The federal government bailed out Wall Street with $700 billion on October 2, 2008. Now we have the 2300-page Wall Street Reform bill. It establishes over 400 new agencies that are neither funded yet or have any rules. Congress, Wall Street, and bankers will be generating new regulations for decades – after which time we will have an old Societ-style central economy (if we don’t already).
The Federal Reserve has the authority to loan up to $4 trillion “in extreme circumstances.” This was one of those times, and over the next 12 months the Fed gave zero-percent loans to banks in the amount of $2 trillion, in addition to the $700 billion bail out.
What this means is that these giant banks got zero-interest loans. This cost the taxpayers 3% due to inflation, plus the Fed had to sell U.S. Treasury bills because the government has no cash on hand and had to borrow the money, which cost the taxpayers 4% in interest. Thus, the $2 trillion loaned to banks cost the taxpayers 7% in interest, or $140 billion in interest a year.
These banks were supposed to loan this money out to diminish the “liquidity crisis.” Now, these giant investment firms all have a leverage of about 25 (they can purchase 25 times in securities what they actually have in cash on hand), so they could have taken this money and bought U.S. Treasury bonds at 4% interest and made 100% interest. Nobody knows what they really did with the money.
Finally, the power of “derivatives” means they could take this one step further and bundle all these “U.S. Treasury-backed securities” into derivative contracts and quadruple the return again – for a grand total of a 400% return.
Leverage
Here “Wall Street” refers to the 20 or so “Too Big To Fail” banks (TBTF). These giant investment banks, e.g. Goldman Sacs, had an average leverage of 20 in 2003. When the system cratered in 2009, their leverage was 30 or so.
I have a mutual fund account that I can buy stocks on margin. My leverage is 2, and when I use this method, I pay ten percent interest on the money I borrow from my own account.
The TBTF banks have a line of credit equal to 25 times what they actually have in cash, and they never pay any interest on what they borrow.
The Great Depression
This same ponzi scheme caused the Crash of ’29 and the worldwide Depression in the 1930’s. Congress passed the Glass-Steagall law back then to prohibit investment banks, commercial banks, and insurance companies from being owned by the same entity.
This law was repealed in 1999. In the following ten years, the TBTF banks bought up the more conservative insurance companies and commercial banks, and used them as collateral for taking on more and more risk – building up to a higher and higher leverage ratio.
Derivatives
To give you an idea of how far this has gone, there were $80 trillion in derivatives contracts owned by the TBTF banks in 1998. Today there are $600 trillion in derivatives contacts. On average, each TBTF banks owns more derivatives contracts than the entire annual output of the United States, our GDP.
Wall Street Reform
Congress should be trying to roll back the rules so that Glass-Steagall is once again the law of the land. However, if you take the insurance companies and insurance banks away from the TBTF banks as collateral, that will immediately double or triple their leverage. Merrill Lynch failed when its leverage went above 32. Thus, the new Wall Street Reform bill does not change the status quo.
Warren Buffet’s company Berkshire Hathaway owns 250 derivatives contracts. He says it will cost his form $1 billion to firmly ground those assets in solid cash and securities. Each of the TBTF banks owns millions of derivatives contracts. The new Wall Street Reform bill changes nothing.
Warren Buffett, a multi-billionaire himself, wants the federal government to reimburse this $1 billion if the law is passed, because he says the government is at fault for changing the rules in the middle of the game.
