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Has Private Commercial Banking Become Obsolete?

According to these commentators, the secret epidemic of bank
insolvencies is not just the result of individual mismanagement and
overreaching but marks the inevitable end times of a Ponzi scheme
that is inherently unsustainable. When the dollar was on the gold
standard, banks had to deal with periodic bank “runs” because they
did not have sufficient gold to cover their transactions. The Federal
Reserve was instituted early in the twentieth century to provide backup
money to prevent such runs. That effort was followed 20 years later
by the worst depression in modern history. The gold standard was
then abandoned, allowing larger and larger debt bubbles to flood the
system, resulting in the derivative and housing crises looming today.
When those bubbles pop, the only option may be another change in
the rules of the game, a Copernican shift of the sort envisioned by
Professor Liu.
Robert Guttman, Professor of Economics at Hofstra University in
New York, is another academician who feels the current banking
system may have outlived its usefulness. In a 1994 text called How
Credit-Money Shapes the Economy, he states, “It may well be that banks,
as currently constituted, are in the process of becoming obsolete. Increasingly
their traditional functions can be carried out more effectively by other
Chapter 34 - Meltdown

institutions . . . .” He goes on:
American banks have been hit over the last two decades by a
variety of adverse developments. Their traditional functions,
taking deposits and making loans, have been subjected to
increasing competition from less-regulated institutions. In the
face of such market erosion on both sides of their balance-sheet
ledger, the banks have had to find new profit opportunities. . . .
Even though most commercial banks have managed to survive
the surge in bad-debt losses . . . , they still face major competitive
threats from less-regulated institutions. It is doubtful whether
they can stop the market inroads made by pension funds, mutual
funds, investment banks, and other institutions that benefit from
the “marketization” of our financial system. . . . The revolution
in computer and communications technologies has enabled
others to access and process data at low cost. Neither lenders nor
borrowers need banks anymore. Both sides may find it increasingly
more appealing to deal directly with each other.4
At the time he was writing, hundreds of banks had failed after
writing off large chunks of non-performing loans to developing coun-
tries, farmers, oil drillers, real estate developers, and takeover artists.
Commercial banks and thrifts facing growing bad-debt losses were
forced to liquidate assets and tighten credit terms, producing a credit
crunch that choked off growth. The banks were also facing growing
competition from investment pools such as pension funds and mutual
funds. The banks responded with a dramatic shift away from loans,
their core business, to liquid bundles of claims sold as securities. The
commercial banking business was also eroding, as corporations
switched from loans to securities for funding. FDIC insurance, which
was originally intended to protect individual savers against loss, took
on the quite different function of bailing out failing institutions. “Such
a shift in focus led directly to adoption of the FDIC™s ˜too-big-to-fail™
policy in 1984,” Guttman wrote. “The result has been increasingly costly
government intervention which now has bankrupted the system.”

Web of Debt

The Shady World of Investment Banking

As banks have lost profits in the competitive commercial lending
business, they have had to expand into investment banking to remain
profitable. That expansion was facilitated in 1999, when the Glass-
Steagall Act, which forbade commercial and investment banking in
the same institutions, was repealed. Investment banking includes
corporate fund-raising, mergers and acquisitions, brokering trades,
and trading for the bank™s own account. 5 Despite this merger of
banking functions, however, profits continued to falter. According to
a 2002 publication called “Growing Profits Under Pressure” by the
Boston Consulting Group:
As the effects of the economic downturn continue to erode
corporate profits, large commercial banks “ both global and
regional “ face growing pressures on their corporate- and
investment-banking businesses. . . . From the outside, commercial
banks confront increasing competition “ particularly from global
investment banks . . . that are competing more vigorously for
commercial banks™ traditional corporate transactions. In
addition, commercial banks are finding that their corporate
clients are increasingly becoming their rivals. . . . [C]ompanies
today...meet more of their own banking needs themselves . . . .
In recent years, many commercial banks have acquired
investment banks, hoping to gain access to new clients . . . . But
. . . investment-banking revenues have suffered with the decline
in mergers and acquisitions, equity capital markets, and trading
activities. All too often, costs have continued to rise.6
An article in the June 2006 Economist reported that even with the
success of bank trading departments, the overall share values of in-
vestment banks were falling. Evidently this was because investors
suspected that the banks™ returns had been souped up by trading with
borrowed money, and they feared the risks involved.7
Meanwhile, banking as a public service has been lost to the all-
consuming quest for profits. As noted in Chapter 18, investment banks
make most of their profits from trading for their own accounts rather
than from servicing customers. According to William Hummel in
Money: What It Is, How It Works, the ten largest U.S. banks hold almost
half the country™s total banking assets. These banks, called “money

Chapter 34 - Meltdown

market banks” or “money center banks,” include Citibank, JPMorgan
Chase, and Bank of America. They are large conglomerates that
combine commercial banking with investment banking. However,
very little of their business is what we normally think of as banking “ taking
deposits, providing checking services, and making consumer or small
business loans. Rather, says Hummel, they mainly engage in four
Portfolio business “ asset accumulation and funding for their own
accounts, something they do by borrowing money cheaply and
selling the acquired assets at a premium;
Corporate finance “ corporate lending and public offerings;
Distribution “ the sale of the banks™ own securities, including
treasuries, municipal securities, and Euro CDs; and
Trading “ largely market-making.8
Recall that market makers are the players chiefly engaged in naked
short selling, an inherently fraudulent practice. (Chapter 19.) Patrick
Byrne, who has been instrumental in exposing the naked shorting
scandal, states that as much as 75 percent of the profits of big
investment banks may come from their role as “prime brokers” --
something he says is a fancy word for the stock loan business, or
renting the same stock several times over.9 Stocks are “rented” for
the purpose of selling them short. According to an article in Forbes,
“prime brokerage” is “the business of catering to hedge funds;
particularly, lending securities to funds so they can execute their trading
strategies.”10 We™ve seen that hedge funds are groups of investors
colluding to acquire companies and bleed them of their assets, speculate
in derivatives, manipulate markets, and otherwise make profits for
themselves at the expense of workers and smaller investors.
The big money center banks facilitating these dubious practices
are also the banks that must periodically be bailed out by the Fed and
the government because they are supposedly “too big to fail.” Yet
these banks are not even providing what we normally think of as
banking services! They are “too big to fail” only because they are
responsible for a giant Ponzi scheme that has the entire economy in its
death grip. They have created a perilous derivatives bubble that has
generated billions of dollars in short-term profits but has destroyed
the financial system in the process. Collusion among mega-banks has
made derivative trading less risky, but this has not served the larger

Web of Debt

community but rather has hurt small investors and the fledgling
corporations targeted by “vulture capitalism.” The fleas™ gain has
been the dog™s loss.

The Secret Nationalization of the Banks

In a March 2007 article called “Too Big to Bail (Out),” Dave Lewis
observes that the next major bank bailout may exceed the capacity of
the taxpayers to keep the private banking boat afloat. Lewis is a veteran
Wall Street trader who remembers the 1980s, when banks actually
could fail. The “too big to fail” concept came in at the end of the
1980s, when the savings and loans collapsed and Citibank lost 50
percent of its share price. In 1989, Congress passed the Financial
Institutions Reform, Recovery and Enforcement Act, which bailed out
the S&Ls with taxpayer money. Citibank™s share price also recouped
its losses. Then in 1991, a Wall Street investment bank called Salomon
Brothers threatened bankruptcy, after it was caught submitting false
bids for U.S. Treasury securities and the New York Fed Chief
announced that the bank would no longer be able to participate in
Treasury auctions. Warren Buffett, whose company owned 12 percent
of the stock of Salomon Brothers, negotiated heavily with Treasury
Secretary Nicholas Brady; and Salomon Brothers was saved. After
that, says Lewis, “too big to fail” became standard policy:
It is now 16 years later, the thin edge of the wedge has done
its thing and the circuit is now complete. The financial industry
has been, in a sense, nationalized. Credit rating agencies . . . will
now simply assume government support for large financial
institutions. . . . [But] there are limits to the amount of support
even the mighty US taxpayers can provide . . . . If the derivatives
inspired collapse of LTCM was a problem how much more
problematic would be a similarly inspired derivatives collapse
at JPMorgan given their US$62.6T in exposure. According to
the Office of the Comptroller of the Currency . . . , this US$62.6T
in derivatives exposure is funded by assets of only US$1.2T. . . .
And who will fill in the gap, US taxpayers? Are we now willing
to upend social harmony, or what little that remains, by breaking
promises of social security and other “entitlements” in order to keep
big banks that mismanaged their investment portfolios afloat? And
all this, by the way, while the upper class has been enjoying its

Chapter 34 - Meltdown

biggest tax breaks in decades.
. . . The $150B bail out of the S&Ls in the late 80s caused a
recession and cost George Bush the Elder a second term. I wonder
what effects a $1T or even $5T bail out would cause . . . . Short
of a military dictatorship, I can™t imagine a bail out of that size
for that reason passing through Congress. . . .
What if the problem arises due to a collapse of some
intervention scheme? Will US taxpayers be expected to bail out
a covert scheme to keep the price of gold down? or oil? More to
the point, could US taxpayers bail out such schemes? . . . [I]n the
event support was needed and could be obtained under these
conditions, why would anyone want to buy US bonds?11
If the financial industry has indeed been nationalized, and if we
the taxpayers are footing the bill, we can and should demand a bank-
ing system that serves the taxpayers™ interests rather than working at
cross-purposes with them.

The Systemic Bankruptcy of the Banks

Only a few big banks are considered too big to fail, entitling them
to taxpayer bailout; but in some sense, all banks operating on the frac-
tional reserve system are teetering on bankruptcy. Recall the defini-
tion of the term: “being unable to pay one™s debts; being insolvent;
having liabilities in excess of a reasonable market value of assets held.”
In an article called “Fractional Reserve Banking,” Murray Rothbard
put the problem like this:
[Depositors] think of their checking account as equivalent to
a warehouse receipt. If they put a chair in a warehouse before
going on a trip, they expect to get the chair back whenever they
present the receipt. Unfortunately, while banks depend on the
warehouse analogy, the depositors are systematically deluded.
Their money ain™t there.
An honest warehouse makes sure that the goods entrusted
to its care are there, in its storeroom or vault. But banks operate
very differently . . . Banks make money by literally creating money
out of thin air, nowadays exclusively deposits rather than bank
notes. This sort of swindling or counterfeiting is dignified by the
term “fractional-reserve banking,” which means that bank
deposits are backed by only a small fraction of the cash they

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promise to have at hand and redeem.12
Before 1913, if too many of a bank™s depositors came for their
money at one time, the bank would have come up short and would
have had to close its doors. That was true until the Federal Reserve
Act shored up the system by allowing troubled banks to “borrow”
money from the Federal Reserve, which could create it on the spot by
selling government securities to a select group of banks that created
the money as bookkeeping entries on their books. By rights, Rothbard
said, the banks should be put into bankruptcy and the bankers should
be jailed as embezzlers, just as they would have been before they
succeeded in getting laws passed that protected their swindling.
Instead, big banks are assured of being bailed out from their folly,
encouraging them to take huge risks because they are confident of
being rescued if things go amiss. This “moral hazard” has now been
built into the decision-making process. But small businesses don™t get
bailed out when they make risky decisions that put them under water.
Why should big banks have that luxury? In a “free” market, big banks
should be free to fail like any other business. It would be different if
they actually were indispensable to the economy, as they claim; but
these global mega-banks spend most of their time and resources making
profits for themselves, at the expense of the small consumer, the small
investor, and small countries.
There are more efficient ways to get the banking services we need
than by continually feeding and maintaining the parasitic banking
machine we have now. It may be time to cut the mega-banks loose
from the Fed™s apron strings and let them deal with the free market
forces they purport to believe in. Without the collusion of the Plunge
Protection Team, the CRMPG and the Federal Reserve, some major
banks could soon wind up in bankruptcy. The Federal Deposit
Insurance Corporation (FDIC) deals with bankrupt banks by putting


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