Money Power (Part 2)

by Peter Robertson

“I see in the near future a crisis approaching that unnerves me and causes me to tremble for the safety of my country. As a result of the war, corporations have been enthroned and an era of corruption in high places will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people until all wealth is aggregated in a few hands and the Republic is destroyed.”

(President Abraham Lincoln to Colonel William F. Elkins, 1864)

Money Power (Part Two) addresses the big issues of global finance in the modern world. photo credit: Generation X-Ray via photopin cc
Money Power (Part Two) addresses the big issues of global finance in the modern world. photo credit: Generation X-Ray via photopin cc

Historical concern about the influence of the money power in America is based on the belief that a cabal of the world’s wealthiest financiers has been in charge of the planet’s primary monetary systems and thereby controlling much of the global economy. This is a credible notion, given the fact that the Federal Reserve Banks are privately owned by other large banks, that the world’s largest banks are all owned by each other, and that most of the world’s central banks interconnect through their joint ownership of the Bank of International Settlements.  Through these institutional arrangements, a small number of men and women wield enormous power to establish the basic parameters of the monetary and financial system, and thereby to exert considerable influence over global economic conditions.

Americans have long been concerned about the dominance of the money power, the capacity of these elite financiers to exert influence not just on the economy but on politics and government as well, all towards their own ends rather than the public good.  Since it is widely understood that the primary goal in capitalism is to maximize profit, we should assume that the capitalists in charge of the world’s central banks and the international banking system share this objective.  Unfortunately, with profit maximization as their primary goal, capitalists too readily discount the importance of other considerations such as human well-being, with efforts to make money oftentimes generating negative externalities that reduce the quality of life for people outside the profit margins.  This is the great danger in outsourcing Congress’ constitutional power over the monetary system to a consortium of private bankers.  As the history of the 20th century suggests, those controlling the money and the banks have found many ways to profit at the expense of the people.

“[T]he real menace of our Republic is this invisible government which, like a giant octopus, sprawls its slimy length over city, state and nation…[A] small group of powerful banking houses generally referred to as the international bankers…virtually run the United States government for their own selfish purposes…It operates under cover of a self-created screen [and] seizes our executive officers, legislative bodies, schools, courts, newspapers and every agency created for the public protection.”

(John F. Hylan, Mayor of New York City, 1922)

To explain some of the ways the money power benefits from existing arrangements, it will be useful to describe the evolution of the world’s monetary system since the founding of the Federal Reserve.  This includes the significant shift away from a gold standard to a pure fiat money system in which U.S. “petrodollars” have been serving as the global reserve currency in support of international trade.  It also includes the rise and growth of financial instruments and markets that primarily serve the purposes of speculation and the hedging of investment bets, resulting in a “global casino” in which the rich and powerful make and lose fortunes without much regard for the effects of this activity on the real economy.  With a better understanding of the nature of modern capital markets, it will be instructive to then consider some of the more insidious and egregious means through which banks seek to generate profit from the suffering of people and communities.  The point is to clarify that the money power is not a benign force that aims to serve the public good through the benevolent management of our monetary system, but instead is a proactive, self-serving group of powerful people, a cartel, who strive to enrich themselves regardless of the consequences for humanity.

“[W]e have in this country one of the most corrupt institutions the world has ever known.  I refer to the Federal Reserve Board and the Federal Reserve Banks…The predations and iniquities of the Federal Reserve Board and the Federal Reserve Banks acting together have cost this country enough money to pay the national debt several times over…Some people think the Federal Reserve Banks are United States Government institutions. They are not government institutions.  They are private credit monopolies which prey upon the people of the United States for the benefit of themselves and their foreign customers; foreign and domestic speculators and swindlers; and rich and predatory money lenders.”

(Congressman Louis McFadden, Chairman of the House Committee on Banking and Currency, 1932)

When the Federal Reserve (the Fed) was founded in 1913, the nation’s monetary system was on the gold standard, and had been officially since the passage of the Gold Standard Act in 1900.  In essence, the gold standard refers to the notion that a particular supply of money or currency is backed by gold, and in theory can be redeemed for gold at a fixed amount per unit of currency.  Whereas the “continentals” used in the Revolutionary War and the “greenbacks” used during the Civil War were fiat currencies, not backed by any precious metals, for most of the history of the United States, the currencies in use have been convertible into gold and/or silver (in theory if not always in practice).  When the Fed took over control of the nation’s money supply, it was required by law to hold an amount of gold equal to 40 percent of the value of the currency it issued – the Federal Reserve Notes we call “dollars” – which could be converted into gold at a fixed price of $20.67 per ounce.

A primary rationale for backing a currency by precious metals is that doing so serves as a constraint on growth of the money supply; the amount of currency available for use in the economy can only increase proportional to an increase in the amount of gold held in reserve.  This is intended to prevent a rapid infusion of money into the economy, which historically tends to have an inherent inflationary effect because it devalues the currency, rendering paper notes “not worth a continental” as the early Americans used to say.  This constraint on the money supply can be problematic, however, when more money is needed to maintain or increase the level of economic activity and enable necessary trade.  This is essentially the situation Franklin D. Roosevelt faced at the start of his presidency in 1933, three years into the Great Depression that began when the bubble of the Roaring ‘20s suddenly burst just two months before the end of the decade.

“The real truth of the matter is, as you and I know, that a financial element in the larger centers has owned the Government ever since the days of Andrew Jackson…The country is going through a repetition of Jackson’s fight with the Bank of the United States – only on a far bigger and broader basis.”

(President Franklin D. Roosevelt to Colonel Edward Mandell House, 1933)

By the time Roosevelt took office, large quantities of gold had been taken out of the Fed as the American people and firms preferred keeping their money in the form of gold rather than either bank deposits or paper currency, and as foreign investors feared a devaluation of the dollar.  When the Federal Reserve Bank of New York reached the point that it could no longer honor its commitment to convert currency into gold, Roosevelt declared a national banking holiday and issued a proclamation that formally suspended the gold standard.  He issued Executive Order 6102 that forbid the “hoarding” of gold coins and bullion, and required people and businesses to exchange all but small amounts of their gold for $20.67 an ounce.  Congress then passed the Gold Reserve Act early the next year, which not only ratified the President’s decision to confiscate gold from the American public, but immediately changed the fixed rate to $35.00, attracting additional gold from foreign investors taking advantage of the new higher price.  With its bank notes no longer redeemable in gold, and no longer constrained by limited gold reserves, the Fed was able to rapidly increase the nation’s money supply.  While these steps were understandably controversial at the time, they now appear to have played an important role in accelerating America’s recovery from the Depression.

In the summer of 1944, while World War II was still being fought, delegates from the 44 Allied nations came together at the United Nations Monetary and Financial Conference to develop new institutional mechanisms for regulating the international monetary and financial order after the war ended.  Meeting for three weeks in Bretton Woods, New Hampshire, the delegates concluded the conference by signing an agreement establishing the so-called Bretton Woods institutions, i.e., the International Monetary Fund, the International Bank for Reconstruction and Development (now part of the World Bank), and the General Agreement on Tariffs and Trade (now known as the World Trade Organization).  The goal of the conference was to develop a system for governing monetary relations among nations that ensured exchange rate stability, prevented competitive devaluations, and

Inside the Federal Reserve Bank of San Francisco. photo credit: Federal Reserve Bank of San Francisco, #2 via photopin (license)
Inside the Federal Reserve Bank of San Francisco. photo credit: Federal Reserve Bank of San Francisco, #2 via photopin (license)

promoted economic growth.  To accomplish this, it was decided to make the U.S. dollar the world’s reserve currency by making the dollar convertible to gold at the fixed exchange rate of $35 per ounce, and then pegging all other currencies to the dollar at fixed exchange rates.  In other words, Bretton Woods established a system of payments in which the value of other currencies were defined in relation to the dollar, which itself was convertible into gold and thus essentially “as good as gold.”

The Bretton Woods system worked reasonably well in the post-War period.  And it was particularly advantageous to the United States, which essentially took on the role of global monetary hegemon, i.e., the world’s money manager.  In his New York Times review of Benn Steil’s book, The Battle of Bretton Woods, Fred Andrews points out that “it went without saying that [the U.S.] was bent on becoming the globe’s financial capital,” and the American negotiators – Treasury Secretary Henry Morgenthau and his adviser Harry Dexter White – insisted on institutional arrangements that gave America a significant advantage.  As UC Santa Barbara professor Benjamin Cohen puts it, “America became the residual source of global liquidity growth through the deficits in its own balance of payments…The privilege of financing deficits with its own currency (‘liability financing’) meant that America was effectively freed from external payments constraints to spend as freely as its leaders thought necessary to promote objectives believed to be in the national interest.”

In effect, an implicit bargain was struck in which America’s allies acquiesced in a hegemonic system that gave the U.S. greater freedom to act abroad unilaterally to promote its own or collective interests, in exchange for which the U.S. supported its allies’ use of the system to promote their own prosperity even if this entailed steps that incurred a short term expense for the United States.  This bargain held as long as the volume of liability financing was relatively limited, since both sides gained from the flow of U.S. dollars into the reserves of foreign countries.  However, in the late 1950s, the American trade deficit started to grow significantly, and European governments became reluctant to continue to increase their volume of dollar reserves.  Furthermore, as the total worldwide volume of dollar reserves grew to exceed the total value of the gold stock held by the U.S., confidence in the dollar’s continued convertibility began to wane.  As a result, in the 1960s, other countries began demanding that the U.S. settle its trade deficits in gold rather than dollars.  They also started to grow more concerned about the inherent asymmetry in the system that allowed America to benefit from its practice of liability financing, an advantage that French president Charles de Gaulle’s finance minister referred to as an “exorbitant privilege.”  The net effect of this privilege was that other countries were, in effect, subsidizing the American standard of living.

The net effect of this privilege was that other countries were, in effect, subsidizing the American standard of living.

In the late ‘60s, increased government spending on the Vietnam War and domestic social programs put inflationary effects on the dollar and increased the perception that it was overvalued.  As a result, speculators were encouraged to bet against the dollar, raising the risk of a necessary devaluation.  This further motivated foreign governments to exchange some of their dollars for gold, generating fears of a run on gold.  In the midst of the growing uncertainty, West Germany decided to withdraw from the Bretton Woods system in May of 1971, followed by Switzerland in early August.  Under pressure to make a similar move, President Richard Nixon announced on August 15 that the U.S. was unilaterally “closing the gold window,” such that foreign governments could no longer convert dollars to gold.  The “Nixon Shock,” as it has come to be called, all but ended the Bretton Woods system of international financial exchange.  Efforts were made to renegotiate the fixed exchange rates among the currencies of the top industrialized countries, but ultimately they agreed to discontinue the system of fixed rates and instead to let their currencies “float,” meaning that the value of any given currency is not attached to anything and exchange rates fluctuate as a function of the relevant countries’ fiscal conditions.

The U.S. got the Saudis to agree to price all their oil transactions in dollars – i.e., they wouldn’t accept any other currency – and then to use the dollars they earned to purchase U.S. Treasury securities. Before long, this same agreement was reached with all of the oil-producing nations in OPEC, resulting in a new “petrodollar” system that insured global demand for the U.S. dollar since demand for oil was increasing around the world. It also gave America another “exorbitant privilege” in the global economy, in that the Fed could simply print the dollars that America needed to purchase its oil, while the rest of the world had to provide something of value in exchange for the dollars they needed to buy their oil.
The U.S. got the Saudis to agree to price all their oil transactions in dollars – i.e., they wouldn’t accept any other currency – and then to use the dollars they earned to purchase U.S. Treasury securities. Before long, this same agreement was reached with all of the oil-producing nations in OPEC, resulting in a new “petrodollar” system that insured global demand for the U.S. dollar since demand for oil was increasing around the world. It also gave America another “exorbitant privilege” in the global economy, in that the Fed could simply print the dollars that America needed to purchase its oil, while the rest of the world had to provide something of value in exchange for the dollars they needed to buy their oil.

The collapse of the Bretton Wood system had both positive and negative implications for the U.S. Federal Reserve, as the source of the U.S. dollar.  Freed from the constraint of the gold standard, the Fed was now able to expand the money supply as needed to fund the government’s “welfare and warfare” strategy.  However, with the discontinuation of its convertibility negating any inherent advantage the dollar had in the global economy, there was some risk that a decrease in global demand for dollars would undermine the Fed’s newfound capacity to expand the money supply.  To address this concern, President Nixon and Secretary of State Henry Kissinger negotiated a rather remarkable arrangement with Saudi Arabia in 1974.  The U.S. got the Saudis to agree to price all their oil transactions in dollars – i.e., they wouldn’t accept any other currency – and then to use the dollars they earned to purchase U.S. Treasury securities. Before long, this same agreement was reached with all of the oil-producing nations in OPEC, resulting in a new “petrodollar” system that insured global demand for the U.S. dollar since demand for oil was increasing around the world.  It also gave America another “exorbitant privilege” in the global economy, in that the Fed could simply print the dollars that America needed to purchase its oil, while the rest of the world had to provide something of value in exchange for the dollars they needed to buy their oil.

For the last forty years, then, the global economy has been functioning with an international monetary system comprising a number of different fiat currencies that have no inherent value but only a relative value that reflects a complex set of interdependent economic, political, and social factors that drive the dynamics of the currency markets.  These fiat currencies are issued by the world’s central banks, in whatever amounts they choose to suit their purposes, essentially creating the money out of nothing and then loaning it to governments at interest.  This “base money” then becomes the foundation for a banking industry that uses a system of fractional reserve lending to increase the money supply by a factor of ten or more by creating additional money (again, out of nothing) through the process of making loans to people and businesses, who are obligated to pay the money back with interest.

With no constraint on the amount of money created by the banks, the money supply – and the corresponding amount of debt-plus-interest owed – has grown rapidly during this period.  The net effect has been a dramatic devaluation of the dollar due to the inflationary effects of this unrestrained growth, with its value now only 5 percent of what it was when the Fed was founded.  Through it all, the banks and bankers have been skimming up to 40 percent off the top as the “cost of capital,” extracting considerable wealth from the system through their institutionalized right to charge usury for the use of money that they are able to create at no cost to themselves.  From this perspective, the entire monetary system is “the biggest scam in the history of mankind,” nothing but a form of legalized theft.

Image via The Burning Platform by The Resiliency Group

The core premise of economic theory is that actors rationally pursue their self-interests, and the primary objective in capitalism is to maximize profit.  Thus, it is reasonable to presume that the money power – the rich and powerful people running the world’s central banks and the top-tier set of financial institutions that own most of the world’s corporations – acts strategically to accrue as much wealth as possible.  The fact is that war is a very profitable enterprise for banks and an array of large corporations that benefit immensely from increased military activity and warfare.  On one hand, war is expensive for those governments engaged in the conflict, invariably increasing the amount of money they need to borrow from the banks.  In that sense, the longer the war, the better off the banks are.  On the other hand, more business for the weapons manufacturers, military services providers, construction companies, and others that generate revenue through war-related activities means more profit for those who own and/or are invested in these companies.  After serving for over 33 years in the U.S. Marine Corps and rising through the ranks, General Smedley Butler acknowledged in 1933 that “war is a racket…conducted for the benefit of the very few, at the expense of the very many.”

Given the various ways that banks and corporations make money through war, a case can be made that “all wars are bankers’ wars.”  Some wars may well have been provoked by the money power for the purpose of maintaining or gaining a stake in a nation’s economy.  As explained in Part 1, for example, the Revolutionary War was instigated by efforts by the British king and parliament to force the colonists to rely on the Bank of England’s monetary system rather than using their own debt-free scrip.  The year after the charter expired on the first Bank of the United States, England engaged America in the War of 1812, which left the country indebted and its monetary system on unsteady ground, justifying the creation of the Second Bank in 1816 that Andrew Jackson “killed” twenty years later.  The money power may even fund both sides of a conflict, as a way to stimulate or prolong a war and thus increase its profits. In World War II, for example, British and American bankers, working through the Bank of International Settlements, were helping to finance Hitler’s war machine even as Allied soldiers were fighting the Germans in Europe.

“(T)he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences.”

(Professor Carroll Quigley, in Tragedy and Hope: A History of the World in Our Time, 1966)

In this century, the wars throughout the Middle East-North Africa region can readily be understood as an effort to maintain the petrodollar system (and thus American hegemony), and to expand the reach of the money power into countries where it did not have sufficient control.  The reasons the U.S. went to war in Afghanistan had as much if not more to do with controlling the flow of oil from Central Asia than it did with hunting down Osama bin Laden.  Likewise, the purpose of the invasion of Iraq was not necessarily to bring freedom to the people of that country by removing the ruthless dictator Saddam Hussein.  More likely is that the goal of ousting Hussein was a response to his decision in 2000 to start selling Iraqi oil for euros instead of dollars.  This constituted a significant threat to the dollar’s status as the global reserve currency, and since the “exorbitant privilege” bestowed upon America as result of the dollar’s reserve status helps to fund our global military presence, a threat to the dollar is essentially a threat to American hegemony.  For that Hussein had to die.

More recently, Muammar al-Qaddafi befell a similar fate for a similar reason.  He too was challenging the dollar and the world’s fiat monetary system by proposing the development of a new gold-backed currency, the gold dinar, and calling on the Muslim and African nations to unite in their use of the dinar for international trade including the sale of oil.  By essentially selling oil for gold, this system would shift the balance of power in the global economy, as a country’s wealth would largely depend on how much gold it had.  And the IMF estimated that the Libyan central bank was holding nearly 150 tons of gold at the time, which provided a solid foundation for this scheme.  Libya’s central bank was also entirely state-owned – in contrast to the privately owned central banks in most of the rest of the world – which essentially means that the government could create its own money, interest-free.

As Web of Debt author Ellen Brown explains, use of a state-owned central bank enabled Qaddafi to provide an impressive array of benefits to the Libyan people, including free education, free medical treatment in hospitals with the best medical equipment, financial assistance (about $50,000) to young couples getting married, subsidies that lower the prices of cars, gasoline, and bread, and the Great Man-Made River project that brings water from a large aquifer in the south of the country to the populated coastal areas in the north.  She concludes her analysis of this situation (written before the fall of the Qaddafi regime) by observing that, “With energy, water, and ample credit to develop the infrastructure to access them, a nation can be free of the grip of foreign creditors.  And that may be the real threat of Libya: it could show the world what is possible.”  It is telling that the Libyan rebels, in a rather curious and unusual move, created a new central bank for the country even before they had a government, while they were still fighting the entrenched regime.  This adds weight to the claim that a primary purpose of removing Qaddafi was to take over Libya’s banking and monetary system.  Libya’s monetary independence, along with the threat posed by the prospect of the gold dinar, apparently provided sufficient motivation to push for regime change and the killing of Qaddafi too.

“With energy, water, and ample credit to develop the infrastructure to access them, a nation can be free of the grip of foreign creditors.  And that may be the real threat of Libya: it could show the world what is possible.”

In short, a strong case can be made that the conflagrations in the MENA region are driven primarily by a desire to maintain the petrodollar system that underpins the entire global economy and yields billions of dollars of profit for the banks, oil companies, and military industrial complex devoted to maintaining this system.  This would explain why a number of these wars were planned well in advance, as General Wesley Clark claimed in an interview in 2007.  During a visit to the Pentagon about ten days after 9/11, Clark was pulled aside by another general and told that the decision had been made to invade Iraq even though there was no clear reason for doing so.  A few weeks later, Clark was told by the same general that there was actually a plan to “take out” seven countries in five years, namely, Iraq, Syria, Lebanon, Libya, Somalia, Sudan, and Iran.  Brown notes that none of these countries has a central bank that is a member of the Bank of International Settlements, which “evidently puts them outside the long regulatory arm of the central bankers’ central bank in Switzerland” – in other words, beyond the control of the cartel in charge of most of the world’s monetary and financial systems.

Its willingness to wage war to protect its position at the top of the financial food chain is just one of the ways that the money power demonstrates its indifference to the human suffering caused by its pursuit of profits. A close examination of some of its activities over the years reveals a willingness to deliberately and strategically engage in practices that generate considerable wealth for those who are already rich at the expense of the public, the masses, those who already have the least.  For example, in an article published in Rolling Stone, Matt Taibbi explained how Goldman Sachs – the world’s most powerful investment bank – helped to create a number of significant “bubbles” in American history, including the Great Depression as well as the more recent tech stock bubble in the late ‘90s and the housing craze and $4 gasoline in the last decade.  He concluded that the bank’s “unprecedented reach and power have enabled it to turn all of America into a giant pump-and-dump scam, manipulating whole economic sectors for years at a time, moving the dice game as this or that market collapses, and all the time gorging itself on the unseen costs that are breaking families everywhere… The bank is a huge, highly sophisticated engine for converting the useful, deployed wealth of society into the least useful, most wasteful and insoluble substance on Earth – pure profit for rich individuals.”

In contrast to the manipulative practices of a single powerful bank like Goldman Sachs, Pete Brewton’s meticulous research, described in his book The Mafia, CIA, and George Bush, clarifies how a broad network of individuals with connections to high-ranking politicians, the intelligence community, and organized crime orchestrated the crisis in the savings and loan industry between 1985 and 1995.  The key figures in this network used a variety of strategies to essentially loot S&Ls around the country, often by taking out loans and subsequently defaulting on them.  This deliberate and coordinated effort began after the Reagan administration got Congress to deregulate the S&L industry in 1982.  A friend of Vice President George Bush – Texas banker-powerbroker Walter Mischer – was a central player in this network, which also included individuals involved in shipping arms to the Middle East and bringing drugs into the U.S.  Bush sons Jeb and Neil were involved in the scandal as well, each receiving large amounts of money from S&Ls that later went bankrupt.  As a result of this coordinated thievery, nearly a third of the nation’s 3200 savings and loan associations failed during this decade, with their closure or resolution costing the American taxpayers an estimated $125 billion or more.

In her book The Shock Doctrine, Naomi Klein describes what she calls “disaster capitalism,” an even nastier method by which those with wealth and power are able to benefit from the suffering of the people.  She defines disaster capitalism as “orchestrated raids on the public sphere in the wake of catastrophic events, combined with the treatment of disasters as exciting market opportunities,” which results in “using moments of collective trauma to engage in radical social and economic engineering.”  Klein argues that disaster capitalism has a long history, rooted in the “Chicago School” of economics advocated by Milton Friedman and his many followers.  Typically applied after the public experiences some kind of “shock” – the Pinochet coup in Chile in 1973, the Falklands War in 1982, Tiananmen Square in 1989, the turmoil in Russia in 1993, the Iraq War in 2003, the Indian Ocean tsunami in 2004, Hurricane Katrina in 2005 – the tripart strategy to which these neoliberal/neoconservative market fundamentalists are committed is “the elimination of the public sphere, total liberation for corporations and skeletal social spending.”

While ostensibly promoting freedom, Klein points out that, wherever the Chicago School policies have been applied over the last three decades, the result has been the emergence of a powerful ruling alliance between a few large corporations and a class of mostly wealthy politicians who work together to appropriate valuable resources that previously had been held in the public domain.  She calls this a “corporatist” system, the main characteristics of which are huge transfers of public wealth to private hands usually along with increased public debt, a growing gap between rich and poor, and a nationalistic orientation that justifies nearly limitless spending on security.  In the U.S., especially after 9/11, the corporatist state has generated a “homeland security bubble” which Klein describes as “a full-fledged new economy in homeland security, privatized war and disaster reconstruction tasked with nothing less than building and running a privatized security state, both at home and abroad.”  This bubble is financed through tax dollars, which means a direct transfer of wealth from the public into the hands of those profiting from the homeland security industry.  Collectively, these private interests have made billions of dollars as a direct result of the “war on terror,” which Klein suggests can be viewed instead as a “fight for the advancement of pure capitalism.”

Given their history of creating and profiting from bubbles that burst, using financial manipulations and fraud to steal from the public, and taking advantage of others’ hardship as a way to enrich themselves, it should not be surprising that the money power – through illegal and unethical practices on the part of numerous actors throughout the banking and finance sector – conspired to create the housing bubble in the ‘00s and to benefit tremendously from its subsequent collapse.  While the factors and elements that contributed to this scenario are certainly complex, one rather simple storyline in the bigger drama is the role that mortgage-backed securities played in the bubble and its collapse.

photo credit: American Dream, after Grant Wood via photopin (license)
photo credit: American Dream, after Grant Wood via photopin (license)

Mortgage-backed securities (MBSs) are a type of financial instrument that is based on the value of and revenue stream from mortgage loans made to homebuyers.  As the housing boom at the turn of the century fueled greater demand for these profitable securities, banks and other financial institutions began lending more and more to borrowers who were not very credit-worthy.  The banks making these subprime loans then bundled a large number of mortgages and sold them as a package to investment banks, which then divided the bundle up into shares or “tranches” that were sold to investors.  Because they were not affected by any defaults on the mortgages they sold to others to securitize, the banks originating these subprime loans had no incentive to limit them. In fact, they were often quite aggressive in terms of attracting potential borrowers and encouraging them to take out loans that realistically were beyond their means.  Most of these loans were adjustable rate mortgages, and borrowers were enticed with low fixed interest rates and payments early on which were then scheduled to jump to a higher and variable rate after a few years.  When rates adjusted and payments increased, many of the borrowers could no longer afford to make the payments, leading to an increase in the number of defaults and foreclosures.  This contributed to the collapse of the housing market, which in turn exacerbated the problem of mortgage defaults, and all of this then took its toll on the profitability of the mortgage-backed securities.

Because they generated a relatively good rate of return at a time of low interest rates, MBSs had been sold widely as a profitable investment for a number of years.  Even as the mortgage bundles started to include more and more subprime loans, agencies like Moody’s and Standard & Poor’s – under pressure from the banks, and to increase their own profit – continued to give AAA ratings to securities representing shares of those bundles, leading investors to believe they were safe even as the relevant risk continued to grow.  By 2006, about half of all mortgage loans were subprime, and as the number of defaults started to increase, the value of the MBSs naturally began to decrease.  For large investment banks that held a significant volume of these securities, this downturn had an important impact on their own net worth.  A prime example was Bear Stearns, whose financial weaknesses led to a sudden drop in the price of its stock, going in one week from $70 down to the $2 a share that JPMorgan Chase agreed to pay when it acquired its competitor in March of 2008.

The crisis came to a head in September of that year, when Lehman Brothers – one of the large, venerable investment banks on Wall Street – filed for bankruptcy (the largest in U.S. history), quickly triggering a chain of events that pushed Morgan Stanley and Merrill Lynch to the brink of failure as well (the latter eventually being sold to Bank of America) and forced the federal government to bail out the huge insurance company AIG.  The net effect was to tighten up the credit markets, stimulate panic selling of problematic assets, and contribute to the erosion of close to $10 trillion in market capitalization from global equity markets in October.  This was the beginning of the Great Recession, and six years later the American public is still suffering from the effects of high unemployment, reduced wages, millions of foreclosures and millions more homeowners “underwater” (i.e., they owe more on their house than it is worth), and trillions of dollars of lost household wealth.  The Federal Reserve Bank of Dallas has estimated that the cumulative effects of the crisis – “wealth lost during the recession plus the effect that lower earnings and wealth will have on future earnings and output” – could ultimately total more than $28 trillion.  In the midst of these economic challenges still facing Americans, however, the nation’s financial system seems to be healthy once again, with banks reporting near-record profits in 2013 and again last year.

Image via U.S. News & World Report

While the proliferation and diffusion of subprime mortgage-based securities was the proximal cause of the recession, a deeper and more pervasive problem in the global economy is the large volume of “derivatives” that have now infused the world’s financial system.  Derivatives are financial instruments whose value is based on, i.e., derived from, the value of an underlying reference rate, asset, or index, such as foreign exchange rates, interest rates, equities, and commodity prices.  One type of derivative is a credit default swap (CDS), which is essentially a bet as to whether a particular party will default on a financial obligation to another party.  Whereas CDSs can be used as an insurance policy – a creditor can purchase a CDS that would pay out if a debtor defaults on a loan – an interesting feature is that third parties not involved in the transaction being “insured” can also purchase them.  So, hypothetically, Morgan Stanley could purchase a CDS from AIG betting that Bear Sterns is going to default on an obligation to Lehman Brothers.  Because derivatives are unregulated, “over-the-counter” (OTC) financial instruments, there is no oversight or accountability regarding how many derivatives are bought and sold by banks, large corporations, or even governments wanting either to “hedge their bets” by mitigating risk or to “place their bets” by speculating about the future.

Image via Dragonfly Capital source of data is IMF, 2009 Q4

The prevalence of derivatives in the world’s financial system creates two significant challenges.  First, financial institutions have become so interconnected through the use of derivatives that the fate of one can have significant effects on the performance of others throughout the system.  This is the basis of the notion of “too big to fail,” which reflects the fact that the failure of one large bank could have ramifications for enough other entities that could then cause the whole system to collapse.  This notion has justified government use of taxpayer money to keep financial institutions solvent, such as the $85 billion bailout of AIG followed by the Troubled Asset Relief Program (TARP) which doled out $426 billion to banks and the U.S auto industry.  The government essentially closed the books on TARP last month, with the final numbers indicating that a profit of $15.3 billion was made on the sale of the assets purchased in the bailouts.  However, while the public trough may have benefitted rather unexpectedly from this program, it’s fair to say that, with $140 billion in bonuses being paid out by the banks in 2009, the bankers made out like bandits.

“The legislation that created TARP, the Emergency Economic Stabilization Act, had far broader goals, including protecting home values and preserving homeownership…The act’s emphasis on preserving homeownership was particularly vital to passage. Congress was told that TARP would be used to purchase up to $700 billion of mortgages, and, to obtain the necessary votes, Treasury promised that it would modify those mortgages to assist struggling homeowners. Indeed, the act expressly directs the department to do just that.  But it has done little to abide by this legislative bargain. Almost immediately, as permitted by the broad language of the act, Treasury’s plan for TARP shifted from the purchase of mortgages to the infusion of hundreds of billions of dollars into the nation’s largest financial institutions…In the final analysis, it has been Treasury’s broken promises that have turned TARP…into a program commonly viewed as little more than a giveaway to Wall Street executives.”

(Neil M. Barofsky, special inspector general for the Troubled Asset Relief Program,
in a New York Times op-ed printed on his last day in office in March, 2011)

A second challenge associated with the unregulated use of derivatives is the sheer volume of bets being placed in the “global casino.”  While it is difficult to get an accurate measure of how much all these derivatives are worth, one estimate is that the total notional value of the derivatives held by just nine large banks is over $220 trillion – with an interesting visualization of how much money that actually is!  According to the Bank of International Settlements, the notional amount of outstanding derivative contracts totaled $710 trillion at the end of 2013, with a gross market value of $19 trillion.  Others believe that the total is greater than that, probably well over a quadrillion dollars, with the actual cash-at-risk associated with these instruments being at least $12 trillion.  Regardless of the precise numbers, the point is that, with a total global GDP of around $60 trillion, the actual debt obligations associated with all these derivative contracts may be equal to twenty percent or more of the world’s economy, with the notional value being ten times larger than the entire economy.  The big risk is that some significant financial event – such as Greece defaulting on its debt – will trigger a chain reaction of derivative payoffs that essentially bankrupts everyone and causes a systemic collapse.

Most of these derivatives – possibly upwards of 80% of them – are tied to interest rates, meaning that investors are either betting on a change in rates or are using the derivatives as a way to reduce the risk associated with such a change.  The primary benchmark interest rate in the world is Libor (the London interbank offered rate), which is used as a reference rate for hundreds of trillions of dollars worth of derivatives, commercial and consumer loans, and other financial products.  Libor is set or “fixed” daily, through a process in which a number of large international banks provide information at 11am London time regarding their estimated borrowing costs, with the average of these estimates then being published as the daily Libor.  Given the size of the interest rate derivative market, a significant consequence is that billions of dollars ride on even very small changes in Libor.

In the summer of 2012, it came to light that a number of the banks involved in setting Libor had been manipulating the rate for many years in an effort to fraudulently boost their profits.  Traders at these banks had been colluding with each other to submit false information that would influence the daily rate in ways that allowed them to profit on their own derivatives positions.  For example, a change of as little as .01 percentage point could result in hundreds of millions of dollars of profit or loss for some banks.  According to a report in Der Spiegel, this collusion reflected a case of “organized fraud” that some would call a cartel, with one European Justice Commissioner suggesting that the bankers involved should be called “banksters” instead.  The investigation into this illegal rate-fixing indicates that, with regulators essentially looking the other way, as many as twenty large banks were involved.  A number of criminal investigations have resulted in billions of dollars of fines being imposed on many of the banks involved.  Parties claiming they suffered losses due to rate manipulations have file dozens of lawsuits.  These include a number of American municipalities who believe they were cheated out of interest payments due to rates being set artificially low.  These lawsuits could ultimately result in tens of billions of dollars more being paid out by the banks as compensation for their fraud.

If the Libor rate-fixing were the only example of banksters colluding on prices so as to be able to manipulate markets in their favor, we might be able to chalk it up to an informal network of opportunistic traders who found an easy way to work together to rig the system.  However, a number of other collusive manipulations have surfaced recently as well.  In a situation very similar to the Libor case, regulators have been investigating the possibility that a small group of brokers at the London-based firm ICAP may have worked with up to fifteen of the world’s largest banks to manipulate ISDAfix, a benchmark number used around the world to calculate the prices of interest-rate swaps (a particular type of derivative, with a market of over $300 trillion).  Furthermore, investors are pursuing a class-action lawsuit against twelve major banks for fixing prices and restraining competition in the roughly $21 trillion market for credit default swaps.  Taibbi concludes that these price-fixing scandals suggest there is “a single, giant mushrooming conspiracy of collusion and price-fixing hovering under the ostensibly competitive veneer of Wall Street culture.”

It gets worse.

It gets worse. Numerous authorities around the world are investigating the alleged rigging of the largely unregulated, $5 trillion-a-day currency market.  In the summer of 2013, Bloomberg reported insider claims that traders at some of the world’s biggest banks, on a daily basis for at least a decade, had been manipulating foreign-exchange rates used to set the value of trillions of dollars of investments and trade globally.  The head of the UK Financial Conduct Authority acknowledged that the allegations of exchange rate manipulations have the potential to be “every bit as bad” as the Libor case.  And as pointed out by Mark Taylor, the dean of the Warwick Business School, this manipulation “doesn’t just affect banks and traders, but the man in the street as well, as it is our pension and insurance funds that could be swindled out of millions of pounds by this.”  In the zero-sum world of the finance markets, whenever the banksters find a way to profit through fraud, other people in other places are paying the price.

Since all of the above still does not satisfy its insatiable desire for more wealth, it appears that the money power is manipulating prices in the gold and silver markets as well.  Many people have believed for quite some time that the precious metals markets are rigged in various ways and for various purposes, all of them to the benefit of the banks.  Dr. Paul Craig Roberts, former Assistant Secretary of the Treasury in the Reagan administration, provides a detailed explanation of the “hows and whys of gold price manipulation,” and a close analysis of a significant one-day drop in the price of gold helps to demonstrate the machinations through which this occurs.  One method in particular that seems to be used to manipulate this market is the rigging of the London gold fix, the benchmark used by central banks, mining companies, and jewelers to price their gold.  Research examining intraday trading in the spot gold market from 2001 to 2013 found, starting in 2004, frequent spikes in price at the time of the 3pm phone call during which five large banks determine the fix, with the price dropping on most of these occasions.  The researchers conclude that these unusual trading patterns are a sign of collusive behavior, and as a result, a lawsuit was filed last year accusing these banks of “fixing the fix,” as it were.  Regulators in Germany and the UK are investigating these claims, which are easy to take seriously in light of the banks’ similar manipulation of interest rates and foreign exchange rates.

It is certainly heartening to know that these various criminal activities of the banks and banksters are being investigated, and it is good to know that some of them have already been fined for some of their activities (although it is useful to bear in mind that paying a monetary penalty isn’t a terrible hardship when banks, using a fractional reserve-based fiat currency, are essentially able to create money out of nothing).  On the other hand, it remains clear that the money power has enough influence in the government apparatus through which these investigations and any subsequent prosecutions are to be conducted that it may be quite difficult to hold anyone accountable for these crimes by sentencing them to prison.  Taibbi reported that Attorney General Eric Holder and former Justice Department Criminal Division chief Lanny Breuer confessed that prosecuting offending banks and making arrests is dangerous in that doing so could lead to “collateral consequences” in the economy.  Apparently, they’re too big to fail, and too big to jail.

Moreover, it certainly appears as though the government is essentially colluding with the banksters to enable them to continue their practices and thereby extract even more wealth from the public.  For example, Taibbi chronicles the case of whistle-blower Alayne Fleischmann, and the measures taken by JPMorgan Chase in cooperation with regulators and Justice Department officials to prevent her inside information about the bank’s involvement in “massive criminal” mortgage-backed securities fraud from becoming public, thereby minimizing the price paid by the bank for its crimes.  In his earlier discussion of the Goldman Sachs bubbles, Taibbi begins by identifying all the “Goldmanites” who have played key roles on both the giving and receiving end of the billions of dollars of bailouts following the 2008 collapse.  More generally, there has been a “revolving door” between Goldman and the government that gives the bank considerable influence in various policy arenas pertinent to its business, including undue impact on decisions at the New York Federal Reserve Bank.  Most recently, Citigroup has been working to get Congress to repeal portions of the Dodd-Frank legislation that had been imposed on banks after the collapse, an effort that received support from Chase CEO Jamie Dimon as well. The “Cromnibus” bill passed by Congress in December included text actually written by Citigroup which removes provisions that protect Americans’ deposits and pensions from exposure to derivatives losses by allowing derivative traders to gamble with taxpayer money and get bailed out by government when their risky bets threaten the financial system.

While these few examples only scratch the surface, they help to illustrate the point that the money power essentially has control of the government, influencing public policy and its execution in ways that benefit the banks and banksters specifically and the rich and powerful more generally.  Yet the real story is not that the elite class has captured the government, a truth that most people already know and recent research has verified.  The more remarkable aspect of this situation is that “we the people” continue to tolerate it even though a significant portion of the wealth produced from the fruits of our labor is being siphoned off as a result of the institutionalized design of our monetary and banking system as well as the actions of greedy, criminal banksters who use collusion, fraud, and obstruction of justice to cheat us out of our money.  The Occupy Wall Street movement a couple years ago was, at its heart, a protest against the money power and the array of consequences of its selfish agenda on the quality of life for everyone else.  Unfortunately, most of the “99%” on whose behalf the Occupiers were protesting did not see much value or meaning in their efforts, and in the absence of a large public mobilization of support, the occupation was tolerated by the powers that be for only a short time before the police were sent in to forcefully and sometimes violently suppress the movement – a brief small threat to the money power effectively squashed.

The more remarkable aspect of this situation is that “we the people” continue to tolerate it even though a significant portion of the wealth produced from the fruits of our labor is being siphoned off as a result of the institutionalized design of our monetary and banking system as well as the actions of greedy, criminal banksters who use collusion, fraud, and obstruction of justice to cheat us out of our money.

It is telling that the only time the Bible records Jesus getting angry and violent was when he confronted the “money-changers” at the temple, overturning their tables and driving them out with a whip.  The problem was that they were cheating temple-goers in the process of exchanging the different types of coinage in use at the time.  We are in the same boat today, with contemporary money-changers using the various financial markets to pursue more and more profit at the expense of anyone and everyone they can take money from.  In this sense, the money power isn’t necessarily some secret cabal of the world’s top-level financiers running the world as they see fit, although the small number of people in control of the Bank of International Settlements, its member central banks, and the big investment banks could certainly be described in these terms.  Rather, the money power in our late-modern global village can be thought of as the financial system itself, bigger and more powerful than any set of actors playing some part within it, and seemingly impervious to any efforts to change the system.  Ironically, if the whole point of the liberal agenda emanating from the Enlightenment was to empower the individual human against the coercive and exploitative powers of the state, the money power has successfully subverted that agenda by creating instead a financial system that dis-empowers humans by leaving them subject to its coercive and exploitative effects that put most of the wealth into the hands of those managing and manipulating the money.  In the absence of another historic figure to come and “turn the tables,” so to speak, this exploitation will likely continue until the 99% get angry enough to demand fundamental changes to the system.

Rather, the money power in our late-modern global village can be thought of as the financial system itself, bigger and more powerful than any set of actors playing some part within it, and seemingly impervious to any efforts to change the system.

On the other hand, there is plenty of reason to believe that the system itself is ready to collapse under its own debt weight, and/or that a significant transformation in some of its basic parameters is about to occur.  It is not hard to find those whose assessment of the extant monetary and financial system leads them to the conclusion that it is inherently unsustainable and has to end.  Some point to the total volume of derivatives – which Warren Buffett once referred to as “financial weapons of mass destruction” – and suggest that a failure in that market could trigger a systemic reset of currency values, asset prices, etc.  Others point out that the petrodollar system is increasingly at risk as more and more countries are reaching bilateral or multilateral agreements to buy or sell oil, and other commodities as well, in currencies other than the dollar.  With the dollar no longer in demand as a reserve currency, it is unlikely to hold its value in the currency market, and a significant devaluation could easily and quickly lead to considerable economic hardship in the U.S.  Yet the currency market itself is now in considerable flux, with the recent surprise de-pegging of the Swiss franc from the euro and as more and more central banks start to engage in a “currency war” that will likely exacerbate the financial turmoil.

One reasonable projection from all of this chaos is that the global fiat currency system is coming to an end, collapsing like fiat currencies usually do.  China, Russia, and India (i.e., the BRICS) have been accumulating a significant amount of gold bullion in the last couple of years, leading to speculation that this could provide metal backing for a new currency that would compete with the fiat dollar and euro.  In this context, it is interesting to note that even some European countries – including Germany and the Netherlands – have recently been taking steps to “repatriate” some of their bullion that has been held in storage in the U.S. and elsewhere, suggesting that they are losing faith in the current monetary system and/or are planning for the creation of a new gold-backed currency.  Some observers even go so far as to suggest that the IMF is facilitating the collapse of the dollar in order to usher in a new global currency along with centralized administration of the global economy.  True or not, the possibility of some kind of global financial “reset” may be in the making, which could and should entail a widespread program of debt forgiveness that gives all countries and peoples a fresh start – a “year of jubilee,” of sorts, to initiate a new era for humanity.

While the future is quite uncertain, at present the money power is being challenged by the new Syriza government in Greece, which is refusing to give in to the demands of the Troika (i.e., the European Central Bank, the International Monetary Fund, and the European Commission).  Events there in the coming weeks could have considerable impact on how the future unfolds, in terms of added momentum towards economic collapse and/or broader resistance to the bankers’ bullying.  And Greece is not alone in this resistance to the banks.  In Spain, for example, the remarkable rise to popularity of the anti-austerity Podemos party reflects the Spanish citizenry’s anger at the entrenched elite, the “extractive” government class, and the cosy relationship between politicians, oligopolistic business interests, and an inert bureaucracy; current polls indicate the party is likely to do very well in elections coming up later this year.  Reflecting a different strategy, a case going to the Supreme Court in Canada is trying to restore the Bank of Canada to its mandated purpose of providing interest-free loans to the federal, provincial, and municipal governments to finance public expenditures when there is a budgetary deficit.

As useful as these steps may be, the most significant actions taken by any government to date to challenge the power of the banksters have been in Iceland, where the three top banks were allowed to fail, a number of bankers were sentenced to jail for fraud, and a considerable amount of mortgage debt held by citizens was forgiven.  Since taking these steps, the country’s economy has been doing reasonably well, demonstrating the fallacy of the banksters’ claims that the people should have to adopt “austerity” in order to save the banks so as to protect the economy.  Iceland’s recovery even during the recession also suggests that “failing and jailing” can be a useful strategy that other countries could emulate.

One way or another, it appears that the global economy is on the brink of a turning point.  On one hand, there is growing populist resistance to the bankers and to economic policies that are a boon to the wealthy and a bane to everyone else; it is easy enough to assume that the strength of this movement will grow in coming months and years, putting more pressure on politicians to adopt different approaches, à la Iceland and Greece, that are expressly intended to benefit the people rather than to save the banks and protect the economy.  On the other hand, that political process may be unfolding too slowly; a collapse of the fiat petrodollar system seems imminent, and can probably be avoided only by some kind of financial reset that is coordinated on a worldwide basis.  Having been following this story for a number of years, my best guess is that some form of collapse will happen first, creating a degree of chaos and sparking public outcry in nations around the world, with the people demanding changes and taking whatever actions are necessary to insure that their leaders respond accordingly.

Maybe the most insidious feature of the money power has been its capacity to fool the public into believing that private central banks are necessary and useful, that usurious fractional reserve banking is normal and healthy, that fiat currencies are viable and valuable, that the greedy pursuit of profit is rational and reasonable, and that the banksters are good and helpful people.  If nothing else, it looks as though this illusion is being swept away as more and more folks recognize the falsity of these claims and realize that an alternative reality is possible.  This long story of the money power is still being written, and it is now up to the people of Earth to write the next chapter.  Whatever happens, it is sure to be dramatic!

 

 

The opinions expressed are those of the author, and do not reflect in any way those of the USC Bedrosian Center.