Wednesday, August 31, 2011

Federal Reserve - Was Woodrow Wilson Right?

Woodrow Wilson has been credited with the following insightful quote: "The government, which was designed for the people, has got into the hands of the bosses and their employees. An invisible empire has been set up above the forms of democracy."

This quote came to mind when reading a recent extensive investigative report from Bloomberg, "Wall Street Aristocracy Got $1.2 TRILLION In Secret Loans." The report looked into the secret relationships that the Federal Reserve Board has been having with the major banks of the world over the past few years. According to the article of the investigation, the Fed did not easily and voluntarily give up the information and the descriptions of their behavior.

I am, by far, not an expert on the workings of the Federal Reserve System, banking systems, high finance, and monetary system. However, I am a somewhat educated person who thinks that some of the findings of the Bloomberg analysis are distressing, scary, and a danger to democracy in America:
  • In 2006, the 10 largest U.S.banks and brokerage firms had their best year ever, earning $104 billion in profits.
  • Within two years, the Federal Reserve  had lent these same banks $669 billion, in addition to the $160 billion these banks had received from the Treasury Department.
  • Thus, in 2008, the U.S. government had endangered  $829 billion worth of the nation's wealth to save these ten large financial services firms, or about $7,200 per U.S. household.
  • The extent of this Federal Reserve activity had been kept secret until now.
  • In total, the Fed gave out $1.2 TRILLION worth of public money to keep banks afloat and out of bankruptcy.
  • Turns out that the Fed took taxpayer money and also gave it to many foreign financial services  firms including Royal Bank Of Scotland ($84.5 billion), Zurich-based UBS ($77.2 billion), and Germany's Hypo Real Estate ($28.7 BILLION).  This last loan calculated out to about $21 million for each of Hypo's 1,366 employees. Banks in Belgium and France also received loans from America's central bank.
  • The peak of the lending was $1.2 TRILLION which occurred in December, 2008. This amount was about three times the size of the Federal government that year and more than the cumulative earnings of ALL Federally insured banks for the past ten years.
  • This total was 25 times larger than the actions the Fed took after the 9-11 attacks shook the U.S. economy.
  • The Fed contends that it had no losses from this outrageous spending and loan spree and actually netted $13 billion in interest and loan fees. This comes out to a return on investment of 1.1% when calculated against the $1.2 TRILLION amount.
  • The reason for extremely low returns could be the fact that the Fed made these loans to the biggest banks at less than one third of the current interbank rates at the time of these loans, obviously a great deal for the banks.
  • Two weeks after Lehman Brothers folded in September, 2008, Morgan Stanley proclaimed that it had "strong capital and liquidity positions." They forget to mention that same day that the Fed loan's of $107.3 billion was almost all of Morgan Stanley's available cash. Thus, investors could have believed that Morgan Stanley was in good financial shape when in fact it was being kept alive by over $100 billion of Fed credit loans, distorting investors' investment decisions.
  • While the Fed insisted on collateral to protect their loans, what started out as accepting only high quality collateral of the banks such as Treasuries, corporate bonds, and mortgage bonds, but as the program wore on, the Fed started to accept junk bonds, those that were rate below investment grade, endangering the taxpayer wealth on the line for these loans.
  • Citigroup was the most chronic borrower among the largest U.S. banks, so much so that Richard herring, a finance professor at the University of Pennsylvania is quoted in the article stating that "Citibank basically was sustained by the Fed for a very long time." In other words, the U.S. taxpayer kept Citigroup from going bankrupt, all for about a 1% risky return on the taxpayer investment.
And the Fed and the banks wanted to keep all of these transactions secret. My conclusions about this dangerous use of taxpayer wealth:
  • Keeping this all secret in a democracy is the biggest problem, it reinforces Wilson's observation that there is collusion above the current forms of democracy between the highest levels of government and the banking industry.
  • By being kept secret, investment decisions of Americans were distorted since the banks were in far worse condition than the public information on their financial condition would show.
  • Why the American taxpayer had to lend money to foreign banks is still unexplained. Shouldn't Americans be involved in any decisions like that which involves untold billions of dollars being loaned out at very favorable rates to foreign banks?
  • Richard Herring, who is quoted above, stated that some banks may have used the lending program to "maximize profits by borrowing form the cheapest source, because this was supposed to be secret and never revealed." Thus, the professor has raised the obvious issue that American taxpayers may have subsidized the profitability, and payouts to high ranking banking executives, without their knowledge.
  • Furthermore, the professor feels that the loans from the Fed "amounts to a free insurance policy for banks guaranteeing the arrival of funds in a disaster." In other words, the Fed's secret loan programs may have rescued bad bankers from their own bad practices which may lead these same bankers to assume that the Fed, using taxpayer wealth, will always rescue them from themselves.
  • The IMF supports Herring's conclusions, stating in an IMF report that the banks should be charged a fee for accessing Fed funds to discourage using Fed loans as a source of profitability.
  • Despite all of this risk, the latest issue of Business Week magazine indicates that many of these rescued banks are now in the financial doldrums. Bank of America's stock price is down 53% this year. The stock of JP Morgan is down 18%. The stock market index tracking financial stocks is down 21%. The revenues of the top ten investment banks are down 10% this year.
  • Thus, the Fed may have risked over a TRILLION dollars on the bankers and the banks they operate, bankers who deserved to fail at their jobs, and despite such high levels of Fed/government support, the same executives continue to struggle to run a successive financial firm.
Wow, I think Woodrow Wilson was right. We have people in the Federal government (the Federal Reserve Board) who get little oversight from Congress, who prefer to keep their dealings secret, are not accountable to the American voter, and who may have been just plain lucky not to have lost up to over a TRILLION of taxpayer wealth.

How bad and out of sync have our government's priorities become to support this "invisible empire"? Consider the frustration of Congressman Walter Jones of North Carolina: "Why in hell does the Federal Reserve seem to be able to find the way to help these entities that are gigantic? They get help when the average businessperson down in eastern North Carolina, and probably across America, they can't even go to a bank they've been banking with for 15 or 20 years and get a loan?"

Great question, Congressman. Democracy and freedom cannot survive when government operations are so secret and risky. It is time for the Obama administration to step up to its transparency vow and work with Congress to make the the operations of the Fed as transparent as possible. It is the only way to defeat the "invisible empire" and break the too cozy relationship between private market bankers and Federal government banking enablers.









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