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Re: The Name Of The Game Is Bailout
This is an excerpt from a book called "The Creature From Jekyll Island". It's a pretty long read, but I promise it will provide an enhanced and vital understanding of the current financial crisis, and those to come in the future.
by G. Edward Griffin
RULES OF THE GAME
The game begins when the Federal Reserve System allows commercial banks to create checkbook money out of nothing. The banks derive profit from this easy money, not by spending it, but by lending it to others and collecting interest.
When such a loan is placed on the bank's books it is shown as an asset because it is earning interest and, presumably, someday will be paid back. At the same time an equal entry is made on the liability side of the ledger. That is because the newly created checkbook money now is in circulation, and most of it will end up in other banks which will return the canceled checks to the issuing bank for payment. Individuals may also bring some of this checkbook money back to the bank and request cash. The issuing bank, therefore, has a potential money pay-out liability equal to the amount of the loan asset.
When a borrower cannot repay and there are no assests which can be taken to compensate, the bank must write off that loan as a loss. However, since most of the money originally was created out of nothing and cost the bank nothing except bookkeeping overhead, there is little of tangible value that is actually lost. It is primarily a bookkeeping entry.
A bookkeeping loss can still be undesirable to a bank because it causes the loan to be removed from the ledger as an asset without a reduction in liabilities. The difference must come from the equity of those who own the bank. In other words, the loan asset is removed, but the money liability remains. The original checkbook money is still circulating out there even though the borrower cannot repay, and the issuing bank still has the obligation to redeem those checks. The only way to do this and balance the books once again is to draw upon the capital which was invested by the bank's stockholders or to deduct the loss from the bank's current profits. In either case, the owners of the bank lose an amount equal to the value of the defaulted loan. So, to them, the loss becomes very real. If the bank is forced to write off a large amount of bad loans, the amount could exceed the entire value of the owner's equity. When that happens, the game is over, and the bank is insolvent.
This concern would be sufficient to motivate most bankers to be very conservative in their loan policy, and in fact most of them do act with great caution when dealing with individuals and small businesses. But the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Federal Deposit Loan Corporation now guarantee that massive loans made to large corporations and to other governments will not be allowed to fall entirely upon the bank's owners should those loans go into default. This is done under the argument that, if these corporations or banks are allowed to fail, the nation would suffer from vast unemployment and economic disruption.
THE PERPETUAL-DEBT PLAY
The end result of this policy is that the banks have little motive to be cautious and are protected against the effect of their own folly. The larger the loan, the better it is, because it will produce the greatest amount of profit with the least amount of effort. A single loan to a third-world country netting hundreds of millions of dollars in annual interest is just as easy to process - if not easier - than a loan for 50.000$ to a local merchant on the shopping mall. If the interest is paid, it's gravy time. If the loan defaults, the federal government will "protect the public" and, through various mechanisms described shortly, will make sure that the banks continue to receive their interest.
The individual and the small businessman find it increasingly difficult to borrow money at reasonable rates, because the banks can make more money on loans to corporate giants and to foreign governments. Also, the bigger loans are safer for the banks, because the government will make them good even if they default. There are no such guarantees for the small loans. The public will not swallow the line that bailing out the little guy is necessary to save the system. The dollar amounts are too small. Only when the figures become mind-boggling does the ploy become plausible.
It is important to remember that banks do not really want to have their loans repaid, except as evidence of the dependability of the borrower. They make a profit from interest on the loan, not repayment of the loan. If a loan is paid off, the bank merely has to find another borrower, and that can be an expensive nuisance. It is much better to have the existing borrower pay only the interest and never make payments on the loan itself. That process is called rolling over the debt. One of the reasons the banks prefer to lend to governments is that they do not expect those loans ever to be repaid.
When this activity is carried out in the United States, as it is weekly, it is described as a Treasury bill auction. But when basically the same process is conducted abroad in a foreign language, the news media usually speak of a country's "rolling over its debts". The perception remains that some form of disaster is inevitable. It is not.
To see why, it is only necessary to understand the basic facts of government borrowing. The first is that there are few recorded instances in history of government - any government - actually getting out of debt. Certainly in an era of $100-billion deficits, no one lending money to the government by buying a Treasury bill expects that it will be paid at maturity in any way except by the government's selling a new bill of like amount.
THE DEBT ROLL-OVER PLAY
Since the system makes it profitable for banks to make large, unsound loans, that is the kind of loans which banks will make. Furthermore, it is predictable that most unsound loans eventually will go into default. When the borrower finally declares that he cannot pay, the bank responds by rolling over the loan. This often is stage managed to appear as a concession on the part of the bank but, in reality, it is a significant forward move toward the objective of perpetual interest.
Eventually the borrower comes to the point where he can longer pay even the interest. Now the play becomes more complex. The bank does not want to lose the interest, because that is its stream of income. But it cannot afford to allow the borrower to go into default either, because that would require a write-off which, in turn, could wipe out the owner's equity and put the bank out of business. So the bank's next move is to create additional money out of nothing and lend that to the borrower so he will have enough to continue paying the interest, which by now must be paid on the original loan plus the additional loan as well. What looked like certain disaster suddenly is converted by a brilliant play into a major score. This not only maintains the old loan on the books as an asset, ut actually increases the apparent size of that asset and also results in higher interest payments, this, greater profit to the bank.
THE UP-THE-ANTE PLAY
Sooner or later, the borrower becomes restless. He is not interested in making interest payments with nothing left for himself. He comes to realize that he is merely working for the bank and, once again, interest payments stop. The opposing teams go into a huddle to plan the next move, the rush to the scrimmage line where they hurl threatening innuendoes at each other. The borrower simply cannot, will not pay. Collect if you can. The lender threatens to blackball the borrower, to see to it that he will never again be able to obtain a loan. Finally, a "compromise" is worked out. As before, the bank agrees to create still more money out of nothing and lend that to the borrower to cover the interest on both of the previous loans but, this time, they up the ante to provide still additional money for the borrower to spend on something other than interest. That is a perfect score. The borrower suddenly has a fresh supply of money for his purposes plus enough to keep making those bothersome interest payments. The bank, on the other hand, now has still larger assets, higher interest income, and greater profits.
THE RESCHEDULING PLAY
The previous plays can be repeated several times until the reality finally dawns on the borrower that he is sinking deeper and deeper into the debt pit with no prospects of climbing out. This realization usually comes when the interest payments become so large they represent almost as much as the entire corporate earnings or the country's total tax base. This time around, roll-overs with larger loans are rejected, and default seems inevitable.
But wait. What's this? The players are back at the scrimmage line. There is a great confrontation. Referees are called in. Two shrill blasts from the horn tell us a score has been made for both sides. A voice over the public adress system announces: "This loan has been rescheduled".
Rescheduling usually means a combination of a lower interest rate and a longer period for repayment. The effect is primarily cosmetic. It reduces the monthly payment but extends the period further into the future. This makes the current burden to the borrower a little easier to carry, but it also makes repyament of the capital even more unlikely. It postpones the day of reckoning but, in the meantime, you guessed it: The loan remains as an asset, and the interest payments continue.
THE PROTECT-THE-PUBLIC PLAY
Eventually the day of reckoning arrives. The borrower realizes he can never repay the capital and flatly refuses to pay interest on it. It is time for the Final Maneuver.
The banks can absorb the losses of their bad loans to multinational corporations and foreign governments, but that is not according to the rules. It would be a major loss to the stockholders who would receive little or no dividends during the adjustment period, and any chief executive officer who embarked upon such a course would soon be looking for a new job. That this is not part of the game plan is evident by the fact that, while a small portion of the debt is being absorbed, the banks are continuing to make gigantic loans to governments in other parts of the world, particularly Africa, China, Russia, and Eastern European nations. There is little hope that the performance of these loans will be different than those previously. But the most important reason for not absorbing the losses is that there is a standard play that can still breathe life back into those dead loans and reactivate the bountiful income stream that flows from them.
Here's how it works. The President of the lending bank and the finance officer of the defaulting corporation or government will join together and approach Congress. They will explain that the borrower has exhausted his ability to service the loan and, without assistance from the federal government, there will be dire consequences for the American people. Not only will there be unemployment and hardship at home, there will be massive disruptions in the world markets. And, since we are now so dependent on those markets, our exports will drop, foreign capital will dry up, and we will suffer greatly. What is needed, they will say, is for Congress to provide money to the borrower, either directly or indirectly, to allow him to continue to pay interest on the loan and to initiate new spending programs which will be so profitable he will soon be able to pay everyone back.
As part of the proposal, the borrower will agree to accept the direction of a third-party referee in adopting an austerity program to make sure that none of the new money is wasted. The bank also will agree to write off a small part of the loan as a gesture of its willingness to share in the burden. This move, of course, will have been foreseen from the very beginning of the game, and is a small step backward to achieve a giant stride forwards. After all, the amount to be lost through the write-off was created out of nothing in the first place and, without this Final Maneuver, the entirety would be written off. Furthermore, this modest write down is dwarfed by the amount to be gained through restoration of the income stream.
THE GUARANTEED-PAYMENT PLAY
One of the standard variations of the Final Maneuver is for the government, not always to directly provide the finds, but to provide the credit for the funds. That means to guarantee future payments should the borrower again default. Once Congress agrees to this, the government becomes a co-signer to the loan, and the inevitable losses are finally lifted from the ledger of the bank and placed onto the backs of the American taxpayer.
Money now begins to move into the banks through a complex system of federal agencies, international agencies, foreign aid, and direct subsidies. All of these mechanisms extract payments from the American people and channel them to the deadbent borrowers who then send them to the banks to service their loans. Very little of this money actually comes from taxes. Almost all of it is generated by the Federal Reserve System. When this newly created money returns to the banks, it quickly moves out again into the economy where it mingles with and dilutes the value of the money already there. The result is the appearance of rising prices but which, in reality, is a lowering of the value of the dollar.
The American people have no idea they are paying the bill. They know that someone is stealing their hub caps, but they think it is the greedy businessman who raises prices or the selfish laborer who demands higher wages or the unworthy farmer who demands too much for his crop or the wealthy foreigner who bids up our prices. They do not realize that these groups also are victimized by a monetary system which is constantly being eroded in value by and through the Federal Reserve System.
Public ignorance of how the game is really played was dramatically displayed during a Phil Donahue TV show. The topic was the Savings and Loans crisis and the billions of dollars that it would cost the taxpayer. A man from the audience rose and asked angrily: "Why can't the government pay for these debts instead of the taxpayer?". And the audience of several hundred people erupted in enthusiastic approval!
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