A century ago, between 1913 when The Federal Reserve Act was passed and 1929 when the economy came crashing down, banks with the power to create new money could also invest it. This ability to self-deal created a booming economy as a few wealthy people created money for themselves to buy real estate, invest in new technologies, monopolize old technologies and live a Gilded Age lifestyle. An asset bubble was created that burst on October 29, 1929. Within a year 90 percent of the value of the stock market vanished, and the nation sunk into the Great Depression, which lasted 10 years.
Recognizing that this ability of money creators to self-deal is a problem, Congress passed the Glass-Steagal Act in 1933, which required a legal separation between deposit bankers (who get to create new money by issuing loans) and investment bankers (who gather investment funds to make investments). This law meant a money creator bank could not loan itself money for investment; a bank could not create money for its own, or a subsidiary’s risky investing.
However, by the late 1990s Wall Street had found so many creative ways to get around Glass-Steagal, they could successfully argue it wasn’t really a meaningful law in practice. In 1999, bankers convinced Congress and President Clinton that the Glass-Steagal Act was old-fashioned hooey – an unnecessary constriction on their activities in this modern world of hedging risk, never failing, always wise profit-taking. The Gramm-Leach-Bliley Act, euphemistically called the Financial Services Modernization Act of 1999, was passed.
The law went into effect in 2000. It took a brief seven years of bankers’ self-interested gambling to bring several big banks to insolvency and put the entire economy at risk of collapse. In October 2007, our stock market had hit an all-time bubble high of 14,164. Within 18 months the value had dropped more than 50 percent to 6,595. There has been no substantial systemic correction. The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) made some feeble efforts at risk containment, but a Republican Congress in June 2018, gutted many of the protective regulations.
A continuing flood of newly created money loaned into the financial sector pushed the stock market back up beyond its 2007 high of 14,200, to over 26,617 in January 2018. After this high, the market began showing the little fits and drops that presage a major meltdown. By June the market had dropped 4.86 percent to 25,384. It doesn’t take much foresight to see trouble is ahead.
— when the central Fed’s loan programs are not enough
Over nearly a century, the central Fed took three basic actions: it managed loans between the banks of their reserves; it created new money for the banks by giving them direct loans; and it bought and sold US Securities to the banks and the general public.
In 2008, this was not enough to keep most of the major banks solvent. As the economy crashed, the central bank tried to create enough money for the insolvent banks by issuing them loans. When this proved inadequate, the central Fed decided it could create new money by buying up the insolvent banks’ sour investments, or the sour investments of businesses that owed the banks money. So, the central Fed echoed the freedom that the Gramm-Leach-Bliley Act gave their member banks: it created money to make investments on its own behalf. It started in a convoluted way. Congress passed the Troubled Asset Relief Program, otherwise known as TARP. This authorized the Fed to create $700 billion in new money guaranteed by IOUs from the US Government. This was standard US government IOU-debt procedure.
But Congress authorized the Fed to use this money to buy a variety of toxic assets from struggling banks and private companies, including stock ownership in the companies themselves. Some call this strategy quantitative easing because it increases the quantity of money in the whole system by feeding it to the big players in the financial sector – which takes the stress of consequences off their shoulders and makes their lives easier. New money on their balance sheets eases the financial sector’s distress. In theory, their newfound comfort will trickle down to the rest of the economy. It does not.
The Fed bought toxic assets from an insurance company (AIG), from mortgage companies, Fannie Mae and Freddie Mac, and from the investment arms of banks. Most of these purchases were at a market high valuation instead of the current market value. If the banks and companies had been required to mark their portfolios at after-crash values, nearly all of them would have been insolvent. Most of these Fed purchases were repurchase agreements that required the original owners to buy back their investments once the market value came back up, and to pay an interest premium in the interim. It was a gamble on the part of Congress that put taxpayer debt on the line for these investments. It was a gamble on the part of the central Fed: they became a market player taking a risk the borrowers would be able to make the premiums and/or the assets would return to their previous book value. This was a radical departure from their previous scope of action.
Their gamble paid off. The Fed made money on these deals, and after expenses, passed an additional $50–70 billion on to the Federal Government’s operating fund for several years. As for most gamblers, this early win made this high-risk strategy seem like a sure bet.
Fertilizer for self-dealing
These maneuvers meant a massive shift of new cash money onto the balance sheets of the financial sector, where it could continue to be played in the financial markets to rake in double digit profits, swinging the financial sector of the economy back into boom mode. High profit margins from gaming, or facilitating speculation, meant the big bank players were not very interested in loaning to Main Street. A Main Street starved of credit-money, meant a very slow recovery for the national economy. However, the financial sector, the market gamers and the global businesses have been doing just fine. They have been raking in some of their biggest profits for years – and creating a new asset bubble in the process. But, wages have stagnated, and small Main Street businesses hang on by their fingernails because few people can afford to spend. By mid 2018, this is changing some with modest job additions and unusually low unemployment – all typical of a pre-crash high.
While the Fed’s new strategy worked to keep the banks and the economy afloat in the short-term, it opened the flood gates of self- dealing even further. The central Fed is now heavily into this game. It reported $906 billion in assets in 2008. In 2009 the central Fed more than doubled its assets to $2,007 billion. By 2016 (November) – just seven more years – its assets had grown to $4,453 billion. Most of the TARP IOUs have been repurchased and no longer sit on their books, so the Fed has clearly been using this new found strategy to pump up their asset column (which means creating new money). A central bank that has increased its assets more than 5-fold in 10 years should trigger clanging alarm bells. If you know where to listen, there are little tinkles on the edges of general awareness. A humongous crash is coming.
The housing market has soared past its 2007 median home value of $196K to $216K in June 2018.60
While the central Fed may have gotten the TARP purchases off its books, it still increased its IOUs from others, which includes mortgage- backed security assets from $1,101 billion in 2011 to $1,819 billion in 2016 (next section). This suggests it is still using its power to create money to keep toxic assets off the books of marginally solvent big players, specifically the government-sponsored enterprises like Freddie Mac and Fannie Mae. Or, it decided it likes participating in investing in the marketplace in hopes of great returns on its investments. In either case, it pumped $664 billion into Wall Street investments in 5 years. Compare this $664 billion 5-year investment in Wall Street by the Fed to the $388 billion investment our Government made in our national transportation infrastructure and operations over the same period of time. Does that seem like a sensible priority?
From 2006 to 2016, the Fed increased its assets by 18 percent every year on average (Next section)! Think of that exponential curve. The Fed is trying to cope with our nearly vertical ascent up the money creation curve. Common sense says it cannot keep this up.
US Government Debt – Treasury Securities
To keep up with the exponentially increasing rate of money creation by the private sector, US Government debt to the public grew at an annual rate of 11 percent, more than doubling since 2008. In 2008 US government debt to the public was $5,836 billion. In 2017 it was $14,724 – an increase of $8,888 billion – two and one half times what it was 10 years earlier.61
In 2016, of $4,453 billion in assets on the central Fed’s balance sheet, $2,567 billion was in US Treasury securities – up from $784 billion in 2006. So of that increase of $8,888 billion in US Government debt, $1,783 billion is sitting on the Fed’s balance sheet. Twenty percent of the increase in government debt is sitting with the central Fed (Chapter 5.54). In the past, member banks, big corporations and the general public held most of the US Government debt. So much sitting on the Fed’s balance sheet is unusual.
The central Fed appears to be propping up the value of our nation’s debt by keeping an increasing amount of it on its own books. This is a short term fix with dire consequences.
This suggests that given the near guarantee of solvency support, the banks and big corporations may not feel they need to keep so many US Government IOUs on hand. And, there may be other reasons why the market for US Government securities dropped. It may reflect a global lack of confidence in the US’s ability to back up our promises, and hence a stagnating demand for our IOUs.
The Pew Research Center’s polls of how people in the rest of the world view America has been a roller coaster for the past 16 years. During the G.W. Bush era, opposition to US foreign policy and rising anti-Americanism dropped favorability ratings into the teens (meaning less than 20 percent of people viewed the US favorably).62
Under President Obama, ratings rose to a global median of 64 percent expressing a favorable opinion of our country. Ratings for President Trump are overwhelmingly negative. A median of just 22 percent say they have at least some confidence in the Trump to do the right thing in world affairs; 74 percent have little to no confidence in him.
While many of his supporters like to thumb their nose at the opinions of the rest of the world, global opinions have real world consequences given our money system. Notice the low favorability for G.W. Bush’s policies and the market crash in 2007–2008. High favorability for Obama and we had eight years of slow, but steady improvement. These are correlations, not causes, but they suggest there will be a financial crash early on in Trump’s presidency.
When the world doubts we are strong and spending wisely on our national well-being, they will doubt the value of our money and the trustworthiness of our debt. And, this has consequences.