The central bank and government stand behind the too-big-to-fail banks and stand ready to assist them in a crisis should 2007-09 repeat.

Ongoing central bank rate rises will cause the interest income from the accumulated loan book to cause automatic income increases to banks on outstanding loans.

The big U.S. banks have a loan book that is over 150% of GDP and some pay a dividend of over 2%.

The purpose of this report is to assess if the big U.S. banks are worth investing in from capital growth and dividend income growth perspective.

To answer this question, an assessment of the success to which the banks have enclosed the economy with debt will be used together with an assessment of how this enclosure of the economy can be made into higher profits.

Enclosure of the Private Sector

The chart below shows the level of private credit creation entering the private sector through commercial banks.

The above chart shows that credit creation from private banks has grown in 2017 and added $US23.3B to the economy or 0.1% of GDP. This is a weak result and shows that not a lot of credit money is demanded at the moment. This makes one wonder why the Fed wants to raise rates in the face of falling credit demand. The Fed's logic is that by raising rates it can choke off credit demand and thus slow inflation, well there is no demand so why raise?

Raising in the face of no credit demand means that another motive must be behind the rate rise regime. This is the optimization of the enclosure of the private sector with credit money.

The flow of credit adds to the stock of private debt in the economy, and this debt is shown in the chart below.

(Source: Professor Steve Keen)

The chart above shows that the U.S. has a high private debt level of 150% of GDP. Private debt levels reached 170% of GDP at the peak set during the GFC marked on the chart.

From the GFC 170% of GDP credit peak in 2006 to the trough in 2012 the Fed lowered rates to near zero using the logic that if we take rates lower more credit will be demanded, and the market will be reinvigorated. The chart shows that the demand for credit fell in this period, more loans were repaid or written off than new ones generated. There was no demand response.

What this means going forward is that one cannot expect the U.S. to be able to sustain a bull run fueled by credit money given that it has reached what can be considered a full debt capacity.

Professor Steve Keen's studies show that economies with private debt levels of 150% and over tend not to become more indebted. They hit a natural barrier where no more debt is demanded.

The reason is that such a large percentage of aggregate demand goes to debt servicing that there is a noticeable drop in the demand for real goods and services. Production goes unsold and is cut back; this leads to job losses, income losses and a further cessation of aggregate demand until the debt is repaid or written off and more income can be spent on buying production rather than debt service.

This phenomenon where debt service absorbs so much aggregate demand has been coined "debt deflation" by economist Professor Michael Hudson. This is in the sense that the real economy is deflated by the weight of the debt service. Professor Hudson likens the finance sector to a parasite riding on the bank of the real economy, adding nothing while drawing out as much as possible. For example, the government could provide credit at the interbank rate and completely cut out the middlemen and their markup and false credit allocation strategies.

Having ensnared the private sector with as much debt as it is deemed able to carry the time comes to increase the rate on the existing stock of debt. This time has come.

Bank Strategy

It is the role of the banking industry to create credit and lend it out at interest and make a profit. In a bank utopia, every creditworthy citizen would be "loaned up" and paying interest.

In the U.S. this has been taken to extremes where basic things such as healthcare and college education are left almost entirely to market forces, and the result is very expensive health care or none, and in the latter case a generation of students with large student loans to pay back.

The loan book is the bank's asset and provides the bank income from which to pay shareholder dividends. The aim is to make this loan book as large as possible with as little risk as possible. One could simplify the model as follows:

Loan as much money out to creditworthy borrowers as possible. Seek to create a rising rate environment to maximize profit on the established loan book for as long as possible. Protect the loan book.

A three-stage process where the economy is first enclosed with loans and then squeezed to extract as much income as possible.

One can assess how successful a bank is by looking at how large its loan book is and how much of the economy's income it has secured as an income stream on that loan book.

Stage 1: Grow the Loan Book

In the case of the U.S., the banking sector has been very successful as the charts above show. One could reasonably expect the loan book to grow out to 170% of GDP, as proven possible in 2006. The real limit is the capacity of the economy to support further loans. The lower the rate, the higher the stock of debt that can be carried. Even a static loan book can provide a rising income for a long time without growing in size so long as rates rise. That said, it is still growing at 0.1% of GDP.

Mission accomplished, it is over 150% of GDP. One of the highest in the world. Not much more can be expected, though is possible.

Canada and Australia show that private debt levels of over 200% of GDP are possible. I covered Canada and Australia in these two articles.

Stage 2: Maximize Returns on the Loan Book

For the U.S., one can model the impact of this private debt on the economy over a range of interest rate levels, and this is shown in the table below. The standard home loan in the U.S. is fixed rate over 30 years. Auto loans are normally variable and over a shorter time frame and student loans are between the two. These types of loans make up the bulk of the loan book.

(Source: Author calculation based on Trading Economics dot com GDP data and Prof. Steve Keen private debt data)

One can see at present that over about 4.5% of GDP/aggregate demand goes to private commercial banks as debt service cost and not on real goods and services in the real economy. This is based on the assumption that the loan book averages a return of 3%. Four to five percent is nearer the truth when one adds in business loans and auto loans that tend to be at a higher rate. Not to mention credit cards at over 10% or more and exploding rates when one misses a payment.

One can also conclude that this interest payment from loans underpins the dividend income one can receive from U.S. banks. The largest bank, JP Morgan (JPM), shown in the chart below, yields a dividend of 2.24% and shows steady five-year growth in the share price.

The U.S. has five of the world's largest banks by market capitalization. The other banks have similar growth and dividend patterns as the leader market leader.

Bank Name Code Dividend Yield Market Capitalization Wells Fargo & Co. (WFC) 2.72% $280B Bank of America Corporation. (BAC) 1.54% $320B Citibank Inc. (C) 1.71% $197B Goldman Sachs Group Inc. (GS) 1.16% $97B

Bank profits and dividends can be expected to rise with central bank rate rises.

The central bank wants to raise rates; it keeps saying it each meeting, the popular press trumpets it. The logic is that higher rates will give them more room to move in the next recession, and could paradoxically be the cause of the next recession. This is because with each rate rise more income is diverted to loan service and away from real goods and services. Less is demanded, less is made and resources become unemployed.

Interbank rates now are considered too low at only 1%-1.5% and should be "normalized" to at least 3% to 3.5%. Such a scenario would see variable rates increase to 5% to 6%. By this time banks will be earning about $1676B of extra income per year. A figure about twice the loan book earnings at present. All based on the loan book remaining static with no extra effort on behalf of the banks to generate more loans. The dividend could potentially more than double given the cost base is the same, and yet the rising rates have brought in more income.

America has started the rate rise and QE unwinding process as one can see in the chart below.

From the table above, in the previous section, we can see that each one percent rate rise adds over $US279B to loan interest income when passed onto the consumer.

The unwinding of QE is the selling of Mortgage Back Securities [MBS] and long-dated bonds back to the banks in return for excess reserve they may be holding. This means the banks will be swapping their low-income excess reserve balances for higher-yielding treasuries and other long-dated bonds at a time when the return on those long dated bonds is rising with the Fed rate increases.

An estimate of how much income can be produced from the existing stock of treasuries is shown below.

Each rate rise of 0.25% adds $51B in state money income to the economy. The Fed plans to reduce its $4T+ balance sheet of long-dated bonds, to unwind QE. Banks are one of the main recipients of such securities, it was where they came from in the first place during the GFC. If this $4T were returned to the banking sector the income stream from the bonds would also add to banking income streams. Three percent of $4T is $120B per year of additional income as an estimate of how much this could be.

Stage 3: Protect the Loan Book

All five banks appear in the top ten list of the largest banks in the world by market capitalization as the chart below shows.

By assets under management (size of loan book), six of the U.S. banks also feature in the top fifty banks in the world as the chart below from Wikipedia shows.

In addition to the top five listed above, Morgan Stanley (MS) is also on the list of top 50 in the world.

In the event of a crisis, the "too big to fail" card will be played again and will work as it did in 2006-2009 where national governments across the world guaranteed bank liquidity. What this means is that the banks are backstopped by the national government which is sovereign in its currency and therefore has unlimited U.S. dollars.

In the event of a problem, QE will be activated. Bad loans and long-dated bonds will be bought from the private banks by the central bank, at par though nearly worthless, in exchange for excess reserves. It happened last time, all around the world, and will happen again as well. Profits are privatized, and losses are socialized.

TINA (there is no alternative) will emerge again. The actual alternative is a nationalized banking industry lending at interbank rates. Cheaper, safer and better for everybody, and backed by the currency sovereign. But, for the private banking industry that would be beyond the pale.

Summary Conclusion and Recommendation.

What does this mean for investors? It means that the banks and its accumulated loan book are safe. One can invest in the U.S. big banks with some certainty that both the stock price and dividend will rise with Fed rate rises and QE unwinding. Rate rises for the banks by the banks.

Yes, the system is evil and wrong but learn it and profit from the knowledge.

A diversified exposure to the American banking system and its many sub-sectors can be obtained via the ETFs listed below.

(XLF) Financial Select Sector SPDR Fund (VFH) Vanguard Financials ETF (KRE) SPDR S&P Regional Banking ETF (KBE) SPDR S&P Bank ETF (IYF) iShares U.S. Financials ETF (FAS) Direxion Daily Financial Bull 3X Shares (IYG) iShares U.S. Financial Services ETF (FXO) First Trust Financials AlphaDEX Fund (FTXO) First Trust Nasdaq Bank ETF (FNCL) Fidelity MSCI Financials Index ETF (KBWB) PowerShares KBW Bank Portfolio (UYG) ProShares Ultra Financials (IAT) iShares U.S. Regional Banks ETF (KBWD) PowerShares KBW High Dividend Yield Financial Portfolio (QABA) First Trust NASDAQ ABA Community Bank Index (PSCF) PowerShares S&P SmallCap Financials Portfolio

(KBWR) PowerShares KBW Regional Banking Portfolio (KCE) SPDR S&P Capital Markets ETF (KBWP) PowerShares KBW Property & Casualty Insurance Portfolio (DFNL) Davis Select Financial ETF (PFI) PowerShares DWA Financial Momentum Portfolio (JHMF) John Hancock Multi-Factor Financials ETF (RWW) Oppenheimer Financials Sector Revenue ETF (FINU) ProShares UltraPro Financials (DPST) Direxion Daily Regional Banks Bull 3X Shares (FNCF) iShares Edge MSCI Multifactor Financials ETF

Personally, I prefer KRE as it is representative of domestic U.S. banks who enjoy the full benefit of the rate rise.

Disclosure: I am/we are long KRE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.