Labor Day speech on a government run bank.
The New Deal Revisited
Today’s credit crisis is very similar to that facing Franklin Roosevelt in the 1930s. In 1932, President Hoover set up the Reconstruction Finance Corporation (RFC) as a federally owned bank that would bail out commercial banks by extending loans to them, much as the privately owned Federal Reserve is doing today.
However, like today, Hoover’s plan failed. The banks did not need more loans; they were already drowning in debt. They needed customers with money to spend and to invest.
President Roosevelt used Hoover’s new government-owned lending facility to extend loans where they were needed most – for housing, agriculture and industry. Many new federal agencies were set up and funded by the RFC, including the HOLC (Home Owners Loan Corporation) and Fannie Mae (the Federal National Mortgage Association, which was then a government-owned agency).
In the 1940s, the RFC went into overdrive funding the infrastructure necessary for the U.S. to participate in World War II, setting the country up with the infrastructure it needed to become the world’s industrial leader after the war.
The RFC was a government-owned bank that sidestepped the privately owned Federal Reserve; but unlike the private banks with which it was competing, the RFC had to have the money before lending it. The RFC was funded by issuing government bonds (I.O.U.s or debt) and relending the proceeds. The result was to put the taxpayers further into debt.
This problem could be avoided, however, by updating the RFC model. A system of public banks might be set up that had the power to create credit themselves, just as private banks do now.
A public bank operating on the private bank model could fan $700 billion in capital reserves into $7 trillion in public credit that was derivative-free, liability-free, and readily available to fund all those things we think we do not have the money for now, including the loans necessary to meet payrolls, fund mortgages, and underwrite public infrastructure.
Credit as a Public Utility
"Credit" can and should be a national utility, a public service provided by the government to the people it serves. Many people are opposed to getting the government involved in the banking system, but the fact is that the government is already involved. A modern-day RFC would actually mean less government involvement and a more efficient use of the already-earmarked $700 billion than policymakers are talking about now.
The government would not need to interfere with the private banking system, which could carry on as before. The Treasury would not need to bail out these banks, which could be left to those same free market forces that have served them so well up to now. The “too big to fail” would be done with and if banks went bankrupt, they could be put into FDIC receivership and nationalized.
The government would then own a string of banks, which could be used to service the depository and credit needs of the community. There would be no need to change the personnel or procedures of these newly nationalized banks. They could engage in "fractional reserve" lending just as they do now.
The only difference would be that the interest on loans would return to the government, defraying the tax burden on the populace; and the banks would start out with a clean set of books, so their $700 billion in startup capital could be fanned into $7 trillion in new loans.
This was the sort of banking scheme used in Benjamin Franklin’s colony of Pennsylvania, where it worked brilliantly well. The spiraling-interest problem was avoided by printing some extra money and spending it into the economy for public purposes. During the decades the provincial bank operated, the Pennsylvania colonists paid no taxes, there was no government debt, and inflation did not result.7
Like the Pennsylvania bank, a modern-day federal banking system would not actually need "reserves" at all. It is the sovereign right of a government to issue the currency of the realm. What backs our money today is simply "the full faith and credit of the United States," something the United States should be able to issue directly without having to draw on "reserves" of its own credit at the Federal Reserve.
If Congress were not prepared to go that far, a more efficient use of the earmarked $700 billion than bailing out failing banks would be to designate the funds as the "reserves" for a newly reconstituted RFC.
Rather than creating a separate public banking corporation called the RFC, the nation’s financial apparatus could be streamlined by simply nationalizing the privately owned Federal Reserve.
Since there is already successful precedent for establishing an RFC in times like these, that model could serve as a non-controversial starting point for a new public credit facility
The G-7 nations’ financial planners, appear intent on supporting the banking system with enough government-debt-backed "liquidity" to produce "an inflationary holocaust."
As the U.S. private banking system self-destructs, we need to ensure that a public credit system is in place and ready to serve the people’s needs in its stead.
