Tag Archives: Banking

Building a better banking system, by Alasdair Macleod

Is eliminating limited liability for banks and other dealers of credit the key to a better banking system? From Alasdair Macleod at goldmoney.com:

This article anticipates the rapidly approaching time when we might be engulfed in a combined currency, asset, and banking crisis. It is becoming clear that such an event can no longer be ruled out.

Economists of the Austrian school have argued that sound money would have prevented a crisis of this sort, and without it the crisis becomes inevitable. The argument for sound money, in other words, a credible gold coin exchange system for banknotes, has already been made. But the question remains over how bank credit, whose fluctuations for a long time have been behind the boom and bust of the business cycle, should be addressed.

Some Austrians argue in favour of a dual banking system, split into separate functions of custodians of deposits and arrangers of finance. They say this arrangement would banish bank credit expansion and the destructive business cycle with it.

But credit creation is not restricted to banks and is common in all economic activities. Banning banks from dealing in credit cuts across established law over credit which has evolved since Roman times. By doing so, banks of deposit would probably fail as a permanent solution and could turn out to be impractical as well.

Continue reading→

The Case For A Super Glass-Steagall, by David Stockman

With deposit insurance, the Fed as the lender of last resort, and Too Big To Fail, the government is on the hook for banking system risk, especially risks taken by the largest banks. This is folly that will end in tears. David Stockman proposes moving banking risl to the market. From Stockman at davidstockmanscontracorner.com:

Donald Trump can instantly get to the left of Hillary with respect to Wall Street and the one percenters by embracing Super Glass-Steagall.

The latter would cap U.S. banks at $180 billion in assets (<1% of GDP) if they wished to have access to the Fed’s discount window and have their deposits backed by FDIC insurance. Such Federally privileged institutions would also be prohibited from engaging in trading, underwriting, investment banking, private equity, hedge funds, derivatives and other activities outside of deposit taking and lending.

Instead, these latter inherently risky economic functions would be performed on the free market by at-risk banks and financial services companies. The latter could never get too big to fail or to manage because the market would stop them first or they would be disciplined by the fail-safe institution of bankruptcy. No taxpayer would ever be put in harms’ way of trades like those of the London Whale.

By embracing this kind of Super Glass-Steagall Trump would consolidate his base in the flyover zones and reel in some of the Bernie Sanders throng, too. The latter will never forgive Clinton for her Goldman Sachs speech whoring. And that’s to say nothing of her full-throated support for the 2008 bank bailouts and the Fed’s subsequent giant gifts of QE and ZIRP to the Wall Street gamblers.

Besides, breaking up the big banks and putting Wall Street back on a free market based level playing field is the right thing to do. Today’s multi-trillion banks are simply not free enterprise institutions entitled to be let alone.

Instead, they are wards of the state dependent upon its subsidies, safety nets, regulatory protections and legal privileges. Consequently, they have gotten far larger, more risky and dangerous to society than could ever happen in an honest, disciplined market.

Foremost among these artificial props is the Fed’s discount window. The latter provides cheap, unlimited funding at a moment’s notice with no questions asked. The purpose is to insure banking system liquidity and stability and to thwart contagion, but it also nullifies the essential bank management discipline and prudence that comes from fear of depositor flight.

Likewise, FDIC insurance essentially shields banks’ balance sheets and asset management practices from depositor scrutiny. Whatever its merits in behalf of the little guy, there is no doubt that deposit insurance is a fount of moral hazard and excess risk-taking in the bonus-driven executive suits.

Indeed, the function of maturity transformation—–borrowing short and lending long—-which is the essence of fractional reserve banking is inherently risky and unstable. Once upon a time the state attempted to limit banks’ propensity for excesses by permitting injured depositors to bring suit against stockholders for double their original investment. That tended to concentrate the minds of bank boards and stock owning executives.

The opposite incentives prevail in today’s bailout regime. Under current legal and regulatory arrangements shareholders and boards face no liability at all—let alone double liability—-for mismanagement and imprudent risk taking. Instead, insolvent or failing institutions are apt to be bailed-out; and even if share prices are permitted to plunge, boards and executives are likely to be given new stock options struck at the post-collapse price. That happened in every big bank in America after the 2008 meltdown.

To continue reading: The Case For A Super Glass-Steagall

Elizabeth Warren Takes a Swipe at Paul Krugman’s “Revisionist History” by Michael Krieger

SLL does not take a lot of swipes at Paul Krugman because frankly, he’s a pompous idiot who’s not worthy of the effort, and there are plenty of other sites who do a fine job of taking him down. However, this article is less about him and more about the state of contemporary banking, a subject in which SLL has a keen interest. If you think the Too Big To Fail banks are safer now than in 2008, when they would have gone bankrupt without a helping hand from the federal government, you are mistaken. From Michael Krieger at libertyblitzkrieg.com:

Paul Krugman made the above statement in 1998, and while I stand guilty for plenty of bad forecasts, Krugman’s internet call is arguably the worst prediction in human history. Naturally, that doesn’t prevent the man from retaining his tenured position of punditry at the New York Times, a perch from which he continues expose millions of unsuspecting Americans to his incoherent, status quo coddling nonsense.

It appears Senator Elizabeth Warren of Massachusetts has had enough.

The Huffington Post reports:

WASHINGTON — Sen. Elizabeth Warren (D-Mass.) appeared to offer a thinly veiled rebuke of liberal economist Paul Krugman on Wednesday by highlighting a “scary” too-big-to-fail ruling from federal bank regulators.

The Federal Reserve and the FDIC said Wednesday that five of the biggest banks in the country cannot credibly be unwound safely without bailout money from taxpayers.

“This announcement is a very big deal. It’s scary,” Warren said in a written statement. “After an extensive, multi-year review process, federal regulators concluded that five of the country’s biggest banks are still — literally — too big to fail. They officially determined that five U.S. banks are large enough that any one of them could crash the economy again if they started to fail and were not bailed out.”

But Warren directed her sharpest words at an unnamed set of people who have recently downplayed the role of big banks in the financial crisis and questioned the value of breaking up big banks — an apparent reference to the Nobel Prize-winning Krugman.

“There’s been a lot of revisionist history floating around lately that the Too Big to Fail banks weren’t really responsible for the financial crisis,” Warren said. That talk isn’t new. Wall Street lobbyists have tried to deflect blame for years. But the claim is absolutely untrue.”

“There would have been no crisis without these giant banks,” Warren continued. “They encouraged reckless mortgage lending both by gobbling up an endless stream of mortgages to securitize and by funding the slimy subprime lenders who peddled their miserable products to millions of American families. The giant banks spread that risk throughout the financial system by misleading investors about the quality of the mortgages in the securities they were offering.”

To continue reading: Elizabeth Warren Takes a Swipe at Paul Krugman’s “Revisionist History”

ECB Unveils Ingenious Strategy to Reduce Banking Stress, by Don Quijones

From Don Quijones at wolfstreet.com:

Trying to prop up confidence by hook or crook.

Things have been pretty stressful of late in Europe’s banking sector. The introduction of the banking union’s bail-in rule has caused bondholders and stockholders to have second thoughts. The Euro Stoxx Banks Index has plunged 20% year-to-date despite the recent rally, and is down 38% since July.

Many of the worst affected bank stocks are those of so-called systemically important institutions. Deutsche Bank’s shares are down 50% from highs last July, while Spanish behemoth Santander’s shares have plumbed depths not seen since the 1990s. Concerns have also emerged about the ability of big lenders to turn a profit in a negative-interest-rate environment, following disappointing earnings by Societe Generale SA, HSBC Holdings Plc and Standard Chartered Plc.

In recent years, TBTF institutions like HSBC, Santander, Societe Generale and Deutsche have become so hideously big, complex and interconnected that it’s impossible to get an accurate impression of what’s really happening on and off their books. It is supposedly for this reason that the world’s two biggest central banks – the Fed and the ECB – began conducting regular stress tests of the financial sector to gauge just how effectively such banks would withstand a severe deterioration of macroeconomic conditions.

In the Fed’s last stress test, in May 2015, only two banks out of 31 failed to meet the grade: the U.S. units of Deutsche and Santander. One thing that is clear: European banks remain woefully under-capitalized compared to their U.S. counterparts.

Santander’s failure, its second in two years of taking the test, “was a clear signal that it hasn’t made enough progress on the issues the Fed had identified the previous year,” the Wall Street Journal reported at the time. Santander’s US chief executive, Scott Powell, said the bank still had “meaningful work to do to meet our regulator’s expectations and our own standards of excellence”.

Judging by an article just published in El Confidencial, the bank still has a long way to go:

Although officially speaking the U.S. banking supervisor still hasn’t published the findings of its Comprehensive Capital Analysis Review (CCAR)… at Santander’s headquarters in Boadilla del Monte it’s already taken as a given that it will have to wait at least another year before passing the stress test.

In light of Deutsche’s recent Co-Co fiasco in Germany, one assumes that the bank is in the same leaky boat. Which begs the question: with banking risk surging and investor confidence crumbling, how exactly will the ECB’s European Banking Authority be able to conduct its own rigorous (ha!) stress tests of large European banks without setting off further alarm bells and creating even more stress in the markets?

The answer is quite ingenious.

The London-based EBA will intentionally ignore many of the worst stress points in the system while conducting a test that not a single bank will be able to pass or fail. The reason the test has no pass mark to identify capital shortfalls is that banks have apparently emerged from the financial crisis. No, seriously. In the words of the EBA, they are in a “steady state” and are therefore expected to remain that way.

To continue reading: ECB Unveils Ingenious Strategy to Reduce Banking Stress

Norway’s Biggest Bank Demands Cash Ban, by Tyler Durden

This is why money is way too important to be left to governments. From Tyler Durden at zerohedge.com:

The war on cash is escalating faster than many had imagined. Having documented the growing calls from the elites and propagandist explanations of the “benefits” to their serfs over the last few years, with China, and The IMF entering the “cashless society” call most recently, International Business Times reports that Norway – suffering from its own economic collapse as oil revenues crash – has joined its Scandi peers Denmark and Sweden in a call to “ban cash.”

By way of background, as we explained previously, What exactly does a “war on cash” mean?

It means governments are limiting the use of cash and a variety of official-mouthpiece economists are calling for the outright abolition of cash. Authorities are both restricting the amount of cash that can be withdrawn from banks, and limiting what can be purchased with cash.

These limits are broadly called “capital controls.”

Why Now? Why are governments suddenly so keen to ban physical cash?

The answer appears to be that the banks and government authorities are anticipating bail-ins, steeply negative interest rates and hefty fees on cash, and they want to close any opening regular depositors might have to escape these forms of officially sanctioned theft. The escape mechanism from bail-ins and fees on cash deposits is physical cash, and hence the sudden flurry of calls to eliminate cash as a relic of a bygone age — that is, an age when commoners had some way to safeguard their money from bail-ins and bankers’ control.

Forcing Those With Cash To Spend or Gamble Their Cash

The conventional answer voiced by Mr. Buiter is that recession and credit contraction result from households and enterprises hoarding cash instead of spending it. The solution to recession is thus to force all those stingy cash hoarders to spend their money.

And the benefits of a cashless society to banks and governments are self-evident:

1. Every financial transaction can be taxed.

2. Every financial transaction can be charged a fee.

3. Bank runs are eliminated.

In fractional reserve systems such as ours, banks are only required to hold a fraction of their assets in cash. Thus a bank might only have 1 percent of its assets in cash. If customers fear the bank might be insolvent, they crowd the bank and demand their deposits in physical cash. The bank quickly runs out of physical cash and closes its doors, further fueling a panic.

The federal government began insuring deposits after the Great Depression triggered the collapse of hundreds of banks, and that guarantee limited bank runs, as depositors no longer needed to fear a bank closing would mean their money on deposit was lost.

But since people could conceivably sense a disturbance in the Financial Force and decide to turn digital cash into physical cash as a precaution, eliminating physical cash also eliminates the possibility of bank runs, as there will be no form of cash that isn’t controlled by banks.

So, when the dust has settled who ultimately benefits by this war on cash – government and the central banks, pure and simple.

To continue reading: Norway’s Biggest Bank Demands Cash Ban

The Apple Will Drop, by Robert Gore

If two-thirds of a group of conspirators avoid prosecution, trial, and imprisonment, but the other third does not, has justice been served? That’s a question raised by the movie The Big Short’s treatment of the 2007-2009 financial crisis. The movie is a dramatization of Michael Lewis’s non-fiction book, The Big Short: Inside the Doomsday Machine.

This is not a review of The Big Short, which was entertaining and amusing, with clever writing and strong performances by Christian Bale, Ryan Gosling, and Steve Carell. The movie did not, however, feature a viable explanation of the causes of the financial crisis. Yes, bankers offered mortgages to people who could not afford them, bundled them into junky mortgage-backed securities and more complicated debt instruments, and with the help of asleep-at-the-switch ratings agencies, regulators, and government-blessed mortgage finance agencies, sold them to speculators and investors whose due diligence extended no further than the triple-A rating.

So The Big Short justifiably prosecutes and would like to put in jail the bankers and ratings agencies, but aside from light slaps on the wrists (a heavily leveraged, pole-dancing real estate speculator and a regulator-regulated revolving door vignette), the two other major conspirators—feckless, often dishonest mortgagees and the government—get off scot-free. However, even if the movie had figuratively hauled them off to the hoosegow, it missed entirely the real cause of the financial crisis: financial and political gravity. Gravity doesn’t make for very good cinema, but it’s an appropriate subject for an SLL piece. (SLL doesn’t have a $100 million production and advertising budget to cover, will never be in contention for an Academy Award, and only needs to appeal to an audience that’s maybe one-day’s tally of Big Short viewers at a typical Megaplex.)

Regulatory capture is the first law of political gravity. Reformers set up a regulator for a perceived social ill, pat themselves on the back, and move on to the next cause, while the regulated sabotage the scheme and turn it to their own ends. The regulated have every incentive to do so—it’s often a matter of economic survival—and everybody else, including the supposed beneficiaries of the regulation, have little incentive to engage in the constant bureaucratic, legislative, and judicial infighting necessary to force the regulators to adhere to the stated purposes of the enabling legislation. So all regulation, without exception, devolves into the cynical charade we’ve come to know and loath: lobbying, influence peddling, legal and illegal bribes, revolving doors, use of the regulatory process to cripple competitors and competition, cartelization, and an identity of interests between the regulator and regulated.

It’s no surprise, then, that the banks and their regulators, particularly the Federal Reserve, are in bed together, and have been for over a century now. There is a free market, highly effective regulator of bank behavior: bank runs. In fractional reserve banking, banks will never have enough immediately available money if a large enough percentage of depositors all want their deposits back at the same time. That possibility keeps bankers honest. They extend loans to borrowers who can pay, maintain a prudent level of cash on hand, are selective about the banks with which they establish correspondent relationships, and do their best to appear as sober, solid, confidence-inspiring members of their communities. Such bankers usually weather the inevitable financial squalls, building reputations for probity, while their intemperate, grasping brethren do not. Over time, customers, the smart ones at least, gravitate towards the former and shun the latter.

Bank regulation has replaced this highly effective free market regulatory mechanism—actually making it the enemy—with a highly ineffective, corrupt, and captured panoply of laws, regulations, and agencies. The Fed’s lender of last resort function, deposit insurance, extensive regulation, and the too-big-to-fail doctrine enshrine the political impetus to banish bank runs and their potentially destabilizing, albeit salutary, effects. The government has become the guarantor of the banking system. A second law of gravity: set up a system whereby heads, the bankers win, tails the government (and taxpayers) lose, and the banks and bankers will win and the government (and taxpayers) will lose, repeatedly, until that system is eliminated.

A third law of gravity: governments establish central banks to benefit governments. Fiat money (actually fiat debt, see “Real Money”) gives the government the first user advantage; it gets to spend it and command resources before its fiat money depreciates. That depreciation benefits debtors at creditors’ expense, and governments are invariably debtors. As debtors, governments benefit from lower, central bank-suppressed interest rates. Finally, governments realize political benefits from central bank debt promotion. An increase in debt can produce a short-term, constituent-pleasing bump in economic activity.

A fourth law of gravity: government and central bank debt divorced from the underlying economy will invariably grow faster than the economy as debt’s marginal impact diminishes, and suppressed interest rates and abundant debt-based liquidity will promote malinvestment and increase consumption and speculation at the expense of savings and investment, leading to unsustainable standards of living, indebtedness, and asset bubbles. The fifth and final law of gravity: that which is unsustainable will not be sustained; the system collapses.

These laws of gravity—not ignorant, foolish, or greedy homeowners and house flippers; not greedy, unscrupulous bankers, ratings agencies, and investors in securitized, subprime garbage; not the government’s and the housing finance agencies’ incompetent and corrupt promotion of home ownership and mortgage finance—are the “cause” of the last financial crisis. Or more correctly, the crisis was the inevitable consequence of gravity’s inexorable operation. A reliable facet of any collapse is that its leading edge will be the financial and economic sector towards which the most credit—relative to that’s sector’s ability to service debt—has been channeled. In 2000 that was the technology sector; in 2007 it was housing and mortgage finance.

SLL noted over a year ago that this crisis’s leading edge was commodities (“Oil Ushers in the Depression”), towards which superabundant credit had been channeled based on a fallacious belief in the perpetual growth of the Chinese economy at double-digit rates. That reality is still not generally grasped, even as credit and economic contraction, falling prices, and gluts have spread around the world, from commodities to transportation, production, distribution, wholesale, and retail. General recognition will leave the current, already battered levels of equity indexes as distant specks in the rear-view mirror.

There could be silver linings. After the ultimate crash, market-based money may replace worthless fiat scrip. Bank risk may be “unsocialized”: banking without government and central bank safety nets. And somebody, perhaps Michael Lewis, may write a book about the religious beliefs in the China growth story and the ability of central bankers to control the global economy; the insanity of negative interest rates; the opacity of balance sheets produced by banks allowed to mark asset values to their own assumptions and models, not to market prices, and the travesty of economic policies that reward leverage, speculation, and a small coterie of crony insiders while penalizing savings, investment, integrity, and honest economic effort. If we’re lucky, that book will serve as the source for a movie as entertaining as The Big Short.

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From Daniel Durand, speaking in 1913 from the novel The Golden Pinnacle:

What the government gains from monetary debasement, the wage earner loses. Adjustments to his wage won’t keep up with money inflation. As for promoting economic stability, look at the railroads. Every line upon which the government has laid its ‘benevolent’ hand has come to ruin. You want to make it responsible for the entire economy? The Wall Street moneyed class will a field day with elastic money and financial instability. It’s your average wage-earning American who will be hurt the most.




Bankers’ Nirvana by Robert Gore

Bankers are no longer heartlessly stingy stewards of their banks’ capital and depositors’ funds, deniers of loans to all but those who do not need them, they are the fountainheads of democratic credit—loans for all! Banking has become a public-private partnership, although determining if banks are an arm of the government or vice versa requires time, effort, and a strong stomach. The question may prove as irrelevant as the distinction between coxswain and crew in a shell headed over a waterfall.

How many people know that when they deposit their money in a bank, they become its unsecured creditors and it uses their deposits to fund its loans and investments? Speculating with or investing other people’s money, offering some recompense for the usage but keeping most of the profits, has been an alluring business model for centuries. It is at the heart of banking. When done correctly, the depositor earns a return, individuals and enterprises receive loans that they repay, and the bank makes money.

It is not without risks. The wise banker navigates the Straits of Prudence between excessive greed and caution. He must keep money on hand for depositor withdrawals, but that money earns no return, so most of the bank’s funds must be “working,” earning a return on lending, speculation, or investment. Too aggressive, and the costs and losses from bad loans, speculations, and investments outweigh the returns from good ones. Not aggressive enough, and returns are inadequate to pay depositors interest, cover costs, and leave a satisfactory profit for the owners. The bankers’ Holy Grail is risk minimization and compensation maximization: public sector security and private sector pay. After a hundred-year quest, they have found it.

The Federal Reserve, established in 1913, was to meet the varying liquidity demands of what was still primarily an agricultural economy, and also act as an emergency lender of last resort during financial panics, lending against money-good but temporarily illiquid bank collateral to forestall bank runs, the old-time bankers’ worst nightmare. A nod was made to the gold standard; the legislation required 40 percent of the central bank’s assets to be backed by gold. However, this was clearly the fiat-money camel’s nose under the monetary tent. Step by step the link between dollars and gold was severed, from President Roosevelt outlawing the private ownership of gold in 1932 to President Nixon suspending the last vestige of convertibility, for foreign governments, in 1971. “Good as gold” morphed into “good as promises by always trustworthy politicians and bureaucrats not to debase dollars too much.” Dollars today are nothing more than pieces of paper or electronic accounting entries, buying about 2 percent of what they bought a century ago.

Knowing the Fed had their backs, like Ebenezer Scrooge on Christmas morning, bankers turned less heartless and stingy. The Fed is ostensibly independent, but is headquartered in Washington. Politicians like seeing money in their constituents’ pockets; bankers like invitations to Georgetown parties. The year 1913 kicked off a century-long democratization of credit. Bankers became great guys and (later) gals, and the banking system became the economy’s consumption-priming, job-creating silent partner. Regulatory capture is an iron-clad law in Washington, and that insidious process had begun even before the Federal Reserve Act was passed—bankers led by JP Morgan’s crew drafted the legislation.

Nobody had heard of “too big to fail” during the Great Depression, when many banks were too small to succeed. Scores of them, geographically confined by branch banking and interstate banking restrictions, went under because they were dependent on one region or industry for their survival. (Canada had nationwide banks and few failures.)

Doing something, no matter how conceptually flawed or counterproductive, was the New Dealers’ default option, and deposit insurance was one of many “somethings.” President Roosevelt was against deposit insurance, which put the government on the hook for a substantial portion of the banking system’s liabilities. He eventually signed the legislation (the Glass-Steagall Act of 1933), mollified by the law’s regulatory regime, which was sold as the way to keep bankers on the straight-and-narrow. The New Dealers’ creation—the Federal Deposit Insurance Corporation—now insures member bank accounts up to $250,000.

Banks have loans, investments, and speculations outstanding that are some multiple of their capital. A decline in value in their assets greater than the reciprocal of that multiple wipes out their capital. (If a bank’s assets are ten times its capital, a realized 10 percent drop in value eliminates that capital.) In the globally interconnected financial system, the failure of one bank impairs the assets of others, setting off a chain reaction. Asset prices collapse, economic activity implodes, and governments are on the hook for a major portion of banks’ deposit liabilities. “Systemic risk” has been the monster under the bed mega-bankers invoke to make their behemoths failure proof.

Too big to fail has been the final step to bankers’ nirvana. Heads they win, reaping the rewards of lending, investing, and speculating. If that comes a cropper, tails the government, and taxpayers, lose. Two consequences flow from bankers’ nirvana: the rate of expansion of credit is greater than the growth rate of the economy—claims on the economy increase as it becomes more indebted—and this debt imbalance leads to financial crises.

Regulation is a useless fig leaf. Bankers have every incentive to game the regulations. Even if they did not, you can’t regulate away bad ideas. Bankers’ nirvana is the culmination of bad ideas: central banking, deposit insurance, and too big to fail. World debt is substantially higher than it was in 2008; the too big to fail banks are substantially bigger. The inevitable tidal wave of the next crisis will wash away both banks and the governments with whom they are joined at the hip.