FacebookTwitterGoogle+RedditEmail

What the Big Banks Have Won

by MIKE WHITNEY

The trouble started 24 months ago, but the origins of the financial crisis are still disputed. The problems did not begin with subprime loans, lax lending standards or shoddy ratings agencies. The meltdown can be traced back to the activities of the big banks and their enablers at the Federal Reserve. The Fed’s artificially low interest rates provided a subsidy for risky speculation while deregulation allowed financial institutions to increase leverage to perilous levels, creating trillions of dollars of credit backed by insufficient capital reserves. When two Bear Stearns hedge funds defaulted in July 2007, the process of turbo-charging profits through massive credit expansion flipped into reverse sending the financial system into a downward spiral.

It is inaccurate to call the current slump a “recession”, which suggests a mismatch between supply and demand that is part of the normal business cycle. In truth, the economy has stumbled into a multi-trillion dollar capital hole that was created by the reckless actions of the nation’s largest financial institutions. The banks blew up the system and now the country has slipped into a depression.

Currently, the banks are lobbying congress to preserve the “financial innovations” which are at the heart of the crisis. These so-called innovations are, in fact, the instruments (derivatives) and processes (securitization) which help the banks achieve their main goal of avoiding reserve requirements. Securitization and derivatives are devices for concealing the build-up of leverage which is essential for increasing profits with as little capital as possible. If Congress fails to see through this ruse and re-regulate the system, the banks will inflate another bubble and destroy what little is left of the economy.

On June 22, 2009, Christopher Whalen, of Institutional Risk Analysis, appeared before the Senate Committee on Banking, Housing and Urban Affairs, and outlined the dangers of Over-The-Counter (OTC) derivatives. He pointed out that derivatives trading is hugely profitable and generates “supra-normal returns”  for banking giants JP Morgan, Goldman Sachs and other large derivatives dealers.  He also noted that, “the deliberate inefficiency of the OTC derivatives market results in a dedicated tax or subsidy meant to benefit one class of financial institutions, namely the largest OTC dealer banks, at the expense of other market participants.” As Whalen testified:

“Regulators who are supposed to protect the taxpayer from the costs of cleaning up these periodic loss events are so captured by the very industry they are charged by law to regulate as to be entirely ineffective….The views of the existing financial regulatory agencies and particularly the Federal Reserve Board and Treasury, should get no consideration from the Committee since the views of these agencies are largely duplicative of the views of JPM and the large OTC dealers.”

Whalen’s complaint is heard frequently on the Internet where bloggers have blasted the cozy relationship between the Fed and the big banks. In fact, the Fed and Treasury are not only hostile towards regulation, they operate as the de facto policy arm of the banking establishment. This explains why Bernanke has underwritten the entire financial system with $12.8 trillion, while the broader economy languishes in economic quicksand. The Fed’s lavish gift amounts to a taxpayer-funded insurance policy for which no premium is paid.

Whalen continues:

“In my view, CDS (credit default swaps) contracts and complex structured assets are deceptive by design and beg the question as to whether a certain level of complexity is so speculative and reckless as to violate US securities and anti-fraud laws. That is, if an OTC derivative contract lacks a clear cash basis and cannot be valued by both parties to the transaction with the same degree of facility and transparency as cash market instruments, then the OTC contact should be treated as fraudulent and banned as a matter of law and regulation. Most CDS contracts and complex structured financial instruments fall into this category of deliberately fraudulent instruments for which no cash basis exists.”

No one understands these instruments; they are deliberately opaque and impossible to price. they should be banned, but the Fed and Treasury continue to look the other way because they are in the thrall of the banks. This phenomenon is known as “regulatory capture”.

Credit default swaps (CDS) are a particularly insidious invention. They were originally designed to protect against the possibility of bond going into default, but quickly morphed into a means for massive speculation which is virtually indistinguishable from casino-type gambling. CDS can be used to doll-up one’s credit rating, short the market or hedge against potential losses. CDS trading poses a clear danger to the financial system (The CDS market has mushroomed to $30 trillion industry) but the Fed and other regulators have largely ignored the activity because it is a cash cow for the banks.

Whalen again:

“It is important for the Committee to understand that the reform proposal from the Obama Administration regarding OTC derivatives is a canard; an attempt by the White House and the Treasury Department to leave in place the de facto monopoly over the OTC markets by the largest dealer banks led by JPM, GS and other institutions….

The only beneficiaries of the current OTC market for derivatives are JPM, GS and the other large OTC dealers…. Without OTC derivatives, Bear Stearns, Lehman Brothers and AIG would never have failed, but without the excessive rents earned by JPM, GS and the remaining legacy OTC dealers, the largest banks cannot survive and must shrink dramatically.” (Statement by Christopher Whalen to the Committee on Banking, Housing and Urban Affairs, Subcommittee on Securities, Insurance, and Investment, United States Senate, June 22, 2009)

The Geithner-Summers “reform” proposals are a public relations scam designed to conceal the fact that the banks will continue to maintain their stranglehold on OTC derivatives trading while circumventing government oversight. Nothing will change. Bernanke and Geithner’s primary objective is to preserve the ability of the banks to use complex instruments to enhance leverage and maximize profits.

The banks created the financial crisis, and now they are its biggest beneficiaries. They don’t need to worry about risk, because Bernanke has assured them that they will be bailed out regardless of the cost. Financial institutions that have explicit government guarantees are able to get cheaper funding because lending to the bank is the same as lending to the state.

MIKE WHITNEY lives in Washington state. He can be reached at fergiewhitney@msn.com

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at fergiewhitney@msn.com.

More articles by:

CounterPunch Magazine

minimag-edit

bernie-the-sandernistas-cover-344x550

zen economics

Weekend Edition
February 24, 2017
Friday - Sunday
Jeffrey St. Clair
Roaming Charges: Exxon’s End Game Theory
Pierre M. Sprey - Franklin “Chuck” Spinney
Sleepwalking Into a Nuclear Arms Race with Russia
Paul Street
Liberal Hypocrisy, “Late-Shaming,” and Russia-Blaming in the Age of Trump
Ajamu Baraka
Malcolm X and Human Rights in the Time of Trumpism: Transcending the Master’s Tools
John Laforge
Did Obama Pave the Way for More Torture?
Mike Whitney
McMaster Takes Charge: Trump Relinquishes Control of Foreign Policy 
Patrick Cockburn
The Coming Decline of US and UK Power
Louisa Willcox
The Endangered Species Act: a Critical Safety Net Now Threatened by Congress and Trump
Vijay Prashad
A Foreign Policy of Cruel Populism
John Chuckman
Israel’s Terrible Problem: Two States or One?
Matthew Stevenson
The Parallax View of Donald Trump
Norman Pollack
Drumbeat of Fascism: Find, Arrest, Deport
Stan Cox
Can the Climate Survive Electoral Democracy? Maybe. Can It Survive Capitalism? No.
Ramzy Baroud
The Trump-Netanyahu Circus: Now, No One Can Save Israel from Itself
Edward Hunt
The United States of Permanent War
David Morgan
Trump and the Left: a Case of Mass Hysteria?
Pete Dolack
The Bait and Switch of Public-Private Partnerships
Mike Miller
What Kind of Movement Moment Are We In? 
Elliot Sperber
Why Resistance is Insufficient
Brian Cloughley
What are You Going to Do About Afghanistan, President Trump?
Binoy Kampmark
Warring in the Oncology Ward
Yves Engler
Remembering the Coup in Ghana
Jeremy Brecher
“Climate Kids” v. Trump: Trial of the Century Pits Trump Climate Denialism Against Right to a Climate System Capable of Sustaining Human Life”
Jonathan Taylor
Hate Trump? You Should Have Voted for Ron Paul
Franklin Lamb
Another Small Step for Syrian Refugee Children in Beirut’s “Aleppo Park”
Ron Jacobs
The Realist: Irreverence Was Their Only Sacred Cow
Andre Vltchek
Lock up England in Jail or an Insane Asylum!
Rev. William Alberts
Grandiose Marketing of Spirituality
Paul DeRienzo
Three Years Since the Kitty Litter Disaster at Waste Isolation Pilot Plant
Eric Sommer
Organize Workers Immigrant Defense Committees!
Steve Cooper
A Progressive Agenda
David Swanson
100 Years of Using War to Try to End All War
Andrew Stewart
The 4CHAN Presidency: A Media Critique of the Alt-Right
Edward Leer
Tripping USA: The Chair
Randy Shields
Tom Regan: The Life of the Animal Rights Party
Nyla Ali Khan
One Certain Effect of Instability in Kashmir is the Erosion of Freedom of Expression and Regional Integration
Rob Hager
The Only Fake News That Probably Threw the Election to Trump was not Russian 
Mike Garrity
Why Should We Pay Billionaires to Destroy Our Public Lands? 
Mark Dickman
The Prophet: Deutscher’s Trotsky
Christopher Brauchli
The Politics of the Toilet Police
Ezra Kronfeld
Joe Manchin: a Senate Republicrat to Dispute and Challenge
Clancy Sigal
The Nazis Called It a “Rafle”
Louis Proyect
Socialism Betrayed? Inside the Ukrainian Holodomor
Charles R. Larson
Review: Timothy B. Tyson’s “The Blood of Emmett Till”
David Yearsley
Founding Father of American Song
FacebookTwitterGoogle+RedditEmail