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Ever since going off the gold standard, the economy has been based on worthless paper or, more accurately, paper that is worth only what the market pretends it is worth. It has no intrinsic value. Banks are holding piles and piles of mortgage papers that the market has now decided are worth zero. The banks have run out of fools to buy these "toxic" loans, so they are stuck with them. Thus, they are unable to borrow more funds from the Federal Reserve to continue lending additional monies to new or existing customers. These banks are at their lending limits under funds' reserve rules that require them to have a certain percentage of their total funds as "cash" on hand. This has frozen the credit markets.
Now, let me make clear I am not an expert on investment or mortgage banking; my expertise and experience is in consumer lending. But, I have been a student of banking and credit issues for many years, and I worked in credit card operations for one of the largest banks in the world. I have railed against many of the changes in our banking system for years.
How did we get into this crisis? First and foremost, we foolishly went off the gold standard. That was the first step down this road to economic oblivion. If we ever hope to have a truly stable economy again, we must return to a monetary system based on gold, a commodity with intrinsic value. We cannot do that suddenly or immediately. If we did, our economy would completely collapse. However, returning to the gold standard should be our ultimate goal. We must recognize that the transition will be painful but necessary for long-term stability.
The next most disastrous change made in the banking system was deregulation that allowed federal banks to go into the mortgage, securities, and insurance businesses. This is the direct result of a mass amnesia regarding our economic history, specifically the Crash of 1929. I do not know if it is a failure of history education or a certain innocence that causes us to think such a disaster could not happen again to us. Whatever it was, we as a nation collectively forgot the lessons of the Great Depression.
Before that catastrophe, banks were heavily involved and leveraged in mortgages, security investment schemes, and insurance or risk management. After the crash, regulations in the the Glass-Steagall Act of 1933 were put in place that strictly separated banking from mortgages, securities, and insurance. Mortgages were offered by Savings & Loans. Securities were handled by stock brokers, and insurance was sold only by insurance agencies. Commercial (consumer) banks could not engage in investment banking. "Never the twain would meet" was the rule to keep these different financial businesses separate.
These regulations kept the financial markets relatively stable for over sixty years until 1999. Then, the Gramm-Leach-Bliley Act, passed by the Republican Congress and signed into law by the Democratic President Bill Clinton, discarded these stabilizing rules. "Universal banking" became the standard, launching a feeding frenzy of larger national and international banks gobbling up local and regional banks. Banks, stock brokerages, and insurance companies cannibalized each other. The lines between commercial and investment banking blurred. Financial institutions ballooned in size and diversity of products offered.
Although the process is too complicated to explain in this essay, the end result of banking deregulation of U.S. banking was the transformation of our economy from one based on industrial capitalism to financial capitalism. For an excellent analysis of this process, go to http://www.atimes.com/atimes/Global_Economy/II06Dj01.html . There, Henry C. K. Liu, chairman of a New York-based private investment group, explains, "Finance capitalism is a system in which capital is only a notional value upon which to build a gigantic mountain of hidden debt." In such a system, financial instruments, including stocks, are traded with valuations not based on physical assets. Instead, their value becomes "conceptual," something that exists only in the ether of financial computer systems or cyberspace. Critics' concerns about institutional and economic risk exposure have been dismissed as silly and old-fashioned in a post-modern financial world without borders.
Liu wrote for Asia Times in 2007:
"As an economist, Ben Bernanke [U.S. Federal Reserve Chairman] no doubt understands that the credit market through debt securitization has in recent years escaped from the funding monopoly of the banking system into the non-bank financial system...The Fed can only intervene in the money market through the shrinking intermediary role of the banking system, which has been left merely as a market participant in the overblown credit market. Thus the Fed is forced to fight a raging forest fire with a garden hose." [Henry C.K. Liu, "CREDIT BUST BYPASSES BANKS Part 1: The rise of the non-bank financial system," Asia Times Online, September 6, 2007 http://www.atimes.com/atimes/Global_Economy/II06Dj02.html]
Liu understood that "the liquidity crunch is a symptom, not the disease. The disease is a decade of permissive tolerance for credit abuse in which the banks, regulators and rating agencies were willing accomplices." [Ibid.] The SEC is suppose to be the watchdog of these markets and an advocate or protector for investors. Liu said in 2007that there has been massive withholding of information from investors on the actual condition of many firms' books. He accuses, "The aim of this charade has not been to enhance the return on the public's investment, but to exploit the public trust to shore up a declining market and postpone the inevitable demise of wayward institutions." [Ibid.]
Liu warned in 2002 that unregulated markets always collapse. He went on to say,
"Such a decline can happen in a period of days in this age of program trading and socialized risk, even with circuit breakers and trading curbs. When that happens, structured finance will be a sea of dead and wounded in counterparty casualties, regardless of who won and who lost." [op.cit.]He was spot-on as proven by the headlines of this past weekend.
Ultimately, our current financial crisis can be laid at the feet of our national foolishness in creating the Federal Reserve Bank. Our most esteemed founding fathers warned against ever establishing a central bank. Thomas Jefferson wrote, "If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless." James Madison, father of the Constitution, understood the danger of tyranny if a central bank controlled the currency. He advised, "History records that the money changers have used every form of abuse, intrigue, deceit, and violent means possible to maintain their control over governments by controlling the money and its issuance."
We did not listen, and we created a monster that was intended to protect free markets but is now about to devour our free market economy. As Liu states in his most recent essay,
"The lender of last resort has become a predator of last resort, nationalizing all dying enterprises. But it seems to be racing headlong onto the road of nationalization not so much as to help the common people as to keep dying financial dinosaurs alive." [Henry C K Liu, "Too big to fail versus moral hazard," Asia Times Online, September 23, 2008 http://www.atimes.com/atimes/Global_Economy/JI23Dj13.html]
This is exactly where we find ourselves today. We failed to learn the hard lessons of history. Treasury Secretary Paulson, along with the Federal Reserve Chairman and the SEC Chairman, are trying to persuade Congress and the American people that it is absolutely necessary to bail out the banks to the tune of $800 billion. The arguments of necessity can take away liberties as surely as conquering armies, as Thomas Jefferson warned.
Let us be very clear. If Congress approves this bailout, then we will cease being a capitalistic society. We will have slipped into national socialism if we nationalize our financial markets. We will no longer have a free market economy. Do we even remember who the last great advocate of National Socialism was? It was Adolf Hitler.
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