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Fortune magazine and the N-word

July 11th, 2008

Nationalization, that is. In this piece on doomsday scenarios for Fannie Mae and Freddie Mac (H/T Calculated Risk) the cutely named and quasi-private mortgage packagers and guarantors, Katie Benner says

So what might it look like if the government had to lend a hand? Outright nationalization is an unlikely option given that neither the current administration nor the presidential candidates could afford to support such a move in an election year.

but goes on to imply that the likely alternatives could be far more costly, citing a Standard & Poors estimate of a trillion dollar cost to taxpayers, and possible loss of the US government’s AAA rating. Agency ratings aren’ t reliable indicators, but the US government has been in the category of issuers who are assumed to be exempt from scrutiny. A change in this status would be a huge problem for a big debtor like the US.

Either a bailout or a nationalization of Fannie and Freddie would make the Northern Rock fiasco in the UK pale into insignificance. The Northern Rock case shows that a policy towards financial enterprises in which both failure and nationalization are regarded as unthinkable cannot be sustained. The shareholders of these companies have been happy to accept the higher returns associated with an implicit government guarantee and they (the shareholders) should pay the price when the guarantee is needed.

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  1. July 11th, 2008 at 07:46 | #1

    …and they should pay the price when the guarantee is needed.

    Do I correctly assume “they” means the government, not the shareholders?

    Now that everything has been privatised over the past 25 years or more, I cannot help but wondering how long it might take before nationalisation again becomes a popular political policy. We saw it in Argentina (several times over) and elsewhere – all it takes is a major economic catastrophe, which we just happen to have en route.

  2. costa
    July 11th, 2008 at 08:49 | #2

    Maybe not – look at the release below.

    For Immediate Release
    July 10, 2008



    “OFHEO has been monitoring and continues to monitor closely Fannie Mae, Freddie Mac and the mortgage and financial markets. As one would expect, we are carefully watching the Enterprises’ credit and capital positions.

    As I have said before, they are adequately capitalized, holding capital well in excess of the OFHEO-directed requirement, which exceeds the statutory minimums. They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets.

    At the time of our March 2008 capital agreement with the Enterprises I said: `OFHEO will remain vigilant in supervising the safe and sound operations of these companies, and will act quickly to address any deficiencies that may arise. Furthermore, we recognize the need to ensure that their capital levels are strong, protecting them from unforeseen risks as the market recovers.’

    Including the $7.4 billion Fannie Mae raised in May in accordance with our March agreement, the Enterprises have raised over $20 billion in capital. They are using it to continue to grow and to play a critical role in the mortgage markets, which we expect them to continue to do. To support their mission, Freddie Mac is committed to raising an additional $5.5 billion, which they will do given appropriate market conditions. At a very difficult time in the market, the Enterprises have the flexibility and sound operations needed to support their mission.�

  3. jquiggin
    July 11th, 2008 at 08:56 | #3

    Adapting Galbraith’s Law of Political Wisdom we’ll count this as denial #1.

  4. observa
    July 11th, 2008 at 10:25 | #4

    Some of us would argue that it was nationalisation of the printing press that caused the problem in the first place. Being made responsible for errant offspring makes immediate sense, but there is the practical question of returning such children to a hopeless parent.

  5. smiths
    July 11th, 2008 at 10:29 | #5

    if only it were true observa,

    but the printing press is not nationalised, it is owned by a group of private banks that supply the money with interest to the governement

    and most of the ‘money’ in circulation comes not from a press, but a computer terminal again created, by private banks

  6. observa
    July 11th, 2008 at 10:33 | #6
  7. smiths
    July 11th, 2008 at 10:41 | #7

    could you please explain your tortured metaphor,

    who are the parents – the fed?

    so what role do goldman sachs and jp morgan play – the children?

    i’m baffled

  8. July 11th, 2008 at 11:35 | #8

    The government “guarantees” of the terrible twins has always been implicit, never legal. One of the (many) pities of this US government on the economic front is that they did not take advantage of the US housing boom to end the implicit guarantee by making an announcement that there is no guarantee – and announcement is all it would take.
    That said, what now? Given the state of the US housing market (due, in part, to the activities of these two) it should be made clear now that the guarantee currently applies to the liabilities only – not the equity (although I doubt the shareholders would be relying on this in any case) and that it has a sunset on it – say 2 to 3 years and that it applies to current (actual and contingent) liabilities only. The current value of the equity would drop, no doubt, but the current liability holders would be protected for a time.
    Bumbling along with this sort of structure is just plain silly. The whole thing was silly in the first place.

  9. Smiley
    July 11th, 2008 at 12:28 | #9

    and most of the ‘money’ in circulation comes not from a press, but a computer terminal again created, by private banks

    I have to agree. The fractional-reserve system creates money from thin air. As stated in the wiki entry on fractional-reserve banking:

    Referred to as the fractional reserve system, it permits the banking system to create “money”.[4]

    Maybe enlarging the fraction will help.

  10. smiths
    July 11th, 2008 at 12:38 | #10

    i dont mind fractional reserve banking,

    i’d like the concept extended outwards,

    fractional payment for goods,
    i go to buy a car, the price tag is $30,000,
    working with the carlyle groups ratio of 30-1
    i pay $1,000 for the car


  11. July 11th, 2008 at 12:57 | #11

    FRB has been the subject of very long threads at catallaxy, which I think our good host would be happy to note I do not plan to repeat here. My own take on it is here. It is simply down to how you define “money”. If you define amounts deposited in a bank to be “money” then of course money is created when those deposits are subsequently lent out – but this is meaningless. As money flows around an economy it is used many times in any defined period. Some of those uses are to create various bank deposits and loans. It is trivial and useless to observe this in isolation – banks no more create money than you do when you borrow from a mate and buy something with it.

  12. July 11th, 2008 at 13:02 | #12

    You do this in any case if you lease the vehicle or borrow part of the price. It is exactly the same as what the banks do.

  13. July 11th, 2008 at 13:32 | #13

    Enron should have spelled the end of corporate fraud. Sadly, thanks to Bush and his friends, it was just the beginning.

    If a government has any sort of responsibility to support irresponsible lenders like Fannie and Freddy (can we call them FanFred, like BradJen?) then it has an even greater obligation to maintain a secure and stable economy for taxpayers. Bailing out these criminally insane corporate fools sends completely the wrong message.

    Nationalise them, split them up, sell ’em off. Whatever. Just don’t ask taxpayers to keep coming through.

  14. July 11th, 2008 at 13:36 | #14

    And I wonder if John McCain is going to tell the FanFred shareholders that it’s just a “mental” problem they are having? Whoops – time to get a new economics adviser! Anyone want the job?

  15. July 11th, 2008 at 13:56 | #15

    I would suggest you review the history of those two before further commenting on them as you appear to have misunderstood what they are, what they do, where they come from and where they are going. Briefly, though – they were founded as part of FDR’s New Deal and their current status was put in place under LBJ.
    Corporate “fraud” of this type started under Democratic presidents.
    Like most of the “New Deal” and “Great Society” measures, the real pity is the Republicans did not take it round the back of the shed and kill it with an axe.

  16. Smiley
    July 11th, 2008 at 15:54 | #16

    As money flows around an economy it is used many times in any defined period.

    So the banks are charging a “moving� fee. It must cost them millions in petrol.

    Actually I seem to remember you pointing this out before. I don’t think I had a chance to respond last time.

    Fractional-reserve gives the banks access to the same money multiple times at any one instance. It’s a bit disingenuous when we say the banks have a lending margin of 1-2 percent, because they can lend the same money (in diminishing amounts) multiple times.

    Ok, so they don’t “create� money, they just lend it multiple times at any one instance… it’s not like a normal business. It’s illegal to sell the one item to two different people at the same time. I guess this is what makes the practice so risky.

    The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the mount, because he has contracted . . . .

    So is this saying that bankers have no responsibilities to their depositors? If so, then this is exactly why regulating higher reserves is required.

  17. smiths
    July 11th, 2008 at 16:44 | #17

    andrew reynolds,

    paying a deposit and then slowly paying off the rest is not the same as having money and lending it out thirty times

    if i walk into a bank and they agree to give me $100,000 and later that day it is there in my bank account, where did they get it from?

  18. July 11th, 2008 at 16:51 | #18

    Bollocks – complete bollocks. Someone lends them money (i.e. makes a deposit). They then lend that money out minus a reserve ratio. They are not, repeat not, lending out the same money twice – they can only lend out the money that has been deposited minus a reserve ratio.
    The standard nonsence from the Economics 100 class on this is that the money is then re-deposited and then lent out again, once again minus the reserve ratio. My response is “So what?”
    This is a flow concept. Trying to reduce it to static analysis is about as useless as trying to depict any flow as a static over a period of time.

  19. July 11th, 2008 at 16:53 | #19

    The answer to your question is simple. They got the money partly from the shareholders and mostly from depositors.
    That is where it came from – not from some “manufacturing” process.

  20. smiths
    July 11th, 2008 at 17:02 | #20

    ah, thats gold,

    so the incredible volume of lent money has all been deposited first by people or shareholders,

    so for every person who owes the bank $500,000, there are people who had $500,000 laying about and shoved it into the bank in the first place?

  21. July 11th, 2008 at 17:08 | #21

    Banks would look to having 1,000 people with $500 each as a better option to fund a single large loan to reduce the liquidity risk and then a further 120-150 to provide funding cover – mixed in with equity as well – but substantially correct.

  22. observa
    July 11th, 2008 at 17:14 | #22

    “banks no more create money than you do when you borrow from a mate and buy something with it.”

    Andrew has this rather quaint notion that if we all went down the banks to draw our money out it would all be there waiting for us. Well that might be a bit simplistic because Andrew reckons what’s not there is in our wallets or under our mattresses so no need to worry. He might like to explain how all the money got there in the first place but space forbids naturally.

    Sorry Andrew, you’re falling for the old fallacy of composition matey. You’re right with defining money, that it might similarly depend on how you define a ‘membership’ to Footy Park. The SANFL note that only 0.9X people roll up on average to the X seats available at the Members so they quietly flog 1.1X Memberships. (no need to bother the Members with such fine administrative details naturally) Things tick along fine with Crows vs Geelong and such rubbish until one fine day there’s a must go blockbuster between Port and the Dees. Alas Andrew thinking he had to go and watch 27 Dresses with the missus, has lent his ticket to his mate Tom, but finds his missus has decided to go with Tom’s missus instead. Rings Tom who unfortunately has the flu and has lent it Dick, but no worries he’s sure his mate Harry will have one, but alas Harry has lent his out too. Naturally when 1.1X Members roll up there’s a bit of a wee problem, but no worries, the SANFL in their wisdom decide the only fair way to allocate the seats is to let all 1.1X ticketholders bid for the X seats, so everyone’s happy with supply meeting demand again. You might like to think of the SANFL here as having a Central Banker’s outlook on the world and that printing press of theirs. Like all good Central Bankers, naturally the SANFL blame Bass and Ticketek for the problem.

  23. July 11th, 2008 at 17:17 | #23

    I have no such imaginings. I have been in banking more than long enough to know that this is not the case. Your “analogy” bears no resemblance at all to banking operations.
    Have a look here if you want to do more than pontificate.

  24. smiths
    July 11th, 2008 at 17:21 | #24

    well i have more questions regarding that,

    in 1960 the ratio of debt to M3 money supply was .5,
    now there is twice as much debt as there is M# money,

    where did this ‘debt’ come from and how could it have been half the size of the money supply 40 years ago and double now

  25. observa
    July 11th, 2008 at 17:21 | #25

    Or you might like to think of it as their spokesperson Swan berating St George and the Commonwealth for getting a wee bit ahead of his precious Reserve.

  26. smiths
    July 11th, 2008 at 17:24 | #26

    if producing a link to your own writings constitutes evidence to conclude a discussion then we should have all the big questions wrapped up in no time

    anyway i think i’m going to head off and use some funny money to buy something of diminishing value, beer

  27. July 11th, 2008 at 17:36 | #27

    The answer is that there are many different reasons. For example, in 1960 cash balances as a proportion of the total figure of M3 (and of the economy as a whole) were much higher, as we tended to use cash to pay for everything. This takes time to process – even if (for example) I pulled 1 pound 10 shillings and sixpence out of my bank account to pay for something and the shop deposited it back into the bank soon it may take days to get back to a bank. With payroll being in cash the money might not get back to a bank for months, as people pulled funds out of the till to pay wages.
    Now we hand over a card and the funds go from one account to another in a second – or at most overnight. The result is that the cash component of M3 is much smaller as less is needed to support the same level of activity.
    “Money” is therefore being used much more efficiently, meaning higher levels of gearing and therefore debt are sustainable. This means that less of our “money” is sitting on its collective behind wasting time and more of it is out there earning interest.
    I will leave further discussion on that side to the economists, though. From the bank’s point of view, though – the answer is simple. Banks cannot lend out the same funds more than once.

  28. July 11th, 2008 at 17:43 | #28

    Pity you do not seem to want to finish, then. I would have thought that either you read the piece and came back with discussion on it or left some discussion there.
    I just to not like copying and pasting whole piles of text.

  29. observa
    July 11th, 2008 at 17:44 | #29

    “I have no such imaginings.”
    What, that you’re not just a Bass or Ticketek flogging 1.1X SANFL tickets to your Member customers that walk up to the counter? How on earth would your particular agency know? As your link shows only too well you’re governed by that computer driven liquidity ratio, but it says nothing about the overall size of your turnover and whether that ends up chasing too few goods in the marketplace out there in the street. Leave that to the CPI to measure.

  30. July 11th, 2008 at 17:48 | #30

    Sorry, observa, but I think your metaphors a more than a little mixed there.
    Banks are not and cannot, flog more loans than they have liabilites and equity. No 1.1x loans out there on deposits – it is (legally) at most 0.91x.

  31. observa
    July 11th, 2008 at 18:54 | #31

    Analogies are limited because we’re talking about all the footy grounds and everything else. That’s the X factor and your little bank has no idea whether it’s dealing with X bucks or 1.1X bucks as it goes about its daily liquidity calcs. You deal in irredeemable currency. I can’t lend you $100 at say 8% for 12 months and at the end of it ask you for another 4% because of its loss of purchasing power. You hand me back the agreed amount of paper, assuming you’re solvent, rather than the same proportion of a barrell of oil or weight in spuds. The paper only had any value because of its past exchange rate and that depends largely on its quantity after 12 months, relative to the quantity of goods its now chasing. Explain where all the money comes from in the first place and why you don’t charge what the Reserve tells you to charge for it. After all, how can raising interest rates above the Reserve gurus’ utterings possibly help St George and the Commonwealth, if cash is cash? All they’re doing is upsetting the Treasurer and their borrowers by all accounts. A bunch of silly futile masochists or just nasty pasties perhaps? Just like the Reserve by the looks of things.

  32. observa
    July 11th, 2008 at 19:06 | #32

    Or perhaps a little reverse engineering of the problem might help you a bit here Andrew. ‘We’ pass a law that all loans shall be at the agreed contractual interest rate plus CPI compensation to all lenders at the term’s end and see what that does to financial intermediaries’ profits eh?

  33. Smiley
    July 11th, 2008 at 20:18 | #33

    “Money� is therefore being used much more efficiently, meaning higher levels of gearing and therefore debt are sustainable.

    So, being a banking expert Andrew, in your opinion, what has caused the “credit crisis”?

  34. Smiley
    July 11th, 2008 at 20:41 | #34

    Actually, I just spotted this quote in the Wiki page I mentioned earlier:

    Fractional-reserve banking is the basis for many financial systems throughout the world. Because the nature of fractional-reserve banking involves the possibility of bank runs, central banks have been created throughout the world to address these problems.[17][3]

    Wasn’t Northern Rock a bank run?

  35. costa
    July 12th, 2008 at 00:36 | #35

    Denial No:2?

    Secretary Henry M. Paulson Jr. made the following comment today on news stories about “contingency planning” at Treasury:
    “Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission.
    “We appreciate Congress’ important efforts to complete legislation that will help promote confidence in these companies. We are maintaining a dialogue with regulators and with the companies. OFHEO will continue to work with the companies as they take the steps necessary to allow them to continue to perform their important public mission.”

  36. observa
    July 12th, 2008 at 09:20 | #36

    Here it is in a nutshell-
    In particular note-
    ‘To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call “inflationâ€? the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase. They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying “catch the thiefâ€?. The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices. (Ludwig von Mises, Economic Freedom and Interventionism, the Foundation for Economic Education p.94.)’

    Recognise all that Fuelwatch, Pricewatch, blaming speculators for oil and commodity prices and now Swan blaming the banks for those interest rate rises folks? As if people are going to save and lend at zero or negative real rates of return for long. Recognise all the past malinvestments caused by central bankers supposedly targetting money supply to increases in GDP? All those lovely house prices while lots of manufacturing was hollowed out and offshored, as the financial intermediation and services industries ballooned? All living in the fool’s paradise of low inflation as Asians worked even harder to keep it all happening as the savings and investments of the local productive sector was squandered in the process. We’re the luckier country of course because of all that commodity wealth in the ground, except that now we’re too indebted to Asian wealth producers to maintain control of it for much longer. It’s time to pay the debt collector come knocking at the stock exchange door. If you want the classic example of irredeemably money, you need look no further than the Govt being afraid to spend all those surpluses now, because apparently that would be inflationary. Inflationary? How on earth could distributing all those tanks full of oil, those warehouses full of steel and plasmas, etc to struggling working families be inflationary you may well ask? Keep asking and keep asking and one day the penny might drop dummies.

  37. observa
    July 12th, 2008 at 09:46 | #37

    Of course if the aging or stupid, lazy, fat indigenes are not up to the task of running your new investments, then there’s only one logical solution. Nationalise them!

  38. Iain
    July 12th, 2008 at 21:03 | #38

    It never seizes to amaze me how efficiently capitalist systems privatise profit and socialise the losses.

  39. Iain
    July 12th, 2008 at 21:04 | #39

    or ceases

  40. charles
    July 12th, 2008 at 23:00 | #40

    # Andrew Reynolds Says:
    July 11th, 2008 at 11:35 am

    The whole thing was silly in the first place.

    Try to remember why the first one was set up back in 1930.

  41. July 13th, 2008 at 01:41 | #41

    In reverse order, then –
    While I am not old enough to remember, (as I fancy you are not either) I do believe I do have a good idea of the causes. Government reacts to an economic downturn (caused, at the very least in part) by government action, by withdrawing large quantities of gold and therefore credit from the economy. Massively restricts trade. It then blames it on the workings of the market (it can’t be their fault, can it) and then imposes even more regulation, keeping it going for much longer. Odd reaction, I think.
    They can only socialise the losses if (guess what) the government allows them to.
    Northern Rock was a bank run caused by several things, including poor management. Banks, like other businesses, will occasionaly fail. It happens. It is the attempt to make them fail proof that causes a lot of problems.
    On the causes of the so-called “credit crisis” I think there are many – too many for a blog comment, but I will try to summarise. Institutional and regulatory errors, compounded by aggresive lending into new areas causes some losses – resulting in risk being repriced. This lead to a withdrawal of liquidity from particular sectors as people waited from the market to clear. As information improves, market trading resumes, with better information. Long term a good learning experience. Short term, a bit nasty.
    Either you are talking way beyond my understanding or you appear to be babbling trash. Either way, please explain it better, such that poor little me can understand it.
    On the only question I could actually find in there to answer, banks do offer these products – they are called CPI linked bonds. They have not proven popular with clients.

  42. Iain
    July 13th, 2008 at 09:17 | #42

    “They can only socialise the losses if (guess what) the government allows them to.”

    Or they go busto and take the jenga stack (that is the global financial system) with them.

    We will all end up paying for the collapse of usury based, fractional reserve lending, fiat money systems.

    Just like we all pay the externalities of GDP growth policies.

    Capitalism, in its current form = massive privatised profits, minimal socialised profits, minimal privatised losses, massive socialised losses.

  43. rog
    July 13th, 2008 at 10:52 | #43

    It would appear that for a government to enter into an enterprise entails a conflict of interest and that the governments’ ability to regulate is compromised when having to represent both voters and shareholders.

  44. PeterRickwood
    July 13th, 2008 at 12:54 | #44

    Banks dont create money, surely…..

    Alex lends me $1. I lend it to Bob, and Bob lends it to Cathy. That single $1 has been loaned out 3 times — to me, Bob, and Cathy. This doesnt mean I (or Alex) have ‘created’ any more money. The bank is just the intermediary in this situation, but the fundamental situation of loans and obligations is the same. Banks facilitate lending by being the intermediary, but you can get the same effect through chains of inter-personal loans.

    Or am I missing something? (I dont work in finance or anything, so this is my laymans interpretation)

  45. observa
    July 13th, 2008 at 15:08 | #45

    Here PeterRickwood-http://en.wikipedia.org/wiki/Fractional-reserve_banking#Money_creation
    Your simple analysis is correct providing there isn’t a sleight of hand with those financial assets and liabilities, not to mention that computerised ‘liquidity ratio’, which smashes the terms ‘assets’ and ‘liabilities’ should it alter suddenly and dramatically thus-
    You might like to think of it as Cathy can’t pay and both Alex and Bob are in trouble now. The bank likes to think of it as Alex and Bob are liabilities perfectly matched by their assets in Bob and Cathy and so what’s your problem Alex? Relax and stop panicking mate! The question then arises, is there a liquidity or a solvency problem here for the regulator to step in and defend a run on the bank (given the usual underlying disparity in terms for lenders and borrowers) Given the impossible informational time problem and the urgency for placating nervous depositors, they necessarily opt for liquidity, thereby socialising any underlying insolvency problem.

    You might look at it another way. Alex lends 100 fine oz of gold to the bank and they lend it out to fine upstanding Bob, who agrees to pay it back over 10 years plus 10 oz pa interest, of which they’ll give Alex 8 oz interest. Cathy comes in to borrow 100oz but sorry come back in a year luv and we’ll have 22oz for you or go see Bob as he’s pretty flush at present. Of course Bob might like Cathy’s big knockers and figure her pole dancing business is a sure thing among other considerations, but there’s only so much redeemable gold to go round here my dear. If they all keep sticking it back in the bank for safekeeping (bar that average liquidity ratio needs) then the Cathys can often be accommodated too. It’s all a bit like margin investing, but what goes up gradually and inexorably through gearing can come down even faster if depositors suddenly make those margin calls in big numbers.

  46. July 13th, 2008 at 21:54 | #46

    PeterRickwood is correct – not you. The reason why banks are often accused of creating money is simple – demand deposits are counted as part of the money supply.
    In your example, Bob can on-lend the gold to Cathy (presumably for more that 10% interest) but then he does not have any more “money” – just a claim on the gold he lent to her. Each time there is still only the original 100oz of gold in the system, it has just been used for more things.
    Note also that, each time it has been on-lent it has gone to someone will ing to pay more to have it. At each point there is also another person willing to put themselves on the line to re-pay it.
    Managing that risk is the main job that banks do. Get it right and they pay good returns, both to the lenders (their depositors) and to their shareholders. Get it wrong and they go bust. Just like any other business.
    No magic, nothing special.

  47. Smiley
    July 14th, 2008 at 12:40 | #47

    Managing that risk is the main job that banks do. Get it right and they pay good returns, both to the lenders (their depositors) and to their shareholders. Get it wrong and they go bust. Just like any other business.

    It seems to me that transparency is an issue here. How does the average consumer judge which banks are using risky lending practices (no-doc, negative amortised loans come to mind), and which are not.

    Those of you who have been following this closely will know that while the former chairman of the US Federal Reserve was stating that there “was no housing bubble� and the “market was just a little bit frothy in regions� certain bloggers where highlighting these dubious lending practices. In effect the very organisation that should have been warning the consumer was at the very least AWOL, at worst cheering from the sidelines.

  48. Smiley
    July 14th, 2008 at 14:04 | #48

    sloppy fingers: that should have been “were”.

  49. smiths
    July 14th, 2008 at 14:16 | #49

    100oz of gold plus 10% interest is 110oz of gold

    every time it is lent plus interest there is not the same amount of money in the system

    some more gold must be brought in from outside the loop to complete all the transactions


  50. smiths
    July 14th, 2008 at 14:19 | #50

    the very organisation that should have been warning the consumer was at the very least AWOL, at worst cheering from the sidelines

    the fed is a private bank whose member banks are interested in making money,
    how can they seriously expect to be the chief warners for the consumer,

    this should be seen for what it is,

    a hoovering mechanism tranfering mney from the middle classes to the top class
    as such it has worked beautifully

  51. smiths
    July 14th, 2008 at 14:23 | #51

    Unlike Bear Stearns, which got decimated by the JPM buyout using Federal Reserve money, Lehman Brothers is probably in line for a massive bailout from the Fed.
    At least, that’s what its CEO Richard Fuld seems to believe. The June 4, 2008 Financial Times of London quoted him as stating, “The Federal Reserve’s decision earlier this year to lend directly to investment banks should take questions about Lehman’s liquidity off the table.”
    Whether Lehman can come up with the “liquidity” to meet its debts is no longer an issue, because it expects to be feeding at the trough of the Federal Reserve, just as JPM did when it bought Bear Stearns at bargain-basement prices.

    The difference between the two “bailouts” is that Lehman Brothers, unlike Bear Stearns, will actually get the money. Why is Fuld so confident of this rescue operation? Olagues notes that Fuld, like Dimon (and unlike Bear CEO Alan Schwartz), sits on the Board of the New York Federal Reserve.

    A conflict of interest? It certainly looks like it. Indeed, Olagues points to a statute defining this sort of self-dealing as a criminal offense. 18 U.S.C. Chapter 11, Section 208, makes it a felony punishable by up to 5 five years in prison for members of the Board of Directors of a Federal Reserve Bank to make decisions that benefit their own financial interests. That would undoubtedly apply here:

    “Fuld, at last count, owns 1.9 million shares of Lehman . . . . Although Mr. Fuld sold over $320,000,000 worth of stock at near all time highs in 2006 and 2007, received through the premature exercise of his stock options, he still has value in his present holdings of approximately $100,000,000.”

    Likewise, says Olagues, “James Dimon holds almost 3 million shares of J.P. Morgan stock worth over $120 million with taxes already paid and executive stock options equal in my estimate of another $70 million. His dispositions of stock equaled $140 million over the past few years.” Olagues adds:

    “Fuld, like Jamie Dimon, was at the luncheon on March 11, 2008 with Bernanke, Rubin, CEO of Citigroup, Geithner, President of the New York FED, Thain of Merrill Lynch, and Schwarzman. Some claim that the meeting was about Bear Stearns and how to handle the situation.”

    Needless to say, Bear CEO Schwartz was not invited to the luncheon. “Lehman Bros. is one of the original stock holders of the New York Federal Reserve Bank,” Olagues observes. “Bear Stears does not now have any ownership in the FED banks.”

    The luncheon was held three days before the March 14 collapse of Bear Stearns stock that led to the bank’s demise. If the luncheon attendees were indeed discussing the Bear problem on March 11, testimony before the Senate Banking Committee in which the principals said they first heard of the problem on the evening of the thirteenth, says Olagues, was “less than truthful.”

  52. July 14th, 2008 at 15:22 | #52

    smiths (#49)
    It is perfectly possible to repay a loan of 110oz when there is only 100oz of gold in the system – make staged repayments of (say) 1oz a month over an extended period. As the gold is used for multiple transactions within the economy this is perfectly do-able.
    In fact, removing the physical gold from transactions will improve the ability to do this as transport time is reduced – holding bearer gold certificates (i.e. paper money) is one way and then moving to a purely electronic system is another way. This way that 100oz of gold can be used for thousands of transactions a year without ever moving. This is the process that has happened over the last few centuries (with the exception of the relience on a commodity currency) in our society. Measured M3 would go up and the 100oz may have been used for many deposits into banks during that period, but the actual amount of money in the system has not changed – it is still that original 100oz.
    In this example the question may be whether we have an inflation problem? The question then comes down to whether the efficiency with which that stock of gold has been used for transactions has gone up with the efficiency with which the economy produces goods and services for consumption / investment.

  53. smiths
    July 14th, 2008 at 15:30 | #53

    i’m sorry andrew but that is simply not true,

    first, you can never repay 110 of anything with 100 of it,

    and second, when the fed prints money they do so with no gold backing, they just simply print it and physically increase the money supply

    that was the whole point of seperating from the gold standard, you can increase the money supply with no technical limits

    are you actually trying to say that the money supply has not increased in the last 35 years?

  54. smiths
    July 14th, 2008 at 15:38 | #54

    Banks actually create money when they lend it.
    Here’s how it works: Most of a bank’s loans are made to its own customers and are deposited in their checking accounts.
    Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times.

    that is from the dalls federal reserves own site


  55. Smiley
    July 14th, 2008 at 16:13 | #55

    the fed is a private bank whose member banks are interested in making money,
    how can they seriously expect to be the chief warners for the consumer,

    That doesn’t quite correlate with my earlier quote from the Wiki entry on FRB which stated that central banks were put in place to protect against runs on the banks. Isn’t the fed also classified as a central bank?

    The question then is: protect who? If the answer is the bankers, then that really is a plumb job isn’t it.

    Except the NAB currency traders were sent to jail. And I imagine that there must be some mortgage brokers facing the same situation in the US right now. But the fact that we see these situations over and over again seems to suggest that the potential rewards outweigh the potential costs.

    It is the job of the banker to measure risk, and set appropriate costs for that risk. The sub-prime meltdown is an example of the catastrophic failure of bankers to do their job correctly. So if bankers cannot fulfil their job description, then we need some other mechanism to protect the banking system.

  56. July 14th, 2008 at 16:20 | #56

    I showed you how you can repay an amount of 110oz with only 100oz worth of gold in the system. Please identify where, exectly, I was wrong. A bald contention that “you can never repay 110 of anything with 100 of it” is unsustainable.
    Second – we were talking about gold backed money. If you want to talk fiat, fine, more than happy to, but let’s not confuse the issue, shall we?
    I know well what the Fed says. It has been repeated to me many times in these arguments. You may have found that link on Ozrisk. If you accept that bank call deposits are money they are correct – but this is like saying the sun comes up in the morning. It means nothing useful whatsoever. There is no new money actually available for transactions. Has the amount of money in the economy increased? Why does it matter? If there is new money it cannot be used.

  57. July 14th, 2008 at 16:45 | #57

    Spoken like a true banker – if we get it wrong, please subsidise our bad decisions or save us from making them again. Iain, at #38, would argue (correctly) that this would socialise the losses and privatise the gains.
    The answer is to allow them to fail, like any other business. The shareholders bear the main losses, the lenders bear the rest.
    A bank failure or two tends to concentrate minds wonderfully.

  58. Smiley
    July 14th, 2008 at 17:10 | #58

    if we get it wrong, please subsidise our bad decisions

    I don’t think I argued that… anywhere.

    Iain, at #38, would argue (correctly) that this would socialise the losses and privatise the gains.

    Huh, you’ve lost me.

  59. July 14th, 2008 at 18:34 | #59


    It is the job of the banker to measure risk, and set appropriate costs for that risk. The sub-prime meltdown is an example of the catastrophic failure of bankers to do their job correctly. So if bankers cannot fulfil their job description, then we need some other mechanism to protect the banking system.

    How are you going to do that other than through nationalisation or subsidy? Either way, any losses would fall back on the taxpayer.
    (N.B. – I would regard either option as almost certainly going to produce worse risk management outcomes, but that is another argument).

  60. Ian Gould
    July 14th, 2008 at 23:51 | #60


    The US Treasury is to provide a line of credit to Fannie Mae and Freddie Mac.

    The mortgage acceptance companies are in the classic situation of lending long and borrowing short with the result being a short-term funding crisis as funding dries up.

    There’s a simple rule to remember: markets are only rational on average and in the long term.

    Both institutions are profitable going forward and have substantial net assets.

    I know this is bad news for the socialists and gold bugs in the audience but that’s too bad – doomesday ahs been psotponed.

  61. Smiley
    July 15th, 2008 at 09:21 | #61

    How are you going to do that other than through nationalisation or subsidy?

    Well actually, my first suggestion was to increase the reserve fraction. But maybe this doesn’t necessarily have to be mandatory. If the banks offered accounts with a published reserve fraction, the consumer could choose. Sure you might earn less interest with a higher reserve, but a higher reserve should reduce the risk.

  62. July 15th, 2008 at 16:05 | #62

    You can easily work out the reserve fraction – at least to cash. The question is while we know the denominator, being total short term deposits – oh, wait, how short term is short term? Immediate call, 11am call, 24 hour call or some other period? OK, so we know the numerator – cash, of course – oh, but perhaps we should add in government bonds as they can be liquidated quickly. But then, so can deposits with other banks, including the Reserve. Should we count in only call funds or call periods that may work during a crisis? What about committed lines with other banks – these can be called on unconditionally in a crisis and these are not even assets.
    Historically, these sorts of calculations and simple ratios made sense when the financial markets were really simple and highly regulated (the two go together – regulators like to keep it simple). Now, any simple ratio will simply be laughed at and not worth the paper it is written on.
    Any mandatory raising of the ratio (however calculated) means banks will just hold more liquid assets than is needed to be prudent – as this is the current critieria (see APS 210 on the APRA website). This imposes a dead-weight cost, which customers and shareholders will need to pay. This means all of us will pay more for our banking. It will also encourage more unregulated lending (i.e. pawnbrokers) as they will not have to meet the liquidity criteria.
    This would socialise the costs as I said it would. The other option would provide a largely meaningless ratio that gives the illusion of increased security.

  63. smiths
    July 15th, 2008 at 17:03 | #63

    who are the socialists?

  64. smiths
    July 15th, 2008 at 17:05 | #64

    andrew reynolds,

    there is a very interesting post/discussion at
    globaleconomicanalysis blogspot about measures of money and how useful they are

    i tried to link there but my postr dissapeared permanently

  65. July 15th, 2008 at 17:32 | #65

    Thanks for the pointer – it is interesting. I would agree with the central idea (that M3 is close to , if not actually, useless) and while I normally hesitate to agree with Rothbard on much, TMS does look closer to the mark.
    One thing I would add, though – I think that in practice once economic decision makers start to focus on a particular measure it becomes worth less than it would otherwise have been, with the usefulness inversely proportional to the focus. This appears to have been the case with M3, as with so much else in regulatory statistics.

  66. Smiley
    July 15th, 2008 at 17:35 | #66

    oh, wait, how short term is short term? Immediate call, 11am call, 24 hour call or some other period? OK, so we know the numerator – cash, of course –

    I think that you’re trying to confuse the issue here. If I have a 6 month term deposit you know exactly when it is going to mature. Certain other factors (such as a daily drawing limit) also give the banker an idea of how much money they will have within any 24 hour period.

    Any mandatory raising of the ratio (however calculated) means banks will just hold more liquid assets than is needed to be prudent – as this is the current critieria (see APS 210 on the APRA website). This imposes a dead-weight cost, which customers and shareholders will need to pay.

    I’m not certain why the both the customer and shareholders should pay. I suggested in my last statement that the depositor should expect lower returns for a higher ratio. Therefore the lending margin for the bank could be slightly higher.

    It sounds to me like bankers would like any mandated ratio to be as low as possible. Or in other words, bankers like taking risks, and don’t like asking permission to do so.

    All I’m suggesting is that if the superannuation industry can provide customers with a choice between low risk and high returns, why not the banking industry? I get the feeling that bankers don’t like being told what they can do with other people’s money.

  67. July 15th, 2008 at 19:41 | #67

    I did not want to go into the term deposit area. I could have added that there is no such thing any more. The traditional TD could not be broken in the period of the TD without significant penalty. Now you just pay the economic loss / gain to the bank to break one. I do this regularly with funds I have on 90 day deposit. The banker does not know when I am going to draw on those funds – they are effectively at call, along with everything else we have in the bank.
    It may appear as if I am trying to complicate, but I am actually simplifying.
    Onthe costs of additional liquidity – to be effective in a run liquidity (however defined) would have to be significantly higher – not merely 1 to 2% – as deposit runs typically involve the withdrawal of around 50% of the deposit base, or more if there is genuine concern. Liquidity levels like this would be very expensive. Levels in the 1950s were around 40% – achieveing that now would mean the sorts of margins would simply be ridiculous – and the capacity to borrow overseas would practially vanish (why invest here) and deposits would also vanish overseas – for the same reason.
    On the last paragraph – banks used to do this (remember the difference between the savings and develpment banks in the 1970s?). As soon as the market was opened up people sought the returns. In the final analysis, people trust the banks. With over 100 years of history without a bank failure in Australia, if they actually think about it, they are happy that the risks are being managed adequately. Returns are what they are after.
    If they want total security they can put the cash in a safety deposit box or under their bed. If they want reasonable security plus a return they can put it in a bank. The banks are where it (mostly) is.

  68. Ash
    July 23rd, 2008 at 15:29 | #68

    Gold? Why is gold valuable? I’ve never seen an answer to that that didn’t amount to “because it’s valuable!”.

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