There is no US economic recovery, quite the contrary in fact, there is at best a set of seemingly good looking numbers that indicate good news for financial institutions, and bad news for everyone else. In the same vein, the financial markets don’t reflect what goes on in the streets of America (and beyond). If they did, the Dow and S&P could not reach new records at a point in time when Bernanke himself claims the real economy’s numbers are too weak to taper.
So quit expecting Bernanke or his successor to do anything that would benefit you personally. The longer you keep hoping for that, the more you will be puzzled and disappointed. Central banks and governments worldwide have made the financial system their sole priority, and they will bleed their people dry in order to serve that priority. This should not come as a surprise, since it’s inevitable that if you allow money to enter into your political system, money will end up buying it outright. This happens for the same reason that bad money will always drive out good money from an economy. It’s elementary.
The Federal Reserve doesn’t give a hoot how many Americans are unemployed, how many children live in poverty, and how many millions survive on foodstamps. Their policies, all of them, are geared towards maximizing the profits in the financial system. If that is achieved by raising your standard of living, it will go up. If it’s achieved by making you poor, you will be made poor. In the present situation, where the financial system sits on trillions of dollars in debt and trillions more in highly leveraged wagers, your money, the fruit of your labor, is badly needed to not let the financial system go bust. The Federal Reserve’s iron hold on your money makes the outcome obvious and predictable (and for any loose ends, there’s always the Treasury department).
One area where we will see this inevitable outcome play out is in derivatives. Nothing in the system is riskier, more highly leveraged, or potentially more lethal to our real economies and societies. The political/financial system has made provisions for this in the form of legislation. Under Clinton, regulation of derivatives was strangled, under Bush, bankruptcy law was adapted to accommodate the derivatives markets, and under Obama, the proposed Dodd-Frank legislation is being molded to deliver the few remaining blows.
Dodd-Frank should have been a contemporary Glass-Steagall, but the area of the world where politics and finance converge has both changed and expanded too much over the past 80 years to make that possible. Legislation ostensibly aimed at protecting the people will instead turn out to do the exact opposite.
A good description on how it all works was quoted yesterday by Ellen Brown, and since she had only minor points to add, I’ll turn to the original, two years old, by writer and (documentary) filmmaker David Malone, who also writes a blog as Golem XIV, and add a few bits from Brown afterward.
If [governments convince their populace that private debts should be taken on to the public purse], then the banks are ‘saved’ with the added bonus that democracy and the ‘Rights’ it once guaranteed will all have been redefined as subordinate to finance and its contracts, and our citizenship will have become second to one’s contractual place in a web of private debts. Debts to the private lenders will become more important than taxes to the public exchequer. [..]
MF Global imploded when it could not get the short term funding it needed. There were two kinds of funding MF Global relied upon for its liquidity/cash flow: repo and hypothecation. For those not familiar, Repo is when a bank or brokerage ‘sells’ an asset for cash but with the agreement that it will re-purchase – hence ‘repo’ – the asset at an agreed date for an agreed price. It is not really a sale but a loan. Repo is the oxygen the financial world breathes. Repo is a $10 Trillion market.
The other main source of the essential short term funding was Hypothecation. This is when a bank or brokerage pledges an asset to a ‘lender’ in return for cash but the asset remains in the possession of the borrower. What the ‘lender’ gets is hypothetical control of the asset. Although the asset never actually changes hands, the new ‘owner’s’ hypothetical control of the asset allows her to do what she wishes with the asset. Including re-hypothecating the asset to another bank or brokerage. If she does so then the hypothetical control passes to yet another ‘owner’. Even though physically it remain where it started.
[..] not only did MF Global go bankrupt, but so also did some of their clients when they found the money they thought MF Global was holding for them, went unaccountably missing. Client’s money went missing because it was ‘mingled’ with the brokerage’s money when it should not have been. Brokers should keep them separate. But it seems in the ‘re-hypothecation’ of assets it was mingled. Former CEO of MF Global, Mr Corzine has sworn under oath he knew nothing about his co-mingling nor the irregularities with his company’s re-hypothecation. It has been rumoured the client’s money may now be, possibly, in the hands of JP Morgan.
This hint of illegality has grabbed everyone’s attention. But I think it is actually the legal part of the story not the possibly illegal part which is by far the more important.
[..] … what caused MF to collapse? The answer [lies] in a change to Bankruptcy laws that happened around the world between 2002 and 2005. This might seem like a detour into nerd city but it is not. It is the key.
When a company declares bankruptcy there is what the Americans call an ‘automatic stay’, which means all the assets left in a company at the moment it goes bankrupt are protected from the rush of creditor’s demands until appointed auditors can sort out who should get what. The automatic stay prevents a first come first served disorderly looting where those with the most muscle getting everything and everyone else getting nothing. As we are all painfully aware now, there is a legal pecking order to who gets paid before who, with Senior bond holders at the top. But, in America culminating in 2005 with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) the order was changed. And that change is the crucial event.
[..] what was not talked about was an amendment which was put into the bill …
[..] … one of the most vociferous sponsors of the amendment was none other than Senator Leach whose other claim to fame was the Gram-Leech-Bliley Act which repealed most of the Glass Steagall Act of 1933 whose repeal virtually assured that the present debt crisis would happen. [..] The amendment exempted repos (and hypothecated and re-hypothecated assets) and a whole range of derivatives from the automatic stay. It also allowed lower quality assets to qualify for the exemptions.
[..] … as the official report from the US Financial Crisis Inquiry Commission said,
… under a 2005 amendment to the bankruptcy laws, derivatives counterparties were given the advantage over other creditors of being able to immediately terminate their contracts and seize collateral at the time of bankruptcy. (p. 48)
So when a bank goes bankrupt, BEFORE even the most senior bond holders, the repo lenders and derivatives traders can remove, or keep, all the assets pledged to them.
This amendment which was touted as necessary to reduce systemic risk in financial bankruptcies also allowed a whole range of far riskier assets to be used, making them, too, immune from the automatic stay in the event of bankruptcy. Which meant traders flocked to a market where risky assets would be traded and used as collateral without apparent risk to the lender. The size of the repo market hugely increased and riskier assets were gladly accepted as collateral because traders saw that if the person they had lent to went down they could get your money back before anyone else and no one could stop them.
It also did one other thing. Because the repo and derivatives traders ran no risk – they could get their money out of a failing bank before anyone else, it meant they had no reason at all to try to stop a bank from going under. Quite the opposite.
[..] The same changes to the bankruptcy laws were also adopted in the UK and throughout Europe.
The bankruptcy laws allow a mechanism for banks to disembowel each other. The strongest lend to the weaker and loot them when the moment of crisis approaches. The plan allows the biggest banks, those who happen to be burdened with massive holdings of dodgy euro area bonds, to leap out of the bond crisis and instead profit from a bankruptcy which might otherwise have killed them. All that is required is to know the import of the bankruptcy law and do as much repo, hypothecation and derivative trading with the weaker banks as you can.
For the last four years who has been putting money in to the banks? And who has become a massive bond holder in all the banks? We have. First via our national banks and now via the Fed, ECB and various tax payer funded bail out funds. We are the bond holders who would be shafted by the Plan B looting. We would be the people waiting in line for the money the banks would have already made off with.
It is the money we have been putting in to bail out the biggest banks which they have then been using as collateral for offering weaker banks in weaker nations, repo loans or hypothecation. And the money or government bonds the weaker banks are using to pledge as assets and collateral for those loans or in derivative deals with the bigger banks is also from us. We have and are funding both sides of the deal.
The result is that the assets which the big banks would be legally allowed to seize and keep in the event of the failing bank actually going under would be ours.
To give a concrete example. Spain or Greece puts its tax payer money in to one of its insolvent banks. That bank then uses that money to get a short term repo or hypothecate it for a loan. Or it uses it to hedge its currency problems via a currency swap or buys CDS insurance on assets it is deeply worried about. If the weak bank then goes down all those assets are seized by the big bank who was lending or was the counter-party to the derivative deals. The tax payer gets zero. And there is no redress. It was legally done. And the money the Big bank would have used to get themselves into this position would be the bail out money we had earlier given to the mega banks. They would have used that money against us – again.
The largest banks, those with the greatest exposure to bank and sovereign bonds from the most indebted euro nations, have the most to gain from doing derivative. repo and hypothecation deals with the troubled euro area banks and nations. The more assets the weak banks and nations have pledged in deals with the Big banks, the more the Big banks will walk away with in the event of a crash. I suggest this is why, even as this crisis has worsened, the Big banks have been increasing by 18% their trade in derivatives and why Repo and hypothecation is as large or larger than even before the crash.
As I said before, Ellen Brown adds her own few bits to this yesterday:
Increased regulation and low interest rates are driving lending from the regulated commercial banking system into the unregulated shadow banking system. The shadow banks, although free of government regulation, are propped up by a hidden government guarantee in the form of safe harbor status under the 2005 Bankruptcy Reform Act pushed through by Wall Street. The result is to create perverse incentives for the financial system to self-destruct. [..]
The global credit collapse was triggered, it seems, not by wild subprime lending but by the rush to grab collateral by players with congressionally-approved safe harbor status for their repos and derivatives.
Bear Stearns and Lehman Brothers were strictly investment banks, but now we have giant depository banks gambling in derivatives as well; and with the repeal of the Glass-Steagall Act that separated depository and investment banking, they are allowed to commingle their deposits and investments. The risk to the depositors was made glaringly obvious when MF Global went bankrupt in October 2011. [..]
There is no way to regulate away this sort of risk. If both the conventional banking system and the shadow banking system are being maintained by government guarantees, then we the people are bearing the risk. We should be directing where the credit goes and collecting the interest. Banking and the creation of money-as-credit need to be made public utilities, owned by the public and having a mandate to serve the public. Public banks do not engage in derivatives.
Today, virtually the entire circulating money supply (M1, M2 and M3) consists of privately-created “bank credit” – money created on the books of banks in the form of loans. If this private credit system implodes, we will be without a money supply.
In light of all this, it may perhaps seem a bit odd that I originally started out writing this piece after reading the first installment of a Bloomberg series on US crop insurance, but don’t let’s forget that that is where derivatives originated: in farming. Stories about them go back at least as far as the Roman Empire, and probably further if you start digging, because some way or another of insuring a crop against failure makes a lot of sense, unlike the purely financial and highly explosive instruments derivatives have become today, where nobody cares what the underlying tangibles are, or even if there are any.
Still, reading what is going on with crop insurance may have a message for us when it comes to modern day “non-farming derivatives”: there are parties that engage in such high risk behavior that they need indemnity from losses lest they go under. They purchase this indemnity by buying national and international political systems, which allows them to transfer their losses to (the people in) the real economies, and keep the profits. Once this model is established, nothing bars them from adding ever more risk and leverage (and so they will), until the economy and society they rely on to cover their losses is wholly gutted to the bare and dry bone.
The “original” derivatives may come in an entirely different order of magnitude, but the mechanism by which they operate is remarkably similar. Perhaps they can thus make it easier to understand what goes on with their far more opaque and bloated siblings. Here’s David J. Lynch for Bloomberg:
A Depression-era program intended to save American farmers from ruin has grown into a 21st-century crutch enabling affluent growers and financial institutions to thrive at taxpayer expense. Federal crop insurance encourages farmers to gamble on risky plantings in a program that has been marred by fraud and that illustrates why government spending is so difficult to control.
And the cost is increasing. The U.S. Department of Agriculture last year spent about $14 billion insuring farmers against the loss of crop or income, almost seven times more than in fiscal 2000, according to the Congressional Research Service.
The arrangement is a good deal for everyone but taxpayers. The government pays 18 approved insurance companies to run the program, pays farmers to buy coverage and pays the bills if losses exceed predetermined limits.
[..] President Barack Obama sought this year to cut almost $12 billion from the program over the next decade while his ideological opposite, Republican House Budget Committee Chairman Paul Ryan, has called subsidized insurance “crony capitalism.”
Yet the president and the Republicans’ chief budget expert are no match for the farm and insurance lobbies, which spent at least $52 million influencing lawmakers in the 2012 election cycle. Rather than thin the most expensive strand in the nation’s farm safety net, Congress is poised to funnel billions of dollars more to individuals who already are more prosperous than the typical American.
[..] The heavily-discounted insurance incentivizes farmers to cultivate marginal acres that may or may not be fertile. And the program’s been vulnerable to fraud, notably in North Carolina where a network of insurance agents, claims adjusters and farmers bilked the government of close to $100 million over more than a decade.
[..] Crop insurance, intended to safeguard farmers from natural disasters, has mutated into an income support mechanism that almost eliminates risk from agriculture, say critics such as Vincent Smith, a professor of agricultural economics at Montana State University.
When last year’s drought drove corn prices to record highs, farmers with “harvest price option” policies were paid those inflated prices for what didn’t grow — contributing to a record bill for taxpayers and record income for farmers. “There is no social justification for these subsidies,” says Smith. “This is a program that’s fundamentally designed to give money to farmers.”
[..] Federal crop insurance began in the shadow of the 1930s Dust Bowl, which scorched the soil and left farmers impoverished. Until 1980, when the government began paying about one-third of farmers’ premiums, few farmers participated.
In 2000, Congress made the subsidies more generous, so that farmers now pay only about 38% of their insurance bills or more than $4 billion in 2012. By last year, almost 1.2 million policies covering 282 million acres of farmland were in force.
Each year, farmers choose from a menu of insurance options — and by law, insurers are obligated to cover all who apply. More than seven in 10 policies guarantee income rather than yield.
[..] Taxpayers are helping farmers pay their bills even as farm income this year is expected to top $120 billion, its highest inflation-adjusted mark since 1973, according to the USDA’s Economic Research Service. Farm income has doubled over the past four years thanks to rising land values and surging exports.
In 2011, the median income of commercial farm households — those deriving more than half their income from farming — was $84,649, almost 70% higher than that of the typical American household.
Even as manufacturers and retailers struggle to rebound from the recession that ended four years ago, farm equity ended 2012 at $2.5 trillion, up 37% since the start of the recession in December 2007 …
[..] Even some beneficiaries are uneasy. “I like to think of myself as an independent who’s willing to take risk,” says farmer Jim Handsaker, 65, of Story City, Iowa. “With insurance, it takes the risk out of it.”
[..] Subsidized insurance also gives farmers an incentive to plant on land where crops may or may not flourish, [Handsaker] said, adding that he knew individuals in South Dakota who are “farming the program” with the intent of making an insurance claim rather than harvesting a crop.
[..] Democratic Representative Ron Kind of Wisconsin expects that trend to worsen. “You’re going to see a lot of unproductive land brought into production because the taxpayer will cover the losses from all these riskless decisions,” said Kind, whose proposal to limit program subsidies fell 10 votes short of passage in June. “My concern is that this is eliminating all risk.”
[..] … the House-approved farm measure would expand crop insurance to guarantee as much as 90% of a farm’s income and extend coverage to peanut farms while the Senate bill covers farmers against even the modest losses they currently pay out of pocket.
Lynch so far talks about individual farmers and their lobbies, he doesn’t even yet mention the involvement of the larger parties that everyone knows have a huge influence in Washington. There’s not a single politician on the Hill who would risk being caught on the wrong side of a discussion with Archer-Daniels-Midland, Cargill, Monsanto, ConAgra or Tyson. And there can be no doubt that is a major factor in the shape crop insurance is taking. Americans are very much the prisoners of their own food industry in the same way they are of their banking industry.
When you sit down and absorb this sort of information it should become clear quite rapidly that your options to shake off the shackles of the politico-financial system are really quite limited. When everyone on both – or even all – sides of the aisle represents the same interests, and these are not yours, voting for someone else is not going to do you a lot of good.
It’s not a good idea to depend for your well-being on a system that’s geared towards taking from you all you have whenever that’s seen as the best you can do for it, when you can no longer be useful for it in other ways. And in view of the trillions in losses already in the – hidden – books, plus those yet to be incurred from ongoing wagers, what other use could you possibly have?
There are very few voices today calling for immediate action to make sure the 66% of youth that are unemployed in Greece and Spain become useful members of their societies. Greek PM Samaras picked a random number out of a hat this week and claimed that Greece would recover by 2019. He has no clue what will happen by 2019. What’s clear is that his younger countrymen and women can’t even get a job sweeping their streets today, or cleaning up other people’s dirt. And those very streets by 2019 will be owned by foreign investors. Privatize the planet.
So what makes you think you will be better off than them by 2019? Anything more, anything else, than just wishful thinking? If so, why is that? Do you feel useful, do you think that whatever you do in your day job is indispensable?
US unemployment numbers look somewhat bearable only because they hide so much. Like a plummeting labor force participation rate. What stands between your present situation and becoming an anonymous number in some statistic like that? For most of you, only an eerily thin line does. But then, most of you think Ben Bernanke wants what’s best for you.
Maybe it’s time to smarten up and, just in case, move what you have left to a place where Bernanke and the system he represents either can’t find it or can’t touch it. Just saying. The derivatives trade is a real threat to you and all those around you; it may still largely be hidden from view, but it’s not some fantasy tale.
When Bernanke et al are talking about recovery, they don’t mean you.
Photo top: Dorothea Lange Seven Loaves August 1939
“Kitchen in new home, Yakima Valley, Wash.”