The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

As I’ve noted for years, the government has been guaranteeing that the big banks make money at taxpayer expense by loaning money at very low interest rates, and then letting the banks loan the money back to the government at much higher interest rates.

For example, as I pointed out in January:

Bloomberg notes:

“The trading profits of the Street is just another way of measuring the subsidy the Fed is giving to the banks,” said Christopher Whalen, managing director of Torrance, California-based Institutional Risk Analytics. “It’s a transfer from savers to banks.”The trading results, which helped the banks report higher quarterly profit than analysts estimated even as unemployment stagnated at a 27-year high, came with a big assist from the Federal Reserve. The U.S. central bank helped lenders by holding short-term borrowing costs near zero, giving them a chance to profit by carrying even 10-year government notes that yielded an average of 3.70 percent last quarter.

The gap between short-term interest rates, such as what banks may pay to borrow in interbank markets or on savings accounts, and longer-term rates, known as the yield curve, has been at record levels. The difference between yields on 2- and 10-year Treasuries yesterday touched 2.71 percentage points, near the all-time high of 2.94 percentage points set Feb. 18.

Harry Blodget explains:

The latest quarterly reports from the big Wall Street banks revealed a startling fact: None of the big four banks had a single day in the quarter in which they lost money trading.

For the 63 straight trading days in Q1, in other words, Goldman Sachs (GS), JP Morgan (JPM), Bank of America (BAC), and Citigroup (C) made money trading for their own accounts.

Trading, of course, is supposed to be a risky business: You win some, you lose some. That’s how traders justify their gargantuan bonuses–their jobs are so risky that they deserve to be paid millions for protecting their firms’ precious capital. (Of course, the only thing that happens if traders fail to protect that capital is that taxpayers bail out the bank and the traders are paid huge “retention” bonuses to prevent them from leaving to trade somewhere else, but that’s a different story).

But these days, trading isn’t risky at all. In fact, it’s safer than walking down the street.

Why?

Because the US government is lending money to the big banks at near-zero interest rates. And the banks are then turning around and lending that money back to the US government at 3%-4% interest rates, making 3%+ on the spread. What’s more, the banks are leveraging this trade, borrowing at least $10 for every $1 of equity capital they have, to increase the size of their bets. Which means the banks can turn relatively small amounts of equity into huge profits–by borrowing from the taxpayer and then lending back to the taxpayer.

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The government’s zero-interest-rate policy, in other words, is the biggest Wall Street subsidy yet. So far, it has done little to increase the supply of credit in the real economy. But it has hosed responsible people who lived within their means and are now earning next-to-nothing on their savings. It has also allowed the big Wall Street banks to print money to offset all the dumb bets that brought the financial system to the brink of collapse two years ago. And it has fattened Wall Street bonus pools to record levels again.

Paul Abrams chimes in:

To get a clear picture of what is going on here, ignore the intermediate steps (borrowing money from the fed, investing in Treasuries), as they are riskless, and it immediately becomes clear that this is merely a direct payment from the Fed to the banking executives…for nothing. No nifty new tech product has been created. No illness has been treated. No teacher has figured out how to get a third-grader to understand fractions. No singer’s voice has entertained a packed stadium. No batter has hit a walk-off double. No “risk”has even been “managed”, the current mantra for what big banks do that is so goddamned important that it is doing “god’s work”.

Nor has any credit been extended to allow the real value-producers to meet payroll, to reserve a stadium, to purchase capital equipment, to hire employees. Nothing.

Congress should put an immediate halt to this practice. Banks should have to show that the money they are borrowing from the Fed is to provide credit to businesses, or consumers, or homeowners. Not a penny should be allowed to be used to purchase Treasuries. Otherwise, the Fed window should be slammed shut on their manicured fingers.

And, stiff criminal penalties should be enacted for those banks that mislead the Fed about the destination of the money they are borrowing. Bernie Madoff needs company.

As Shahien Nasiripour reports, the Congressional Research Service has just confirmed what we’ve been saying:

A newly-released study from the Congressional Research Service bolsters claims that the nation’s largest banks profited off the Federal Reserve’s financial crisis-era programs by borrowing cash for next to nothing, then lending it back to the federal government at substantially higher rates.

The report reinforces long-held beliefs that the banking system in essence engaged in taxpayer-financed arbitrage: They got money for free, then lent it back to Uncle Sam while collecting juicy returns. Left out of the equation are the millions of everyday borrowers, like households and small businesses, who were unable to secure loans needed to tide them over until the crisis ended.

The Fed released records under pressure in December and March that showed the extent of its largesse. The CRS study shows for the first time how some of the most sophisticated financial firms could have taken the Fed’s money and flipped easy profits simply by lending it back to another arm of the government.

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In all, more than $3 trillion was lent to financial institutions from the Fed, and terms were generous. Junk-rated securities were pledged as collateral for taxpayer-backed loans. The Fed did not provide conditions for how the money was to be used.

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“Why wasn’t the Fed providing these same sweetheart deals to the American people?” asked Warren Gunnels, senior policy adviser to [Senator] Sanders. “The Fed was practicing socialism for the rich, powerful and the connected, while the federal government was promoting rugged individualism to everyone else.”

At the time, Fed officials said its bailout programs were necessary to restart the flow of credit. If money couldn’t flow to lenders, households and businesses would be next. Even more layoffs and foreclosures could have ensued, officials argued.

Lending, however, decreased, according to Fed and Federal Deposit Insurance Corporation data.

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Sanders said the spread between firms’ borrowing rates and their lending rates to Uncle Sam amounted to “free money.” For Bank of America during the third quarter of 2009, the spread was nearly 3 percent.

No wonder Bill Gross, Nouriel Roubini, Laurence Kotlikoff, Steve Keen, Michel Chossudovsky, the Wall Street Journal and Bernie Madoff all say that the U.S. economy is a giant Ponzi scheme.

As I noted last year:

The governments of the world have spent trillions trying to paper over the fraud and prop up the big, insolvent banks, instead of forcing them to restructure and forcing bondholders and shareholders to take a haircut.

A study of 124 banking crises by the International Monetary Fund found that propping up banks which are only pretending to be solvent drives up the costs to the country:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.

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All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

The American banks and government have certainly pretended that all of the big banks are solvent. As ABC wrote in October 2009:

The Treasury Department and the Federal Reserve lied to the American public last fall when they said that the first nine banks to receive government bailout funds were healthy, [the special inspector general for the Troubled Asset Relief Program] states in a new report released today.

Similarly, the stress tests were a complete and utter sham.The government has given the giant banks huge amounts in loans and guarantees based upon their false representations about their financial health. The Fed has larded up its balance sheet with toxic assets from the banks.

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Throwing trillions at the giant banks – who are mainly using the money to gamble – is not stimulus. It helps the executives of the big banks and their shareholders and bondholders, but not the broader economy.

Indeed, attempting to prop up big, insolvent banks is preventing stimulus from getting out into the economy.

Indeed, the big banks are still insolvent. Moody’s – a mere 3 years too late – just put Bank of America, Citi and Wells Fargo on a downgrade watch. And see this.

The country has been plundered to throw money at the big banks to allow their CEOs to rake in bonuses by playing an extend-and-pretend game (pretending they are solvent). This has driven us from the “wealth of nations” to the “debt of nations”.

As I wrote in 2009:

If the power to create credit were taken away from the Federal Reserve system and its private banks and given back to the [people] (as the Constitution envisioned), then American taxpayers would save hundreds of billions or trillions of dollars in unnecessary interest charges in paying off the national debt, as the government would not have to pay interest to finance its debt (sovereign nations such as the U.S. and England have the power to create credit and money; see this, this, this, and this).