Is $800 billion enough? The covered instruments eligible for conversion include the black hole of derivatives. Derivatives covered by the U.S. banks now estimated at $180 trillion! How will our Treasury acquire the dollars to buy the bad bank assets? It will come from an issue of U.S. securities, or debt. Will our foreign friends continue to lend to a nation that has the highest federal debt in the world? U.S. banks carry twice the leverage of the foreign banks. Tax payers don’t have the extra $80 billion. The lender of last resort is the Federal Reserve Bank. The Federal Reserve is a private banking corporation owned by its member banks. The Fed returns the interest on the bonds it monetizes to the government, but only after deducting its operating costs and a 6% guaranteed return for each of its many bank shareholders. In other words, we the people will be paying interest to the banks to bail out the banks for their own follies.

 

We are told that there are no other alternatives. Notwithstanding, Bush, Paulson and others insisted that this has to be done immediately. No formal deliberations on entertaining alternatives. What is the rush?

 

The banks were trying to beat the 9/30/08 reporting day when they were required to reveal their tier one capital adequacy. Banks must have capital equal to at least 4% of its risk-weighed assets to be adequately capitalized under federal bank regulations. Assets are things that can produce cash flow, including loads and derivatives that actually represent liabilities of the bank, money the bank would have to come up with if the borrower didn’t pay, if the derivative bets were lost, or the other party to the derivative did not pay. To better understand the urgency let’s explain that Capital requirements vary depending on the risk of the bank assets. Tier One capital consists of the shareholder’s equity (the amount originally paid to purchase the bank’s stock), plus retained profits, minus accumulated losses. Because of the recent losses many banks could have trouble meeting the tier one capital adequacy requirement. The talk on the street of a “credit freeze” is a result of the banks not able to make new loans.

 

The recent collapse of our financial system has been in part blamed on the sub-prime loans, but mortgage defaults are just the domino that precipitated and triggered the fall. There derivative Ponzi scheme was the real problem. Derivatives are just bets, which vacuum up value without producing anything. The imploding derivatives bubble is a giant black hole that could suck all the productive assets of our nation into banking coffers.

 

Let’s evaluate how Paulson will probably facilitate his solution to fill the derivative black hole with federal money. The likely source is the Federal Reserve. And how does the Fed get its money? They either print it or create it with accounting entries. I believe the Fed will use its new Term Securities Lending Facility. It does not involve the usual open market operations in which the Fed prints Federal Reserve notes and swaps them for bonds; better known as government I.O.U’s. The process is relatively simple. The Treasury prints bonds and then delivers them to the Federal Reserve, which then trades them with distressed banks for the toxic unmarketable derivative paper. The Fed gets the junk no one can sell or wants and the backs get the AAA Government securities. The result is the bank improves its capital position by holding the risk-free U.S. securities for the purpose of calculating the banks risk weighed assets. Loans then can be made possible again

 

What makes this scheme so beautiful is that no lender has to be found to underwrite the newly issued U.S. securities. The lenders holding the government’s I.O.U.’s are the distressed banks themselves! However, the taxpayers have to pay the interest on these securities. To say it another way, the taxpayers are paying the interest to the banks for the privilege of providing the funds to bail out the banks. This is the first time the Federal Reserve is borrowing fr9om the government instead of visa-versa. ON 9/18/2008 the Associated Press reported:

 

“The Treasury Department, for the first time in history said it would begin selling bonds for the Federal Reserve in an effort to help the central bank deal with its unprecedented borrowing needs. Treasury officials said the action did not mean that the Fed was running short of cash, but simply was a way for the government to better manage its financing needs.”

 

T-Bills and other Treasury securities are the I.O.U.’s of the government and add to the Federal debt. The annual interest on our debt is half a trillion dollars. Taxpayers are on the hook for the interest of the additional billions in loads that the Fed will be making to an unprecedented range of financial institutions, exercising obscure provisions in the Federal Reserve act. We the taxpayers are paying interest to the Fed so that the Fed can use taxpayer money to bail out the banking community from their gambling ventures. Should the Fed and the banks be paying us interest to draw on the national credit card?

 

Is there a better way? At the expense of the taxpayers, Paulson’s bailout plan rewards the guilty. This is not an efficient way to recapitalize the banking industry. On 9/30/08 in an article written by William Engdahl while citing economist Nouriel Roubini said,

“In most ever case of recent banking crisis in which emergency action was needed to save the financial system, the most economical (to taxpayers) method was to have the Government, as in Sweden and Finland in the early1990’s nationalize the troubled banks, take over their management and assets, and inject public capital to recapitalize the banks to allow them to continue to doing business, lending to normal clients. IN the Swedish case, the Government held the assets, mostly real estate, for several years until the economy again improve at which point they could sell them onto the market and the banks could gradually buy the state ownership shares back into private hands. IN the Swedish case end cost to the tax-payers was estimated to have been almost nil. The state never did as Paulson proposed, to buy toxic waste of banks, leaving them to get off free from their follies of securitization and speculation abuses”

 

Let’s define what it means to “inject public capital” to recapitalize the banks. It means to issue the currency and credit of the nation itself. A sovereign government doesn’t need to borrow from private banks that create the money as it is lent. Banks that go bankrupt should be placed in receivership and nationalize them. These truly national banks could issue the “full faith and credit of the United States” directly, without having to borrow money first. Benjamin Franklin, Thomas Jefferson and Abraham Lincoln supported this idea. Thomas Jefferson wrote:

 

“If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until the children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom the property belongs.”

 

IN closing, the United States had its first central bank before the constitution was drafted. It was organized by a member of congress, Robert Morris. The idea was promoted by a group of politicians and merchants who wanted the new nation to imitate the mercantilism of England. It was called the Bank of North America and was modeled closely after the Bank of England. It followed the practice of fractional reserve banking. This means it was able to issue paper promissory notes in excess of actual deposits. The bank failed due to the lack of confidence of its inflated notes.

 

The Constitutional Convention closed the door to paper money and the United States enjoyed a period of economic growth and prosperity. Congress was denied the power to print money but it was not denied the power to borrow it. In layman’s vocabulary, to borrow is to accept a loan of something that already exists. Therefore it is confusing when the banker issues money out of nothing and then says he is lending it. He appears to be lending it but in reality he is creating it. Here is the danger of our current banking crisis that most do not understand; privately issued bank notes (Federal Reserve Notes) could serve precisely the same purpose as printing-press money. The end run to our Constitution was the establishment of a bank (The Federal Reserve Bank), to give that bank power to create money, to lend most of that money to the government, and then make sure the I.O.U.’s are accepted as money by the public.

 

Alexander Hamilton, a contemporary of Robert Morris strongly opposed then Secretary of State, Thomas Jefferson, in the area of banking. In fact, this was one of the central issues that led to the creation of our first political parties. The Federalists gathered around the ideas of Alexander Hamilton. The anti-Federalist’s, later called the Republicans were attracted to Thomas Jefferson. Jefferson believed the Constitution did not grant to Congress the power to create a bank. That power was reserved to the states or to the people. Furthermore, he said , even if the Constitution had granted such power, it would be an extremely unwise thing to do, because allowing banks to create money could only lead to national ruin. Jefferson said:

 

“A private central bank issuing the public currency is a greater menace to the liberties of the people than a standing army.” “We must not let our rulers load us up with perpetual debt.”

 

One answer is not the increase power to those who instigated the problem. Simply tell the gamblers with their Credit Default Swaps that no one will bail them out. A wager made on the side, with no tangible participation and using insurance to make the bet good, cost no one anything by simply telling the gambler’s; bet’s off now bug off! They’ll lose nothing because they put nothing up and the taxpayer owes nothing. Therefore, say no to the $180 trillion in CDS bets. Say good-bye to creating more money out of nothing by the Fed, to have taxpayers pay the interest on newly created money to bail out nothing bets.

 

In another excerpt I’ll address the mortgage crisis with the combination of legislation and deregulation that brought the house of cards down.