Two recent articles, representative of a flurry of similar ones about banking – even sharing one common bank, the Bank of England – contain information so radically at odds that it is hard to get them focused in the same planet.
And very disconcerting when you do.
Because if Anglo-American banking is going to follow a tendency in the EU countries of confiscating or discounting the deposits of individuals held in failing banks – a joint study in December 2012 (2) considers just that – then the Bank of England’s open admission that the populist theory of people like Ellen Brown and Occupy Wall Street has it right about how money is created, may be, as the Guardian reports, a “remarkable ... dose of honesty.” has occurred.
The third article is from our wayward Central Valley financial godfather, the Bank of America, long gone but not forgotten.
We offer no opinion. We just note that there seems to be a commotion going on in the underworld of organized banksters and that perhaps an enlightened citizenry ought to be paying some attention to it. – blj
The Guardian (UK)
The truth is out: money is just an IOU, and the banks are rolling in it
The Bank of England's dose of honesty throws the theoretical basis for austerity out the window
Back in the 1930s, Henry Ford is supposed to have remarked that it was a good thing that most Americans didn't know how banking really works, because if they did, "there'd be a revolution before tomorrow morning".
Last week, something remarkable happened. The Bank of England let the cat out of the bag. In a paper called "Money Creation in the Modern Economy", (1) co-authored by three economists from the Bank's Monetary Analysis Directorate, they stated outright that most common assumptions of how banking works are simply wrong, and that the kind of populist, heterodox positions more ordinarily associated with groups such as Occupy Wall Street are correct. In doing so, they have effectively thrown the entire theoretical basis for austerity out of the window.
To get a sense of how radical the Bank's new position is, consider the conventional view, which continues to be the basis of all respectable debate on public policy. People put their money in banks. Banks then lend that money out at interest – either to consumers, or to entrepreneurs willing to invest it in some profitable enterprise. True, the fractional reserve system does allow banks to lend out considerably more than they hold in reserve, and true, if savings don't suffice, private banks can seek to borrow more from the central bank.
The central bank can print as much money as it wishes. But it is also careful not to print too much. In fact, we are often told this is why independent central banks exist in the first place. If governments could print money themselves, they would surely put out too much of it, and the resulting inflation would throw the economy into chaos. Institutions such as the Bank of England or US Federal Reserve were created to carefully regulate the money supply to prevent inflation. This is why they are forbidden to directly fund the government, say, by buying treasury bonds, but instead fund private economic activity that the government merely taxes.
It's this understanding that allows us to continue to talk about money as if it were a limited resource like bauxite or petroleum, to say "there's just not enough money" to fund social programmes, to speak of the immorality of government debt or of public spending "crowding out" the private sector. What the Bank of England admitted this week is that none of this is really true. To quote from its own initial summary: "Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits" … "In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money 'multiplied up' into more loans and deposits."
In other words, everything we know is not just wrong – it's backwards. When banks make loans, they create money. This is because money is really just an IOU. The role of the central bank is to preside over a legal order that effectively grants banks the exclusive right to create IOUs of a certain kind, ones that the government will recognise as legal tender by its willingness to accept them in payment of taxes. There's really no limit on how much banks could create, provided they can find someone willing to borrow it. They will never get caught short, for the simple reason that borrowers do not, generally speaking, take the cash and put it under their mattresses; ultimately, any money a bank loans out will just end up back in some bank again. So for the banking system as a whole, every loan just becomes another deposit. What's more, insofar as banks do need to acquire funds from the central bank, they can borrow as much as they like; all the latter really does is set the rate of interest, the cost of money, not its quantity. Since the beginning of the recession, the US and British central banks have reduced that cost to almost nothing. In fact, with "quantitative easing" they've been effectively pumping as much money as they can into the banks, without producing any inflationary effects.
What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow. Government spending is the main driver in all this (and the paper does admit, if you read it carefully, that the central bank does fund the government after all). So there's no question of public spending "crowding out" private investment. It's exactly the opposite.
Why did the Bank of England suddenly admit all this? Well, one reason is because it's obviously true. The Bank's job is to actually run the system, and of late, the system has not been running especially well. It's possible that it decided that maintaining the fantasy-land version of economics that has proved so convenient to the rich is simply a luxury it can no longer afford.
But politically, this is taking an enormous risk. Just consider what might happen if mortgage holders realised the money the bank lent them is not, really, the life savings of some thrifty pensioner, but something the bank just whisked into existence through its possession of a magic wand which we, the public, handed over to it.
Historically, the Bank of England has tended to be a bellwether, staking out seeming radical positions that ultimately become new orthodoxies. If that's what's happening here, we might soon be in a position to learn if Henry Ford was right.
The Web of Debt
IT CAN HAPPEN HERE:
THE CONFISCATION SCHEME PLANNED FOR US AND UK DEPOSITORS
Confiscating the customer deposits in Cyprus banks, it seems, was not a one-off, desperate idea of a few Eurozone “troika” officials scrambling to salvage their balance sheets. A joint paper by the US Federal Deposit Insurance Corporation and the Bank of England dated December 10, 2012, shows that these plans have been long in the making; that they originated with the G20 Financial Stability Board in Basel, Switzerland (discussed earlier here); and that the result will be to deliver clear title to the banks of depositor funds.
New Zealand has a similar directive, discussed in my last article here, indicating that this isn’t just an emergency measure for troubled Eurozone countries. New Zealand’s Voxy reported on March 19th:
The National Government [is] pushing a Cyprus-style solution to bank failure in New Zealand which will see small depositors lose some of their savings to fund big bank bailouts . . . .
Open Bank Resolution (OBR) is Finance Minister Bill English’s favoured option dealing with a major bank failure. If a bank fails under OBR, all depositors will have their savings reduced overnight to fund the bank’s bail out.
Can They Do That?
Although few depositors realize it, legally the bank owns the depositor’s funds as soon as they are put in the bank. Our money becomes the bank’s, and we become unsecured creditors holding IOUs or promises to pay. (See here and here.) But until now the bank has been obligated to pay the money back on demand in the form of cash. Under the FDIC-BOE plan, our IOUs will be converted into “bank equity.” The bank will get the money and we will get stock in the bank. With any luck we may be able to sell the stock to someone else, but when and at what price? Most people keep a deposit account so they can have ready cash to pay the bills.
The 15-page FDIC-BOE document is called “Resolving Globally Active, Systemically Important, Financial Institutions.” It begins by explaining that the 2008 banking crisis has made it clear that some other way besides taxpayer bailouts is needed to maintain “financial stability.” Evidently anticipating that the next financial collapse will be on a grander scale than either the taxpayers or Congress is willing to underwrite, the authors state:
An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company [meaning the depositors] into equity [or stock]. In the U.S., the new equity would become capital in one or more newly formed operating entities. In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailed-in creditors would become the owners of the resolved firm. In either country, the new equity holders would take on the corresponding risk of being shareholders in a financial institution.
No exception is indicated for “insured deposits” in the U.S., meaning those under $250,000, the deposits we thought were protected by FDIC insurance. This can hardly be an oversight, since it is the FDIC that is issuing the directive. The FDIC is an insurance company funded by premiums paid by private banks. The directive is called a “resolution process,” defined elsewhere as a plan that “would be triggered in the event of the failure of an insurer . . . .” The only mention of “insured deposits” is in connection with existing UK legislation, which the FDIC-BOE directive goes on to say is inadequate, implying that it needs to be modified or overridden.
An Imminent Risk
If our IOUs are converted to bank stock, they will no longer be subject to insurance protection but will be “at risk” and vulnerable to being wiped out, just as the Lehman Brothers shareholders were in 2008. That this dire scenario could actually materialize was underscored by Yves Smith in a March 19th post titled When You Weren’t Looking, Democrat Bank Stooges Launch Bills to Permit Bailouts, Deregulate Derivatives. She writes:
In the US, depositors have actually been put in a worse position than Cyprus deposit-holders, at least if they are at the big banks that play in the derivatives casino. The regulators have turned a blind eye as banks use their depositaries to fund derivatives exposures. And as bad as that is, the depositors, unlike their Cypriot confreres, aren’t even senior creditors. Remember Lehman? When the investment bank failed, unsecured creditors (and remember, depositors are unsecured creditors) got eight cents on the dollar. One big reason was that derivatives counterparties require collateral for any exposures, meaning they are secured creditors. The 2005 bankruptcy reforms made derivatives counterparties senior to unsecured lenders.
One might wonder why the posting of collateral by a derivative counterparty, at some percentage of full exposure, makes the creditor “secured,” while the depositor who puts up 100 cents on the dollar is “unsecured.” But moving on – Smith writes:
Lehman had only two itty bitty banking subsidiaries, and to my knowledge, was not gathering retail deposits. But as readers may recall, Bank of America moved most of its derivatives from its Merrill Lynch operation [to] its depositary in late 2011.
Its “depositary” is the arm of the bank that takes deposits; and at B of A, that means lots and lots of deposits. The deposits are now subject to being wiped out by a major derivatives loss. How bad could that be? Smith quotes Bloomberg:
. . . Bank of America’s holding company . . . held almost $75 trillion of derivatives at the end of June . . . .
That compares with JPMorgan’s deposit-taking entity, JPMorgan Chase Bank NA, which contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives, the OCC data show.
$75 trillion and $79 trillion in derivatives! These two mega-banks alone hold more in notional derivatives each than the entire global GDP (at $70 trillion). The “notional value” of derivatives is not the same as cash at risk, but according to a cross-post on Smith’s site:
By at least one estimate, in 2010 there was a total of $12 trillion in cash tied up (at risk) in derivatives . . . .
$12 trillion is close to the US GDP. Smith goes on:
. . . Remember the effect of the 2005 bankruptcy law revisions: derivatives counterparties are first in line, they get to grab assets first and leave everyone else to scramble for crumbs. . . . Lehman failed over a weekend after JP Morgan grabbed collateral.
But it’s even worse than that. During the savings & loan crisis, the FDIC did not have enough in deposit insurance receipts to pay for the Resolution Trust Corporation wind-down vehicle. It had to get more funding from Congress. This move paves the way for another TARP-style shakedown of taxpayers, this time to save depositors.
Perhaps, but Congress has already been burned and is liable to balk a second time. Section 716 of the Dodd-Frank Act specifically prohibits public support for speculative derivatives activities. And in the Eurozone, while the European Stability Mechanism committed Eurozone countries to bail out failed banks, they are apparently having second thoughts there as well. On March 25th, Dutch Finance Minister Jeroen Dijsselbloem, who played a leading role in imposing the deposit confiscation plan on Cyprus, told reporters that it would be the template for any future bank bailouts, and that “the aim is for the ESM never to have to be used.”
That explains the need for the FDIC-BOE resolution. If the anticipated enabling legislation is passed, the FDIC will no longer need to protect depositor funds; it can just confiscate them.
Worse Than a Tax
An FDIC confiscation of deposits to recapitalize the banks is far different from a simple tax on taxpayers to pay government expenses. The government's debt is at least arguably the people’s debt, since the government is there to provide services for the people. But when the banks get into trouble with their derivative schemes, they are not serving depositors, who are not getting a cut of the profits. Taking depositor funds is simply theft.
What should be done is to raise FDIC insurance premiums and make the banks pay to keep their depositors whole, but premiums are already high; and the FDIC, like other government regulatory agencies, is subject to regulatory capture. Deposit insurance has failed, and so has the private banking system that has depended on it for the trust that makes banking work.
The Cyprus haircut on depositors was called a “wealth tax” and was written off by commentators as “deserved,” because much of the money in Cypriot accounts belongs to foreign oligarchs, tax dodgers and money launderers. But if that template is applied in the US, it will be a tax on the poor and middle class. Wealthy Americans don't keep most of their money in bank accounts. They keep it in the stock market, in real estate, in over-the-counter derivatives, in gold and silver, and so forth.
Are you safe, then, if your money is in gold and silver? Apparently not – if it’s stored in a safety deposit box in the bank. Homeland Security has reportedly told banks that it has authority to seize the contents of safety deposit boxes without a warrant when it’s a matter of “national security,” which a major bank crisis no doubt will be.
The Swedish Alternative: Nationalize the Banks
Another alternative was considered but rejected by President Obama in 2009: nationalize mega-banks that fail. In a February 2009 article titled "Are Uninsured Bank Depositors in Danger?", Felix Salmon discussed a newsletter by Asia-based investment strategist Christopher Wood, in which Wood wrote:
It is . . . amazing that Obama does not understand the political appeal of the nationalization option. . . . [D]espite this latest setback nationalization of the banks is coming sooner or later because the realities of the situation will demand it. The result will be shareholders wiped out and bondholders forced to take debt-for-equity swaps, if not hopefully depositors.
On whether depositors could indeed be forced to become equity holders, Salmon commented:
It’s worth remembering that depositors are unsecured creditors of any bank; usually, indeed, they’re by far the largest class of unsecured creditors.
President Obama acknowledged that bank nationalization had worked in Sweden, and that the course pursued by the US Fed had not worked in Japan, which wound up instead in a "lost decade." But Obama opted for the Japanese approach because, according to Ed Harrison, “Americans will not tolerate nationalization.”
But that was four years ago. When Americans realize that the alternative is to have their ready cash transformed into “bank stock” of questionable marketability, moving failed mega-banks into the public sector may start to have more appeal.
Ellen Brown is an attorney, chairman of the Public Banking Institute, and the author of eleven books, including Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free. Her websites are >webofdebt.com and ellenbrown.com. For details of the June 2013 Public Banking Institute conference in San Rafael, California, see here.
How the Case Against Bank of America CEO Fizzled
by Jesse Eisinger
The regulatory cloud has lifted for Kenneth D. Lewis. Last week, the former head of Bank of America received a modest penalty, paid for by his former employer, and a temporary ban from an industry he is no longer a part of.
In this seminal financial crisis investigation, regulators put on a master class in how to take a strong case and render it weak.
About The Trade
In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at email@example.com
It's worth recounting the story from its beginning.
Bank of America was an unwieldy agglomeration of dozens of banks tacked together with spit and Excel spreadsheets. As the world economy imploded in the middle of September 2008, the bank rushed into yet another acquisition, taking over Merrill Lynch. Merrill was failing, facing the same short-term funding run that would have collapsed all the investment banks had it not been for the government's intervention.
In what now reads as unintended comedy, Mr. Lewis called it the "strategic opportunity of a lifetime." Oh, and he said there had been "absolutely no pressure" from the Federal Reserve to take Merrill over. He would later admit this was untrue.
We now know, of course, that Bank of America's acquisition of Merrill was one of the worst deals in corporate history. As the two banks moved to consummate the merger in the fourth quarter of 2008, Merrill bled billions while paying huge bonuses to its executives. Bank of America ended up needing two bailouts from the Treasury Department, as well as extraordinary lending from the Federal Reserve.
On Feb. 4, 2010, Andrew M. Cuomo, then New York State's attorney general, accused Bank of America of misleading its shareholders and the public about the losses and the bonuses by failing to disclose them before shareholders voted on the merger on Dec. 5, 2008.
According to the complaint, Bank of America executives wrestled over whether to tell investors about the mounting Merrill losses. On Nov. 13, 2008, Bank of America's general counsel, Timothy J. Mayopoulos, and the bank's outside lawyers from Wachtell, Lipton, Rosen & Katz decided that the numbers would have to be disclosed in a Securities and Exchange Commission filing, according to the complaint. Then, they consulted with Joe Price, the bank's chief financial officer, and decided to reverse their decision.
On Dec. 4, the complaint alleges, Mr. Price knew that the losses had breached the threshold that Mr. Mayopoulos had laid out as the benchmark for requiring disclosure. The shareholder vote went ahead without any filing.
On Dec. 9, according to Mr. Cuomo's complaint, Mr. Mayopoulos listened while Mr. Price told the board that Merrill was going to lose $9 billion in the fourth quarter. This was not accurate. In truth, Merrill had already lost $9 billion and expected to lose billions more before the quarter was over. After the board meeting, Mr. Mayopoulos tried to discuss the losses with Mr. Price, who was unavailable.
The next morning, Mr. Mayopoulos was fired and frog-marched out of the building, according to people briefed on the matter.
Bank of America installed Brian T. Moynihan as general counsel of one of the nation's largest banks. Mr. Moynihan hadn't practiced law in 15 years. His legal career was such an afterthought that he had let his bar membership lapse. He would go on to become the chief executive of the bank.
Kenneth D. Lewis (Jason Miczek/Bloomberg via Getty Images )
Mr. Mayopoulos wasn't alone in his concerns. Merrill's auditors, Deloitte & Touche, told Bank of America that it "might want to consider" informing shareholders of the losses, according to the complaint. Bank of America's corporate treasurer, urging the bank to disclose, said in a conversation with Mr. Price that he did not want to be talking about Merrill's losses "through a glass wall over a telephone."
Merrill's fourth-quarter loss would eventually be more than $15.8 billion, and Merrill paid more than $3.6 billion in bonuses.
It is a crime to knowingly deceive shareholders about the financial condition of your company. Top officers of Bank of America knew about giant, surprising Merrill losses but did not disclose them promptly or precisely to the board or shareholders. They took steps to cut out people who advocated disclosing the information. That sure seems like a lot of smoke.
At least one regulator thought it merited a criminal investigation. The Office of the Special Inspector General for the Troubled Asset Relief Program referred the case for criminal investigation to the United States attorney's office in Manhattan.
Raymond J. Lohier, who was the chief of the securities and commodities fraud task force at the office, took charge of the investigation. But he seemed to view it with skepticism, according to a person close to the investigation. The Federal Reserve, both a regulator and one of the potential victims because it was lending to Bank of America, contended that it did not consider the losses material. The investigation didn't go anywhere.
Mr. Lohier, the Fed and the United States attorney's office declined to comment.
White-collar criminal cases are always difficult, and this one would have been especially hard. One big problem: Mr. Mayopoulos, the general counsel who was summarily fired, never flipped against his former bosses.
Moreover, the government's role in the transaction may have been ultimately absolving. Though his bank hadn't disclosed the Merrill losses publicly, Mr. Lewis used them as a cudgel to push for a second round of bailout money from the Treasury. Through the course of the various investigations, Bank of America executives cited the government's involvement in defending their actions.
The Justice Department, of course, isn't the only securities law enforcer out there. The Securities and Exchange Commission brought its own case. Internally, however, the S.E.C. felt that New York State complaint overreached, unconvinced, for instance, that Mr. Mayopoulos was fired over the issue of whether to disclose the losses. The agency eventually settled with the bank in August 2009 for a paltry $33 million.
Judge Jed S. Rakoff of the United States District Court in Manhattan found that amount ludicrously low. Several months later, the agency bumped it up to $150 million and Judge Rakoff reluctantly signed off, writing with obvious fury that this was "half-baked justice at best."
The New York case was settled last week. Mr. Lewis agreed to pay $10 million, which was provided by Bank of America, which also reached a settlement with the state for $15 million. He did not admit or deny any of the charges. He is barred from being an executive or director of a public company. I don't consider that entirely toothless; it damages his standing in society. But it's not exactly severe.
On Friday, Mr. Schneiderman's office intends to seek to permanently bar Mr. Price, who did not settle, from serving as a director, officer or in any capacity in the securities industry, according to a person close to the investigation. If it happens, it would be a serious accomplishment.
Mr. Price's lawyer did not respond to a request for comment.
The New York State attorney general, Eric T. Schneiderman, moved so slowly that a class-action lawsuit, relying on the facts laid out in the original complaint, settled for $2.4 billion in September 2012. A quirky New York legal decision precluded the state from getting greater restitution for taxpayers because the class-action suit had already been settled. With that opportunity blown, the attorney general went for a fine from Mr. Lewis.
Here's a "Where Are They Now?" roster. Mr. Lohier was appointed by President Obama to be a judge on the United States Court of Appeals for the Second Circuit. Mr. Mayopoulos became the chief executive of Fannie Mae. Mr. Cuomo became governor of New York.
Then there is Mr. Lewis's high-priced lawyer. The lawyer issued a scathing assessment of the case initially. Mr. Cuomo's decision to sue was "a badly misguided decision without support in the facts or the law," this lawyer said. There is "not a shred of objective evidence" to support the case.
Who was this zealous advocate? One Mary Jo White. You may recall her from such roles as the current chairwoman of the Securities and Exchange Commission.
And the public? We got as much justice as we have come to expect.
(1)In the modern economy, most money takes the form of bank
deposits. But how those bank deposits are created is often
misunderstood: the principal way is through commercial
banks making loans. Whenever a bank makes a loan, it
simultaneously creates a matching deposit in the
borrower’s bank account, thereby creating new money.
The reality of how money is created today differs from the
description found in some economics textbooks:
• Rather than banks receiving deposits when households
save and then lending them out, bank lending creates
• In normal times, the central bank does not fix the amount
of money in circulation, nor is central bank money
‘multiplied up’ into more loans and deposits.
Although commercial banks create money through lending,
they cannot do so freely without limit. Banks are limited in
how much they can lend if they are to remain profitable in a
competitive banking system. Prudential regulation also acts
as a constraint on banks’ activities in order to maintain the
resilience of the financial system. And the households and
companies who receive the money created by new lending
may take actions that affect the stock of money — they
could quickly ‘destroy’ money by using it to repay their
existing debt, for instance.
Monetary policy acts as the ultimate limit on money
creation. The Bank of England aims to make sure the
amount of money creation in the economy is consistent with
low and stable inflation. In normal times, the Bank of
England implements monetary policy by setting the interest
rate on central bank reserves. This then influences a range of
interest rates in the economy, including those on bank loans.
In exceptional circumstances, when interest rates are at their
effective lower bound, money creation and spending in the
economy may still be too low to be consistent with the
central bank’s monetary policy objectives. One possible
response is to undertake a series of asset purchases, or
‘quantitative easing’ (QE). QE is intended to boost the
amount of money in the economy directly by purchasing
assets, mainly from non-bank financial companies.
QE initially increases the amount of bank deposits those
companies hold (in place of the assets they sell). Those
companies will then wish to rebalance their portfolios of
assets by buying higher-yielding assets, raising the price of
those assets and stimulating spending in the economy.
As a by-product of QE, new central bank reserves are
created. But these are not an important part of the
transmission mechanism. This article explains how, just as in
normal times, these reserves cannot be multiplied into more
loans and deposits and how these reserves do not represent
‘free money’ for banks.
(2) Resolving Globally Active, Systemically Important,
Resolving Globally Active, Systemically Important, Financial Institutions
Federal Deposit Insurance Corporation and the Bank of England – http://www.fdic.gov/about/srac/2012/gsifi.pdf