An Overnight Banking Crisis? Don't Rescue, Regulate

draft 1, Thursday, October 2, 2008

An Overnight Banking Crisis?

Don’t rescue, regulate.

by David Maxwell Fine, Toledo

What no news article I’ve read has yet dared to explain to the world public: banks lend to each other overnight to cover their daily required reserves they need to back up their deposits, and that is where they are having trouble finding the money, and the overnight interest rate has gone up to around 6 percent, up from 2 percent. Banks do not want to lend for longer periods of time for fear other banks may default.

But meanwhile, Swiss company Roche Holding AG doesn’t think it will have trouble raising money to fund its $44 billion effort to a controlling stake in the company Genentech (Wall Street Journal). So where is money tight again?

Though mergers and acquisitions of companies will probably slow with the tightening of lending, it’s not as though mergers and acquisitions are essential to the health of the world economy. That is, they consume a large amount of liquidity, and their value may be of suspect worth to the global economy as a whole.

What is absurd is that banks have been using overnight lending to get around reserve requirements – about 1/10 to the dollar of deposits in the United States - probably for many decades, which perhaps should be outside the rules of the game – if it were, the banks wouldn’t be desperate right now.

The U.S. Congress’ move to increase FDIC insurance seems to be bogus public relations move that has very little to do with this short-term tight money problem.

There’s a lot of people talking about impending disaster, which could well be more lies and delusions than hyperbole. How can we listen to the fools who caused this “crisis” about what to do to deal with it? “Give us a bunch of money!” Maybe we should give them a bunch of cocaine, too.

A look at the U.S. Federal Reserve’s report on borrowing and lending in global credit markets shows that, compared to 2003 to 2007, household sector borrowing decreased dramatically in 2008, down to about an average annual rate of $325 billion, compared to rates at or near $1 trillion of borrowing annually in the 4 years prior.

www.federalreserve.gov/releases/Z1/Current/z1r-3.pdf

One would think that this huge borrowing contraction would leave billions of dollars in banks looking for a home to be lent out, though it is possible a lot of equity just evaporated with the mortgage defaults, and the financial speculation with mortgage bonds.

That question brings us back to the fact that we just don’t know, because the news media aren’t telling us.

Some factoids from the Federal Reserve:

• Total average annual borrowing has dropped by about half of what it was in 2006-2007, down to about $2.6 trillion. Time and savings deposits went into the negative in the 2^nd quarter of 2008. In 2007 they were at $500 billion.

• Bank loans to the non-financial sector have made up between 7% and 15% of total lending, since 2006, with commercial paper, treasury bonds, municipal and corporate bonds, and “other loans” making up the rest. In 2003 mortgage loans made up about 60 percent of all non-financial sector lending, declining to 43 percent by 2007.

• While borrowing via corporate bonds seems to have collapsed from $660 billion in 2007, and $800 billion in 2006, to an average in 2008 so far of zero.

• Corporate equities (stocks) weighed negatively on national savings estimates in 2007, negative $1 trillion, offset by tangible assets, savings and time deposits, money market funds, pension reserves, and other assets.

That is, Certificates of Deposit may be not just the way to go for the individual investor, but collectively, for the whole economy. Does cash in a CD have more value that shares in a company? If you own stock in a company, you mostly just want the value of the stock to go up, so you can sell it and make a profit. Do you care about your stake in the company? The value of the stock is reduced to market expectations that stocks will go up for whatever reasons, and maybe a dividend, if the company issues one.

But the real value of the stock to the company is the first sale of the stock, where it raises money so the company can expand and build its business. The company likes best its first investors – those who buy in after that really have nothing to do with the company unless they buy a very large quantity of shares and want to play an active role in the company – which few people do.

But if you make time savings deposits in banks, you enable the bank to engage in its core business, lending. You become very important to the bank, in a sense, you’re investing in the bank, though you do not have any ownership in the company. If more people put their money in CDs instead of stocks and mutual funds, the financial system might be more stable – especially if banks’ reserve requirements were higher, and they weren’t allowed to borrow overnight to cover their shortfalls.

Basically, the whole system of banking and finance has been corrupted by speculators and gamblers ever since it was first invented, and it is not operating by sensible rules or philosophies, but runs largely on expectations based on a very long tradition of speculation. That is, millions of investors have agreed upon the rules of the game, be they legitimate or no: that stocks in companies go up and down based upon earnings, news reports and expectations, not because these stocks possess any intrinsic value. The only potential value stocks possess to holders are any dividends they issue, the possibility they will be bought-back by the company, the ability of stockholders to play a role in the company, and future sale value – the latter of which is often determined by a variety of factors, including, possibly, insane hype-afflicted gamblers looking to make a quick buck. Are the stock market and Keno much different?

I’ve noticed that when you read the news media stories about the crisis, you don’t get much detailed information about why there’s a crisis, examples of companies who can’t get loans that want them, and the financial papers just want to regurgitate the numbers of Treasury yields and lending rates, and whether the stock markets are up and down – as if this tells us anything. It tells us all very little.

What tells us something is that the journalists in the news media aren’t telling us much of anything other than there’s a crisis and it could turn into a devastating disaster – they don’t want to tell us more, because they’re lying. They’re like public relations people for the rich speculators. Though Time magazine had the good taste to run this opinion

“Let Risk-Taking Financial Institutions Fail”

http://www.time.com/time/business/article/0,8599,1845209,00.html?imw=Y

But largely the news media is failing the American public in its reporting on this “crisis”.

The U.S. House of Representatives should again vote against this second attempt of rescuing the foolish rich, and let the speculators face the harsh realities of the market.

Not that the U.S. Government can’t inject $250 billion or more into the U.S. Economy – but a “rescue” of these speculators is not the way to do it.

There’s money out there, the financial system can weather the storm. Big banks are buying up smaller banks – but risk averse financiers like Warren Buffet want the government to help insure his investments in places like Goldman Sachs and General Electric.

Then the U.S. Congress should consider forming a task force to evaluate and consider reforming the United States' financial system, its regulations, and possibly providing more incentives for American citizens to buy time savings deposits. Should we allow banks to engage in all of this overnight lending? Should we raise banks’ reserve requirements?

If this “crisis” is as potentially disastrous as the Bush Administration and others are clamoring about, then the punishments for the financial markets and speculators should be severe. It’s ironic, if pathetic, that the Bush Administration and others want to spin this as an attempt at “bold government rescue” of an ostensible disaster caused by moral hazard and criminal irresponsibility on the part of gamblers, speculators, and brokers - and the U.S. Government’s laissez-faire regulation of the markets.

David Maxwell Fine

www.davidfine.org

Toledo, Ohio

(419) 320-6120 cell