This book , in its chapter two, can be fairly said to predict the Wall
Street bailout; and, for that matter, the Long Term Capital Management
bailout ( http://en.wikipedia.org/wiki/Long-Term_Capital_Management).
The" Jekyll Island" meeting was to found the Federal Reserve. It's
list of attendees at the meeting is not guilty of anti-Semitism with
respect to characterizing the ruling clique of financiers.
This author may be marginal to professional economics, but his thesis
is confirmed in practice better than a lot of other theories.
^^^^^
Chapter Two of The Creature from Jekyll Island (1994)
by G Edward Griffin
The analogy of a spectator sporting event as a means of explaining
the rules by which taxpayers are required to pick up the cost of
bailing out the banks when their loans go sour.
It was stated in the previous chapter that the Jekyll Island group
which conceived the Federal Reserve System actually created a national
cartel which was dominated by the larger banks. It was also stated that
a primary objective of that cartel was to involve the federal
government as an agent for shifting the inevitable losses from the
owners of those banks to the taxpayers. That, of course, is one of the
more controversial assertions made in this book. Yet, there is little
room for any other interpretation when one confronts the massive
evidence of history since the System was created. Let us, therefore,
take another leap through time. Having jumped to the year 1910 to begin
this story, let us now return to the present era.
To understand how banking losses are shifted to the taxpayers, it is
first necessary to know a little bit about how the scheme was designed
to work. There are certain procedures and formulas which must be
understood or else the entire process seems like chaos. It is as though
we had been isolated all our lives on a South Sea island with no
knowledge of the outside world. Imagine what it would then be like the
first time we traveled to the mainland and witnessed a game of
professional football. We would stare with incredulity at men dressed
like aliens from another planet; throwing their bodies against each
other; tossing a funny shaped object back and forth; fighting over it
as though it were of great value, yet, occasionally kicking it out of
the area as though it were worthless and despised; chasing each other,
knocking each other to the ground and then walking away to regroup for
another surge; all this with tens of thousand of spectators riotously
shouting in unison for no apparent reason at all. Without a basic
understanding that this was a game and without knowledge of the rules
of that game, the event would appear as total chaos and universal
madness.
The operation of our monetary system through the Federal Reserve has
much in common with professional football. First, there are certain
plays that are repeated over and over again with only minor variations
to suit the special circumstances. Second, there are definite rules
which the players follow with great precision. Third, there is a clear
objective to the game which is uppermost in the minds of the players.
And fourth, if the spectators are not familiar with that objective and
if they do not understand the rules, they will never comprehend what is
going on. Which, as far as monetary matters is concerned, is the common
state of the vast majority of Americans today.
Let us, therefore, attempt to spell out in plain language what that
objective is and how the players expect to achieve it. To demystify the
process, we shall present an overview first. After the concepts are
clarified, we then shall follow up with actual examples taken from the
recent past.
The name of the game is Bailout. As stated previously, the objective of
this game is to shift the inevitable losses from the owners of the
larger banks to the taxpayers. The procedure by which this is
accomplished is as follows:
Rules of the Game
The game begins when the Federal Reserve System allows commercial banks
to create checkbook money out of nothing. (Details regarding how this
incredible feat is accomplished are given in chapter ten entitled The
Mandrake Mechanism.) The banks derive profit from this easy money, not
by spending it, but by lending it to others and collecting interest.
When such a loan is placed on the bank's books it is shown as an asset
because it is earning interest and, presumably, someday will be paid
back. At the same time an equal entry is made on the liability side of
the ledger. That is because the newly created checkbook money now is in
circulation, and most of it will end up in other banks which will
return the canceled checks to the issuing bank for payment. Individuals
may also bring some of this check-book money back to the bank and
request cash. The issuing bank, therefore, has a potential money
pay-out liability equal to the amount of the loan asset.
When a borrower cannot repay and there are no assets which can be taken
to compensate, the bank must write off that loan as a loss. However,
since most of the money originally was created out of nothing and cost
the bank nothing except bookkeeping overhead, there is little of
tangible value that is actual lost. It is primarily a bookkeeping entry.
A bookkeeping loss can still be undesirable to a bank because it causes
the loan to be removed from the ledger as an asset without a reduction
in liabilities. The difference must come from the equity of those who
own the bank. In other words, the loan asset is removed, but the money
liability remains. The original checkbook money is still circulating
out there even though the borrower cannot repay, and the issuing bank
still has the obligation to redeem those checks. The only way to do
this and balance the books once again is to draw upon the capital which
was invested by the bank's stockholders or to deduct the loss from the
bank's current profits. In either case, the owners of the bank lose an
amount equal to the value of the defaulted loan. So, to them, the loss
becomes very real. If the bank is forced to write off a large amount of
bad loans, the amount could exceed the entire value of the owners'
equity. When that happens, the game is over, and the bank is insolvent.
This concern would be sufficient to motivate most bankers to be very
conservative in their loan policy, and in fact most of them do act with
great caution when dealing with individuals and small businesses. But
the Federal Reserve System, the Federal Deposit Insurance Corporation,
and the Federal Deposit Loan Corporation now guarantee that massive
loans made to large corporations and to other governments will not be
allowed to fall entirely upon the bank's owners should those loans go
into default. This is done under the argument that, if these
corporations or banks are allowed to fail, the nation would suffer from
vast unemployment and economic disruption. More on that in a moment.
The Perpetual-Debt Play
The end result of this policy is that the banks have little motive to
be cautious and are protected against the effect of their own folly.
The larger the loan, the better it is, because it will produce the
greatest amount of profit with the least amount of effort. A single
loan to a third-world country netting hundreds of millions of dollars
in annual interest is just as easy to process - if not easier - than a
loan for $50,000 to a local merchant on the shopping mall. If the
interest is paid, it's gravy time. If the loan defaults, the federal
government will "protect the public" and, through various mechanisms
described shortly, will make sure that the banks continue to receive
their interest.
The individual and the small businessman find it increasingly difficult
to borrow money at reasonable rates, because the banks can make more
money on loans to the corporate giants and to foreign governments.
Also, the bigger loans are safer for the banks, because the government
will make them good even if they default. There are no such guarantees
for the small loans. The public will not swallow the line that bailing
out the little guy is necessary to save the system. The dollar amounts
are too small. Only when the figures become mind-boggling does the ploy
become plausible.
It is important to remember that banks do not really want to have their
loans repaid, except as evidence of the dependability of the borrower.
They make a profit from interest on the loan, not repayment of the
loan. If a loan is paid off, the bank merely has to find another
borrower, and that can be an expensive nuisance. It is much better to
have the existing borrower pay only the interest and never make
payments on the loan itself. That process is called rolling over the
debt. One of the reasons banks prefer to lend to governments is that
they do not expect those loans ever to be repaid. When Walter Wriston
was chairman of the Citicorp Bank in 1982, he extolled the virtue of
the action this way:
If we had a truth-in-Government act comparable to the
truth-in-advertising law, every note issued by the Treasury would be
obliged to include a sentence stating: "This note will be redeemed with
the proceeds from an identical note which will be sold to the public
when this one comes due".
When this activity is carried out in the United States, as it is
weekly, it is described as a Treasury bill auction. But when basically
the same process is conducted abroad in a foreign language, our news
media usually speak of a country's "rolling over its debts". The
perception remains that some form of disaster is inevitable. It is not.
To see why, it is only necessary to understand the basic facts of
government borrowing. The first is that there are few recorded
instances in history of government - any government - actually getting
out of debt. Certainly in an era of $100-billion deficits, no one
lending money to our Government by buying a Treasury bill expects that
it will be paid at maturity in any way except by our Government's
selling a new bill of like amount. {1}
The Debt Roll-Over Play
Since the system makes it profitable for banks to make large, unsound
loans, that is the kind of loans which banks will make. Furthermore, it
is predictable that most unsound loans eventually will go into default.
When the borrower finally declares that he cannot pay, the bank
responds by rolling over the loan. This often is stage managed to
appear as a concession on the part of the bank but, in reality, it is a
significant forward move toward the objective of perpetual interest.
Eventually the borrower comes to the point where he can no longer pay
even the interest. Now the play becomes more complex. The bank does not
want to lose the interest, because that is its stream of income. But it
cannot afford to allow the borrower to go into default either, because
that would require a write-off which, in turn, could wipe out the
owners' equity and put the bank out of business. So the bank's next
move is to create additional money out of nothing and lend that to the
borrower so he will have enough to continue paying the interest, which
by now must be paid on the original loan plus the additional loan as
well. What looked like certain disaster suddenly is converted by a
brilliant play into a major score. This not only maintains the old loan
on the books as an asset, it actually increases the apparent size of
that asset and also results in higher interest payments, thus, greater
profit to the bank.
The Up-The-Ante Play
Sooner or later, the borrower becomes restless. He is not interested in
making interest payments with nothing left for himself. He comes to
realize that he is merely working for the bank and, once again,
interest payments stop. The opposing teams go into a huddle to plan the
next move, then rush to the scrimmage line where they hurl threatening
innuendoes at each other. The borrower simply cannot, will not pay.
Collect if you can. The lender threatens to blackball the borrower, to
see to it that he will never again be able to obtain a loan. Finally, a
"compromise" is worked out. As before, the bank agrees to create still
more money out of nothing and lend that to the borrower to cover the
interest on both of the previous loans but, this time, they up the ante
to provide still additional money for the borrower to spend on
something other than interest. That is a perfect score. The borrower
suddenly has a fresh supply of money for his purposes plus enough to
keep making those bothersome interest payments. The bank, on the other
hand, now has still larger assets, higher interest income, and greater
profits. What an exciting game!
The Rescheduling Play
The previous plays can be repeated several times until the reality
finally dawns on the borrower that he is sinking deeper and deeper into
the debt pit with no prospects of climbing out. This realization
usually comes when the interest payments become so large they represent
almost as much as the entire corporate earnings or the country's total
tax base. This time around, roll-overs with larger loans are rejected,
and default seems inevitable.
But wait. What's this? The players are back at the scrimmage line.
There is a great confrontation. Referees are called in. Two shrill
blasts from the horn tell us a score has been made for both sides. A
voice over the public address system announces: "This loan has been
rescheduled".
Rescheduling usually means a combination of a lower interest rate and a
longer period for repayment. The effect is primarily cosmetic. It
reduces the monthly payment but extends the period further into the
future. This makes the current burden to the borrower a little easier
to carry, but it also makes repayment of the capital even more
unlikely. It postpones the day of reckoning but, in the meantime, you
guessed it: The loan remains as an asset, and the interest payments
continue.
The Protect-The-Public Play
Eventually the day of reckoning arrives. The borrower realizes he can
never repay the capital and flatly refuses to pay interest on it. It is
time for the Final Maneuver.
According to the Banking Safety Digest, which specializes in rating the
safety of America's banks and S&Ls, most of the banks involved with
"problem loans" are quite profitable businesses:
Note that, except for third-world loans, most of the large banks in
the country are operating quite profitably. In contrast with the
continually-worsening S&L {2} crisis, the banks' profitability has been
the engine with which they have been working off (albeit slowly) their
overseas debt ... At last year's profitability levels, the banking
industry could, in theory, "buy out" the entirety of their own Latin
American loans within two years. {3}
The banks can absorb the losses of their bad loans to multinational
corporations and foreign governments, but that is not according to the
rules. It would be a major loss to the stockholders who would receive
little or no dividends during the adjustment period, and any chief
executive officer who embarked upon such a course would soon be looking
for a new job. That this is not part of the game plan is evident by the
fact that, while a small portion of the Latin American debt has been
absorbed, the banks are continuing to make gigantic loans to
governments in other parts of the world, particularly Africa, China,
Russia, and Eastern European nations. For reasons which will be
analyzed in chapter four, there is little hope that the performance of
these loans will be different than those in Latin America. But the most
important reason for not absorbing the losses is that there is a
standard play that can still breathe life back into those dead loans
and reactivate the bountiful income stream that flows from them.
Here's how it works. The captains of both teams approach the referee
and the Game Commissioner to request that the game be extended. The
reason given is that this is in the interest of the public, the
spectators who are having such a wonderful time and who will be sad to
see the game ended. They request also that, while the spectators are in
the stadium enjoying themselves, the parking-lot attendants be ordered
to quietly remove the hub caps from every car. These can be sold to
provide money for additional salaries for all the players, including
the referee and, of course, the Commissioner himself. That is only fair
since they are now working overtime for the benefit of the spectators.
When the deal is finally struck, the horn will blow three times, and a
roar of joyous relief will sweep across the stadium.
In a somewhat less recognizable form, the same play may look like this:
The president of the lending bank and the finance officer of the
defaulting corporation or government will join together and approach
Congress. They will explain that the borrower has exhausted his ability
to service the loan and, without assistance from the federal
government, there will be dire consequences for the American people.
Not only will there be unemployment and hardship at home, there will be
massive disruptions in world markets. And, since we are now so
dependent on those markets, our exports will drop, foreign capital will
dry up, and we will suffer greatly. What is needed, they will say, is
for Congress to provide money to the borrower, either directly or
indirectly, to allow him to continue to pay interest on the loan and to
initiate new spending programs which will be so profitable he will soon
be able to pay everyone back.
As part of the proposal, the borrower will agree to accept the
direction of a third-party referee in adopting an austerity program to
make sure that none of the new money is wasted. The bank also will
agree to write off a small part of the loan as a gesture of its
willingness to share the burden. This move, of course, will have been
foreseen from the very beginning of the game, and is a small step
backward to achieve a giant stride forward. After all, the amount to be
lost through the write-off was created out of nothing in the first
place and, without this Final Maneuver, the entirety would be written
off. Furthermore, this modest write down is dwarfed by the amount to be
gained through restoration of the income stream.
The Guaranteed-Payment Play
One of the standard variations of the Final Maneuver is for the
government, not always to directly provide the funds, but to provide
the credit for the funds. That means to guarantee future payments
should the borrower again default. Once Congress agrees to this, the
government becomes a co-signer to the loan, and the inevitable losses
are finally lifted from the ledger of the bank and placed onto the
backs of the American taxpayer.
Money now begins to move into the banks through a complex system of
federal agencies, international agencies, foreign aid, and direct
subsidies. All of these mechanisms extract payments from the American
people and channel them to the deadbeat borrowers who then send them to
the banks to service their loans. Very little of this money actually
comes from taxes. Almost all of it is generated by the Federal Reserve
System. When this newly created money returns to the banks, it quickly
moves out again into the economy where it mingles with and dilutes the
value of the money already there. The result is the appearance of
rising prices but which, in reality, is a lowering of the value of the
dollar.
The American people have no idea they are paying the bill. They know
that someone is stealing their hub caps, but they think it is the
greedy businessman who raises prices or the selfish laborer who demands
higher wages or the unworthy farmer who demands too much for his crop
or the wealthy foreigner who bids up our prices. They do not realize
that these groups also are victimized by a monetary system which is
constantly being eroded in value by and through the Federal Reserve
System.
Public ignorance of how the game is really played was dramatically
displayed during a recent Phil Donahue TV show {4}. The topic was the
Savings and Loan crisis and the billions of dollars that it would cost
the taxpayer. A man from the audience rose and asked angrily: "Why
can't the government pay for these debts instead of the taxpayer?" And
the audience of several hundred people actually cheered in enthusiastic
approval!
Prosperity Through Insolvency
Since large, corporate loans are often guaranteed by the federal
government, one would think that the banks which make those loans would
never have a problem. Yet, many of them still manage to bungle
themselves into insolvency. As we shall see in a later section of this
study, insolvency actually is inherent in the system itself, a system
called fractional-reserve banking.
Nevertheless, a bank can operate quite nicely in a state of insolvency
so long as its customers don't know it. Money is brought into being and
transmuted from one imaginary form to another by mere entries on a
ledger, and creative bookkeeping can always make the bottom line appear
to balance. The problem arises when depositors decide, for whatever
reason, to withdraw their money. Lo and behold, there isn't enough to
go around and, when that happens, the cat is finally out of the bag.
The bank must close its doors, and the depositors still waiting in line
outside are ... well, just that: still waiting.
The proper solution to this problem is to require the banks, like all
other businesses, to honor their contracts. If they tell their
customers that deposits are "payable upon demand", then they should
hold enough cash to make good on that promise, regardless of when the
customers want it or how many of them want it. In other words, they
should keep cash in the vault equal to 100% of their depositors'
accounts. When we give our hat to the hat-check girl and obtain a
receipt for it, we don't expect her to rent it out while we eat dinner
hoping she'll get it back - or one just like it - in time for our
departure. We expect all the hats to remain there all the time so there
will be no question of getting ours back precisely when we want it.
On the other hand, if the bank tells us it is going to lend our deposit
to others so we can earn a little interest on it, then it should also
tell us forthrightly that we cannot have our money back on demand. Why
not? Because it is loaned out and not in the vault any longer.
Customers who earn interest on their accounts should be told that they
have time deposits, not demand deposits, because the bank will need a
stated amount of time before it will be able to recover the money which
was loaned out.
None of this is difficult to understand, yet bank customers are seldom
informed of it. They are told they can have their money any time they
want it and they are paid interest as well. Even if they do not receive
interest, the bank does, and this is how so many customer services can
be offered at little or no direct cost. Occasionally, a thirty-day or
sixty-day delay will be mentioned as a possibility, but that is greatly
inadequate for deposits which have been transformed into ten, twenty,
or thirty-year loans. The banks are simply playing the odds that
everything will work out most of the time.
We shall examine this issue in greater detail in a later section but,
for now, it is sufficient to know that total disclosure is not how the
banking game is played. The Federal Reserve System has legalized and
institutionalized the dishonesty of issuing more hat checks than there
are hats and it has devised complex methods of disguising this practice
as a perfectly proper and normal feature of banking. Students of
finance are told that there simply is no other way for the system to
function. Once that premise is accepted, then all attention can be
focused, not on the inherent fraud, but on ways and means to live with
it and make it as painless as possible.
Based on the assumption that only a small percentage of the depositors
will ever want to withdraw their money at the same time, the Federal
Reserve allows the nation's commercial banks to operate with an
incredibly thin layer of cash to cover their promises to pay "on
demand". When a bank runs out of money and is unable to keep that
promise, the System then acts as a lender of last resort. That is
banker language meaning it stands ready to create money out of nothing
and immediately lend it to any bank in trouble. (Details on how that is
accomplished are in chapter eight.) But there are practical limits to
just how far that process can work. Even the Fed will not support a
bank that has gotten itself so deeply in the hole it has no realistic
chance of digging out. When a bank's bookkeeping assets finally become
less than its liabilities, the rules of the game call for transferring
the losses to the depositors themselves. This means they pay twice:
once as taxpayers and again as depositors. The mechanism by which this
is accomplished is called the Federal Deposit Insurance Corporation.
The FDIC Play
The FDIC guarantees that every insured deposit will be paid back
regardless of the financial condition of the bank. The money to do this
comes out of a special fund which is derived from assessments against
participating banks. The banks, of course, do not pay this assessment.
As with all other expenses, the bulk of the cost ultimately is passed
on to their customers in the form of higher service fees and lower
interest rates on deposits.
The FDIC is usually described as an insurance fund, but that is
deceptive advertising at its worst. One of the primary conditions of
insurance is that it must avoid what underwriters call "moral hazard".
That is a situation in which the policyholder has little incentive to
avoid or prevent that which is being insured against. When moral hazard
is present, it is normal for people to become careless, and the
likelihood increases that what is being insured against will actually
happen. An example would be a government program forcing everyone to
pay an equal amount into a fund to protect them from the expense of
parking fines. One hesitates even to mention this absurd proposition
lest some enterprising politician should decide to put it on the
ballot. Therefore, let us hasten to point out that, if such a
numb-skull plan were adopted, two things would happen: (1) just about
everyone soon would be getting parking tickets and (2), since there now
would be so many of them, the taxes to pay for those tickets would
greatly exceed the previous cost of paving them without the so-called
protection.
The FDIC operates exactly in this fashion. Depositors are told their
insured accounts are protected in the event their bank should become
insolvent. To pay for this protection, each bank is assessed a
specified percentage of its total deposits. That percentage is the same
for all banks regardless of their previous record or how risky their
loans. Under such conditions, it does not pay to be cautious. The banks
making reckless loans earn a higher rate of interest than those making
conservative loans. They also are far more likely to collect from the
fund, yet they pay not one cent more. Conservative banks are penalized
and gradually become motivated to make more risky loans to keep up with
their competitors and to get their "fair share" of the fund's
protection. Moral hazard, therefore, is built right into the system. As
with protection against parking tickets, the FDIC increases the
likelihood that what is being insured against will actually happen. It
is not a solution to the problem, it is part of the problem.
Real Insurance Would Be A Blessing
A true deposit-insurance program which was totally voluntary and which
geared its rates to the actual risks would be a blessing. Banks with
solid loans on their books would be able to obtain protection for their
depositors at reasonable rates, because the chances of the insurance
company having to pay would be small. Banks with unsound loans,
however, would have to pay much higher rates or possibly would not be
able to obtain coverage at any price. Depositors, therefore, would know
instantly, without need to investigate further, that a bank without
insurance is not a place where they want to put their money. In order
to attract deposits, banks would have to have insurance. In order to
have insurance at rates they could afford, they would have to
demonstrate to the insurance company that their financial affairs are
in good order. Consequently, banks which failed to meet the minimum
standards of sound business practice would soon have no customers and
would be forced out of business. A voluntary, private insurance program
would act as a powerful regulator of the entire banking industry far
more effectively and honestly than any political scheme ever could.
Unfortunately, such is not the banking world of today.
The FDIC "protection" is not insurance in any sense of the word. It is
merely part of a political scheme to bail out the most influential
members of the banking cartel when they get into financial difficulty.
As we have already seen, the first line of defense in this scheme is to
have large, defaulted loans restored to life by a Congressional pledge
of tax dollars. If that should fail and the bank can no longer conceal
its insolvency through creative bookkeeping, it is almost certain that
anxious depositors will soon line up to withdraw their money - which
the bank does not have. The second line of defense, therefore, is to
have the FDIC step in and make those payments for them.
Bankers, of course, do not want this to happen. It is a last resort. If
the bank is rescued in this fashion, management is fired and what is
left of the business usually is absorbed by another bank. Furthermore,
the value of the stock will plummet, but this will affect the small
stockholders only. Those with controlling interest and those in
management know long in advance of the pending catastrophe and are able
to sell the bulk of their shares while the price is still high. The
people who create the problem seldom suffer the economic consequences
of their actions.
The FDIC Will Never Be Adequately Funded
The FDIC never will have enough money to cover its potential liability
for the entire banking system. If that amount were in existence, it
could be held by the banks themselves, and an insurance fund would not
even be necessary. Instead, the FDIC operates on the same assumption as
the banks: that only a small percentage will ever need money at the
same time. So the amount held in reserve is never more than a few
percentage points of the total liability. Typically, the FDIC holds
about $1.20 for every $100 of covered deposits. At the time of this
writing, however, that figure had slipped to only seventy cents and was
still dropping. That means that the financial exposure is about 99.3%
larger than the safety net which is supposed to catch it. The failure
of just one or two large banks in the system could completely wipe out
the entire fund.
And it gets even worse. Although the ledger may show that so many
millions or billions are in the fund, that also is but creative
bookkeeping. By law, the money collected from bank assessments must be
invested in Treasury bonds, which means it is loaned to the government
and spent immediately by Congress. In the final stage of this process,
therefore, the FDIC itself runs out of money and turns, first to the
Treasury, then to Congress for help. This step, of course, is an act of
final desperation, but it is usually presented in the media as though
it were a sign of the system's great strength. US News & World Report
blandly describes it this way: "Should the agencies need more money
yet, Congress has pledged the full faith and credit of the federal
government" {5}. Gosh, gee whiz. Isn't that wonderful? It sort of makes
one feel rosy all over to know that the fund is so well secured.
Let's see what "full faith and credit of the federal government"
actually means. Congress, already deeply in debt, has no money either.
It doesn't dare openly raise taxes for the shortfall, so it applies for
an additional loan by offering still more Treasury bonds for sale. The
public picks up a portion of these IOUs, and the Federal Reserve buys
the rest. If there is a monetary crisis at hand and the size of the
loan is great, the Fed will pick up the entire issue.
But the Fed has no money either. So it responds by creating out of
nothing an amount of brand new money equal to the IOUs and, through the
magic of central banking, the FDIC is finally funded. This new money
gushes into the banks where it is used to pay off the depositors. From
there it floods through the economy diluting the value of all money and
causing prices to rise. The old paycheck doesn't buy as much any more,
so we learn to get along with a little bit less. But, see? The bank's
doors are open again, and all the depositors are happy - until they
return to their cars and discover the missing hub caps!
That is what is meant by "the full faith and credit of the federal
government".
Summary
Although national monetary events may appear mysterious and chaotic,
they are governed by well-established rules which bankers and
politicians rigidly follow. The central fact to understanding these
events is that all the money in the banking system has been created out
of nothing through the process of making loans. A defaulted loan,
therefore, costs the bank little of tangible value, but it shows up on
the ledger as a reduction in assets without a corresponding reduction
in liabilities. If the bad loans exceed the size of the assets, the
bank becomes technically insolvent and must close its doors. The first
rule of survival, therefore, is to avoid writing off large, bad loans
and, if possible, to at least continue receiving interest payments on
them. To accomplish that, the endangered loans are rolled over and
increased in size. This provides the borrower with money to continue
paying interest plus fresh funds for new spending. The basic problem is
not solved, but it is postponed for a little while and made worse.
The final solution on behalf of the banking cartel is to have the
federal government guarantee payment of the loan should the borrower
default in the future. This is accomplished by convincing Congress that
not to do so would result in great damage to the economy and hardship
for the people. From that point forward, the burden of the loan is
removed from the bank's ledger and transferred to the taxpayer. Should
this effort fail and the bank be forced into insolvency, the last
resort is to use the FDIC to pay off the depositors. The FDIC is not
insurance, because the presence of "moral hazard" makes the thing it
supposedly protects against more likely to happen. A portion of the
FDIC funds are derived from assessments against the banks. Ultimately,
however, they are paid by the depositors themselves. When these funds
run out, the balance is provided by the Federal Reserve System in the
form of freshly created new money. This floods through the economy
causing the appearance of rising prices but which, in reality, is the
lowering of the value of the dollar. The final cost of the bailout,
therefore, is passed to the public in the form of a hidden tax called
inflation.
So much for the rules of the game. In the next chapter we shall look at
the scorecard of the actual play itself.
Notes:
{1} "Banking Against Disaster", by Walter B Wriston, The New York Times
(September 14 1982).
{2} http://en.wikipedia.org/wiki/Savings_and_loan_crisis
{3} "Overseas Lending ... Trigger for A Severe Depression?" The Banking
Safety Digest (US Business Publishing/Veribanc, Wakefield,
Massachusetts), August 1989, page 3.
{4} http://en.wikipedia.org/wiki/The_Phil_Donahue_Show
{5} "How Safe Are Deposits in Ailing Banks, S&L's?" US News & World
Report (March 25 1985), page 73.
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