April 28, 2004: A Disastrous Day for the American Economy

by Bill Sardi

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On April 28, 2004 these five Americans pictured above, Paul Atkins, Cynthia Glassman, William H. Donaldson, Harvey J. Goldschmid and Roel C. Campos, all Securities Exchange Commission (SEC) commissioners, along with Christopher Cox, then Bush-appointed SEC Chairman, and Annette L. Nazareth, director of market regulation at the SEC, put into motion a relaxation of reserve requirements for five investment banks, an action which doomed the American economy.

These five Securities & Exchange Commission commissioners sealed the future fate of the American economy on that day in 2004 when they approved an appeal by five investment banks (Goldman Sachs, Lehman Brothers, Merrill-Lynch, Bear Stearns and Morgan-Stanley) to expand their reserve ratios — that is, take greater risks with the public’s money. This was done by consent of the regulators and their politically-appointed bosses during the Bush II administration. (Would any of you now care to fund a Presidential library for the man who was in charge during this wholesale theft of your money?)

Only one voice stood in opposition to this expansion of risk, a consultant who writes financial software for the securities industry, Leonard C. Bole.

The widening of reserve ratios by investment banks would be permitted with the prerequisite that advanced computer technology be employed to signal any downturn in the economy at an early point so a collapse of the economy could be corrected before it would occur.

Bole wrote a letter to the SEC that the computer models the SEC would now rely upon to provide information, in advance of any financial collapse, were flawed. You can listen to the live testimony of these SEC commissioners and learn more about Mr. Bole’s letter to the SEC at an online video report prepared by The New York Times.

The aftermath of expanded leverage and exorbitant bonuses

To better comprehend wayward modern banking practices, readers here would benefit from understanding how these expanded leverage ratios (reserves of assets or cash in relation to amount of loans) have been mischievously used. The expanded leverage used by the bankers was then translated into huge bonuses for bankers and bank stock holders, which is described by Edmund Conway, economics editor for the online edition of The Telegraph(UK).

Conway reveals some striking behind-the-scene facts about banking in the United Kingdom and elsewhere. Digging into the UK’s Financial Stability Report, Conway finds Britain’s banks would not have faced insolvency had they withheld a fifth of the bonuses and dividends to executives and stockholders over the past 8 years.

Generally this wouldn’t make much of an impact upon readers who have heard of overly-generous bonuses paid to bank executives, who probably imagine these bonuses to amount to a few extra million dollars. Most people can’t dream just how much money bankers have personally made in recent years.

Between 2000 and 2008 had British banks trimmed 20% of bonuses and dividends, it would have amounted to 75 billion ($120 billion US), more than what was needed in bailout funds. These bankers didn’t become millionaires — they became billionaires, misusing their depositors’ money.

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Bankers threaten to pull up stakes

London bankers are alarmed over threats to limit their bonuses and have even gone to threatening they will take their banking business offshore if such restrictions are implemented. Imagine their audacity in making such a statement. They obviously know they hold their country by the throat in managing trillions of dollars of deposits and assets. London bankers say they would crash their own country’s economy as they depart for parts unknown. British citizens should be angry over this threat. The bankers would be taking citizens’ money with them.

Bankers game their government

But this isn’t the most alarming debacle in recent times with British bankers. What has come into the public’s eye, via reporter Conway, is that the massive profits made by British bankers in recent years were fabricated by making riskier loans.

A report, ironically written by bankers Andy Haldane, the Bank of England’s director for financial stability, along with Piergiorgio Alessandri, proclaims that British bankers, knowing that their government would bail them out, intentionally extended the gap between their balance sheets and the amount of money loaned out, knowing of the "implicit government guarantee of the financial system."

In essence, says Haldane, the British bankers were "gaming the state" and looting their banks for personal gain. Haldane calls this a "doom loop."

Bragging of their monstrous bonuses, and now personally wealthier than some entire countries, these bankers faced no penalties for their reckless risk taking and even would gain more bonuses as their skills are in desperate need to unravel the current economic crisis.

This created a scenario of private gains but socialized losses, says Haldane. British bankers could operate with great bravado — they were not personally responsible for any failures. They took their bonuses off the top, even when their banks were financially going under water.

Fabricated earnings to generate bonuses

Yet even more disconcerting is that the massive profits British banks totaled up in recent years, which their haughty bankers took credit for engineering, were earned over the past century, not by actual performance, but expansion of leverage — widening that gap between deposits/assets and the amount loaned out.

Traditionally, banks would keep 10% of depositors’ cash in reserve, and 8—10% of assets in reserve, a 10-to-1 reserve ratio or so. But bankers employed 20-to-1, 30-to-1 and even 50-to-1 reserve-to-loan ratios. This might have all been dandy except, to expand their loan business, they relaxed residential real estate loan standards and accepted loans from people with marginal incomes, and they offered low introductory "teaser" interest rates, and even no-down payment terms.

The banksters were churning the loans to generate more and more bonuses. Who cares if these loans go into foreclosure, by then the banksters would have run off with their bonuses and blamed the whole fiasco on imprudent loan applicants who fabricated income history and outstanding credit card debt information on their loan application (so called liar’s loans). But the bankers allowed all this to happen. Some home buyers were told just to fudge the numbers and everything would be OK.

The above chart shows the vast majority of historical bank profits have been made by expanding leverage (risk) with their depositors’ money, not by any unusual skill performed by bankers.

Reporter Conway confronted Bank of England officials at the Bank’s Christmas party over the point of excessive bonuses earned by expanding leverage, not by their skills, and "they laughed off such a suggestion." But it’s all in print — such arrogance. The following two charts shows US and UK banks also kept less and less capital on hand as they expanded their earnings to unprecedented levels.

Should bankers’ bonuses be limited?

Who is to begrudge anyone for legitimately striking it rich? There should be no limit to opportunity. What right has government to restrict incomes in a selected profession?

But here we have an example of taking the people’s money, breaking from traditional banking practices, taking bigger risks to generate far greater profits, while bank depositors were offered low interest rates on the use of their banked money. It is preposterous. Where is the jail time? Heads should roll, except in countries like the U.S. where bankers lobby Congress and buy off regulators. Banksters can now operate with impunity.

Why not usher in meaningful reforms rather than restrict bankers’ bonuses? It sets a bad precedent. Though frankly, American and British banks, for all intents and purposes, are nationalized today and bankers are, in essence, public employees.

Fudging the numbers

To add further understanding, there are prudent asset/reserve-to-loan ratios in addition to cash/reserve-to-loan ratios. The banksters also fudged on these numbers as well. The bankers over-appraised the value of their real estate holdings, mostly because they falsely created increased demand for home loans by relaxing loan requirements to prospective homeowners.

Greater (false) demand resulted in a temporary increase in the selling price of homes. But when home loan mortgagees began to default on their monthly payments, the whole charade collapsed. The value of these homes is believed to be at least 30% less than they once sold for. The banks are carrying the value of these real estate properties on their books at the highest selling price. In essence, the banks are cooking their books.

The real mark-to-market value of these properties (the banks assets) is far less than reported in their quarterly reports. Furthermore, many banks have taken non-performing loans off their books, furthering the pretense they are financially stable. Banks asset-to-loan ratios are completely fabricated at the moment. To mark the value of these properties down to their true market value would force these banks into insolvency, and place millions more homeowners into upside-down mortgages (owe more than their property is worth).

Why not let the banks fail?

The only reason why the banks are not forced to own-up to their financial responsibilities, to appraise their real estate assets at mark-to-market values, is that the whole banking system (all 8400 U.S. banks) would be insolvent, and there go all the deposits and life savings of American citizens down the drain! So we "kick the can" as Gary North says, and live day-to-day rather than deal with the problem.

Furthermore, the Federal Deposit Insurance Corporation (FDIC), which insures savings and deposit accounts, is also out of money and is tapping the Treasury Department for money that does not currently exist — it is being made electronically. The banks have no reserves other than bailout funds, and the insurance agency for the banks is broke too!

No easy way out

So the unspoken thinking is, since the nation is technically broke, why not fix the problem by placing this unprecedented amount of debt on the public’s collective credit card? This means adding to the national debt.

The only avenues out of this mess have been to borrow more money from foreigners, who are now reluctant to do so, or to create money out of thin air, which expands the money supply but also dilutes the value of existing money and threatens to spark hyper-inflation (i.e. $5 loaf of bread). We’re talking Zimbabwe-type inflation here.

The banksters’ improprieties have forced England into expansion of its national debt to cover bank losses of incredible proportion. The amount of debt Britain faces can only be fathomed by a comparison with the U.S.

The U.S., a nation of 300 million people and an economy that generates ~$14 trillion in Gross Domestic Product (GDP), has had to expand what it borrows from ~$400 billion per year to ~$1.5 trillion. But Great Britain, with a population of only 61 million, and a GDP of ~$2.65 trillion, now faces a staggering 1.5 trillion of additional debt to deal with its financial crisis, making its accumulated debt load ~2.3 trillion (~$3.7 trillion US dollars)!

Bottom line, trillions of US dollars and British pounds have evaporated from their respective economies.

How much are we worth, net, per person?

So total it all up for us, would you? If all the personal incomes were balanced against all the debt, what would each person be worth, on a per capita basis? Credit Loan, a credit counseling company, has prepared a chart which provides an authoritative answer to that question.

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