The Largest U.S. Banks Have Repeatedly Gone Bankrupt Due to Wild Speculation. The Fed Blessed the Speculation then Helped Cover Up the Bankruptcies → Washingtons Blog
The Largest U.S. Banks Have Repeatedly Gone Bankrupt Due to Wild Speculation. The Fed Blessed the Speculation then Helped Cover Up the Bankruptcies - Washingtons Blog

Monday, October 5, 2009

The Largest U.S. Banks Have Repeatedly Gone Bankrupt Due to Wild Speculation. The Fed Blessed the Speculation then Helped Cover Up the Bankruptcies

As I have previously pointed out, the New York Times wrote in February:

In the 1980s, during the height of the Latin American debt crisis, the total risk to the nine money-center banks in New York was estimated at more than three times the capital of those banks. The regulators, analysts say, did not force the banks to value those loans at the fire-sale prices of the moment, helping to avert a disaster in the banking system.

In other words, the nine biggest banks were all insolvent in the 1980s.

Richard C. Koo - former economist at the Federal Reserve Bank of New York and doctoral fellow with the Fed's Board of Governors, and now chief economist for Nomura - confirmed last year in a speech to the Center for Strategic & International Studies that most of the giant money center banks were insolvent in the 1980s.

Specifically, Koo said:
  • After the Latin American crisis hit in 1982, the New York Fed concluded that 7 out of 8 money center banks were actually "underwater"
  • All the foreign banks (especially the Japanese banks) had to keep their lending facilities open to American banks so the American banking system didn't collapse overtly and out in the open
  • The Fed knew that virtually all of the American banks were "bankrupt", but could not publicly discuss how bad the situation was. If went out and said the "American banks are bankrupt", the next day they will go overtly go bankrupt. So the Fed had to come up with a lot of stories like "its good debt on their books"
  • Then-chairman Volcker instructed the banks to keep lending to the Mexican dictator so that the Mexican economy didn't totally collapse, because - if Mexico collapsed - it would become obvious that all of the U.S. banks were underwater, and they would immediately collapse
  • It took 13 years to manage the crisis (at another point in the talk, Koo says 15 years).
    The way that Volcker approached the problem was that he allowed U.S. banks to keep their lending rates relatively high, while the central bank brought short-term rates down. The spread between the two (the "fat spread") became revenue for the banks, and the banks used the high fat spread to gradually write off problem loans and to repair their balance sheets.
  • Volcker's covert rescue of the American banks using secrecy and a high fat spread didn't cost U.S. taxpayers a cent
  • Koo points out that you can't use the fat spread approach where there are no borrowers
Lessons for Today

So what is the take-home message from all of this? What are the lessons for today?

Well, initially, it shows that it wasn't just some S&Ls, or a Long Term Capital Management or two.

Virtually all of the largest U.S. banks gamble and speculate and then all go bankrupt. The money center banks gambled in Latin America and lost. They went bankrupt.

Moreover, it wasn't just the 1980s. As the New York Times wrote in a separate article:
Over the past 80 years, the United States government has engineered not one, not two, not three, but at least four rescues of the institution now known as Citigroup.
Have they changed their behavior?

No. They have - with the Fed's blessing - simply changed casinos, and for the last decade or so, have put all of their chips into CDOs, CDS, and other leveraged and securitized bets built like a house of cards on top of subprimes and option arms and alt-as and whatnot. Now they've lost and gone bankrupt again.

And the Fed playbook obviously includes pretending banks are solvent when they are not.

Indeed, as ABC news notes today:
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, a government watchdog states in a new report released today.
The Fed (as well as Treasury and other agencies), have cost the American taxpayer quite a few cents this time around - trillions of dollars. So the Fed's approach to the current and the Latin American crises are completely different.

The fat spread approach can't work now, because there has been a secular shift in borrowing habits by Americans. the reduction in American consumer spending is a long-term trend. For example, Alix Partners finds:

While American industry is struggling to get through what could become the worst recession since the Great Depression, Americans say that even after the recession ends, their spending will return to just 86% of pre-recession levels, which would take a trillion dollars per year out of the U.S. economy for years to come. According to this in-depth survey of more than 5,000 people, Americans plan to save (and therefore not spend) an astounding 14% of their total earnings post-recession, with the replenishment of their 401(k) and other retirement savings leading the way among their biggest long-term concern.

And Huffington Post notes:
"There will be a fundamental shift in the kind of cars we buy, a fundamental shift in the homes we buy, and a fundamental shift in consumption generally," says Matt Murray, an economist at the University of Tennessee. "And that is not something that took place in the 1980s."
People are hunkering down, like they did for decades after the Great Depression, and no approach which relies on Americans increasing their debt load will work. See this.

Moreover, as I have repeatedly argued, Summers, Geithner and Bernanke's entire plan seems to be to restart the great leverage machines, but that this plan is doomed to failure.

Specifically, I have argued for months that the boys believe that if they can just re-start the shadow banking system and lever the economy back up, that all boats will be lifted, asset prices will rise (and the "toxic assets will regain their "true" higher value), and the whole economy will be afloat once again, so that we can go merrily sailing onto paradise.

But if Americans don't want to borrow more, and if trust in the entire economic system has collapsed, then how can the boys restart the shadow banking system and re-lever up the economy?

Isn't that like trying to re-start a car after the engine has been removed?

And if those who claim that we are in Minsky moment of crushing debt overhang are right (and everyone - from Federal Reserve governors to Nobel prize winning economists - are dusting off their history books and studying Minsky right now), re-levering simply won't work.

Finally, the big banks are much bigger than they were in 1982. See this and this. What may have worked for 1982-sized banks won't necessary work for the current behemoths.

Hat tip to mannfm11.

The above-referenced statements by Koo start at about 30 minutes into the talk. If you have trouble playing the audio, download it and then play it from your computer.


  1. Addiction is no joke. It is real.

    Gambling banks are seriously addicted.

    What do addicts do to their families, employees, businesses, and their nation?

    Hurt them badly.

    Get it?

    The must go to jail, and receive serious and prolonged rehabilitation from jail.

  2. I think a lot of people are mistaken when they try and convince us -they- know what's going on. Their faulty presumption is that anyone can know what's going on.

    Once one gets over -that- hurdle, all the altruist-bullshit, the King Kong outrage, the mindless holier-than-thou-humanitarian attitudes fade into insignificance for anyone's cogent understanding -or- their easy acceptance of the false notion -someone else they wrongly admire -and- far too much- has a good handle on the problem.

    It's just ain't true. This is fresh ground. It's fresh ground every day when you wake up in this reality, folks. So get comfortable with the idea of it.

    No one has been here before, regardless their citing of history or some mindless accountant's version of -the- statistics.

    The point is, we're still in the game. The fat lady hasn't sung -yet- and she's not even warming up.

    When we look around the global landscape, there's really not much choice about letting the sun come up tomorrow on the British Empire.

    Let me toss out a different view. Indulge me.

    Remember way-back-when Hong Kong went back to the Red Chinese? Does anyone remember the dire predictions about the Red menace gobbling up capitalist Hong Kong?

    It didn't happen, did it?

    In fact, exactly the opposite happened. Hong Kong has gobbled up the Red menace, -entirely.

    Is there really anything wrong with this picture? I don't -think so.

    There's a quaint old saying, that -the sun never sets on the British Empire.

    And while the world continues to spin on its axis, very little remains unchanged, and certainly we're seeing plenty of that lately, it's still also true that -the sun still never sets on the British Empire.

    Does anyone have any good comprehension about just how long that's been going on?

    The blogosphere is taking its reactionary queues from the mainstream media so predictably, it has become just another tool of all these many descendant-empires of the British, and all their empirical allies.

    Capitalism ain't fading, and it ain't gonna fade either.

    No one is going to jail. No one is going to jail -unless- the Bolsheviks or the Maoists come marching into town.

    And -no one- is seriously considering arming any socialist factions to sweep down from the countryside and put all these capitalist pigs on trial.

    You can get over that fantasy right now.

    There is a silly, altruist outrage that all these large banks have gone reckless in their conduct.

    They are merely following a well-worn historic trend in pragmatic capitalist adaption.

    The Treasury and the Fed have a long history of keeping insolvent banks afloat.

    It's even true that quarterly -when the country's companies pay their taxes to the Treasury- this quite literally bankrupts every bank in the country due to the demand for a transfer of cash, which the none of the banks have on hand.

    No one panics. The Treasury always sends them all enough cash back -to keep them afloat.

    There are two things to remember.

    1) The way the geniuses set up economics, it ain't intuitive. And 2) this game is never ending.

    Those clowns who publish these newsletters and websites about the dollar going worthless and gold going to a million dollars an ounce can only be right if -the game- ends.

    Things is awful screwed-up right now. But the game ain't gonna end. You can get over that fantasy, right now.

  3. But, isn't the plan exactly the same as the 80s, just with government leverage instead of private leverage?

    As you point out, the money center banks increased private lending at good spreads in order to paper over their losses in Latin America.

    How is that not what they're doing now, just with the government in the place of private borrowers? Right now, look at Europe, the major European banks are borrowing and buying insane amounts of European government bonds to keep Europe afloat. Essentially Spanish banks are the best example of this since the Spanish government is running such large deficits.

    I don't see how this game isn't the same for the US as it was before, they're borrowing cheaply from the Federal Reserve Discount Window and then turning around and plowing that money into US Government Debt to game the spreads.

  4. "Volcker's covert rescue of the American banks using secrecy and a high fat spread didn't cost U.S. taxpayers a cent"
    Really? So thats why I paid such high interest through the 80's! So thats what deregulation was
    hiding! So the real roots of the the S&L crisis
    were in the Big Banks--who got of Scott Free while
    the S&L's bled all over the map. We Baby Boomers
    should have been going Gangbusters. Instead we
    were indirectly paying off a bunch of bad bets!

  5. I'm no genius, and I don't quite understand all the nuances of what keeps the economy afloat, but I have been reading anything I can to get a solid education on what’s occurring in our economy. I understand that our money is made out of 'thin air' and I understand that interest is applied to the money sent to the government which causes debt. I even watched the movie that made the case that money is debt. I agree with most of the information except that ‘money is debt’. At least that’s not what it is supposed to be.
    I believe that originally, money was nothing more than a placeholder for 'work done'. As in a bartering based system. Example- If a farmer wanted a T.V., he didn't trade the corn he grew directly to Zenith for it. He simply worked and was paid from others who worked using their ‘placeholders of their work’ for the corn, and then he paid the Zenith man for the T.V. with this easily recognized and accepted form of barter/trade system.
    Money was meant to be nothing more than a significant identifier of work done. The smart person could amass this placeholder and use it to leverage goods and services to be used to procure or create more work. He could also loan it out to others against their promise of repayment against their own ‘future’ work which would satisfy the loan.
    When the Fed loans money to the US, its putting into circulation more symbols of all the work done in order to account for the number of people who enter the ‘work force’ and to help identify the work with a symbol that is accepted by the populace as an example of the work to use as trade(read the rest before you shoot off a reply, trust me, I'm not done).

  6. @ Charles: You said: "When the Fed loans money to the US, its putting into circulation more symbols of all the work done in order to account for the number of people who enter the ‘work force’ and to help identify the work with a symbol that is accepted by the populace as an example of the work to use as trade."

    Interesting. Hence, the US govt's (both GOP and Dem administrations) insistence on letting new "free" (cheap) labor into the US from Mexico in spite of gang wars and loss of sovereignty, etc. The illegals can carry more "future work done" than Americans can.

    If you are American and follow this line of reasoning, kiss your country good bye. Charles must be a Brit. "Wealth (money) equals other people's labor (OPL)." A perfect paradigm for monetary imperialism (i.e., modern slavery).

    Where Charles goes wrong: money is indeed debt. It is debt "counted" as money via government support (i.e., unconstitutional legislation). It's the "public-private partnership" between government and bankers. As long as we tolerate this, we are cattle.

  7. Wow, so the Fed covered up the bankruptcies. I've been reading about bankruptcy all over the net, just so I know what I have to face if ever I do reach that point. I certainly hope not, but it doesn't hurt to be ready.

    According to another blog, California is prone to Bankruptcy. Los Angeles has been working against this bankruptcy. I had to get ready because I'm a Californian. This news made me scared of what will happen to my business. Since I've learned of that news, I've been looking for talented Long Beach lawyers.

    Thanks for sharing this news in your blog. More power!


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