Now Fire Geithner and Summers
(RichardcCook.com) -- By Richard C. Cook
The new restraints on bank lending for speculation proposed yesterday by President Barack Obama follow the advice of former Fed Chairman Paul Volcker but will be much more credible if the president now fires Secretary of the Treasury Timothy Geithner and National Economic Council director Lawrence Summers.
What President Obama is calling the “Volcker Rule” would take us back in the direction of the 1932 Glass-Steagall Act which kept commercial and investment banking separate for 67 years, until 1999 when it was foolishly repealed by President Bill Clinton. Then-Treasury Secretary Summers strongly supported the repeal.
It was the demise of Glass-Steagall that allowed commercial banks to create the vast amounts of unbacked credit which fueled the gigantic financial bubbles in housing, commercial real estate, hedge funds, equities, and derivatives during the catastrophic years of the George W. Bush presidency. It was the blowing up of these bubbles that brought the financial crash of 2008-9, the multi-trillion dollar bailouts of the financial industry by the Treasury and Federal Reserve, and the worst recession since the Great Depression.
American financiers became filthy rich in the meantime. Timothy Geithner, as president of the Federal Reserve Bank of New York from 2003-2009, worked closely with Bush’s Treasury Secretary Henry Paulson in overseeing the bailouts of Bear Stearns and AIG. He also favored reducing the capital required to operate a bank which would have exposed the financial system to even greater risk of failure.
Since becoming charter members of the Obama administration, both Geithner and Summers favored a much milder approach to bank reform. According to the Washington Post, industry executives were “startled and disheartened that Geithner was overruled” in favor of Volcker’s approach. Under Geithner’s watch, though, the banks have been using taxpayers’ money not to restart lending but to take over smaller banks, invest in the stock market, and continue to pay their executives obscene bonuses.
The poor bankers, now standing like deer in the headlights, are breaking our hearts. Their flight from the stock market, which began yesterday, caused an immediate drop in the Dow Jones Industrial Average of over 200 points. It shows the stranglehold the banks have had on the nation’s wealth. But in reality, the proposed “Volcker Rule” should be only the first step in the nation’s recovery from the worst financial crime spree in history.
Think about it for a minute. Banks are allowed to create credit “out of thin air” only under a public charter. It is a fiduciary trust that should be regarded as sacrosanct. One way this trust has been abused has been for banks to use this created credit to buy companies whose employees are then fired and assets stripped before the company is sold at a profit to pay off the loans and the bankers’ brokerage fees. If this isn’t a crime against the national interest, what is?...MORE...LINK
Chris Moore comments:
Richard Cook writes: "Think about it for a minute. Banks are allowed to create credit “out of thin air” only under a public charter. It is a fiduciary trust that should be regarded as sacrosanct."
What Cook is referring to here is the concept of fractional reserve banking. From Wikipedia: "Fractional-reserve banking is the banking practice in which banks keep only a fraction of their deposits in reserve (as cash and other highly liquid assets) and lend out the remainder, while maintaining the simultaneous obligation to redeem all these deposits upon demand. Fractional reserve banking necessarily occurs when banks lend out any fraction of the funds received from deposit accounts. This practice is universal in modern banking, and is to be contrasted with full-reserve banking which died out over two centuries ago. By its nature, the practice of fractional reserve banking expands money supply (cash and demand deposits) beyond what it would otherwise be. Because of the prevalence of fractional reserve banking, the broad money supply of most countries is a multiple larger than the amount of base money created by the country's central bank."
Fractional reserve banking is a similar concept to fiat money. From Wikipedia: The term fiat money is used to mean: any money declared by a government to be legal tender; state-issued money which is neither legally convertible to any other thing, nor fixed in value in terms of any objective standard...
While specie-backed representative money entails the legal requirement that the bank of issue redeem it in fixed weights of specie, fiat money's value is unrelated to any physical quantity. Even a coin containing valuable metal may be considered fiat currency if its face value is higher than its market value as metal...
By World War I most nations had a legalized government monopoly on bank notes and the legal tender status thereof. In theory, governments still promised to redeem notes in specie on demand. However, the costs of the war and the massive expansion afterward made governments suspend redemption in specie. Since there was no direct penalty for doing so, governments were not immediately responsible for the economic consequences of printing more money, which lead to hyperinflation – for example in Weimar Germany.
Attempts were made to reassert currency stability by anchoring it to wholesale gold bullion rather than making it payable in specie. This money combined pure fiat currency, in that the currency was limited to central bank notes and token coins that were current only by government fiat, with a form of convertibility, via gold bullion exchange, or via exchange into US dollars which were convertible into gold bullion, under the 1945 Bretton Woods system.
The Bretton Woods system pegged the value of the United States dollar to 1/35th of a troy ounce of gold. Other currencies were pegged to the U.S. dollar at fixed rates. The U.S. promised to redeem dollars in gold to other central banks. Trade imbalances were corrected by gold reserve exchanges or by loans from the International Monetary Fund. This system collapsed when the United States government ended the convertibility of the US dollar for gold in 1971, in what became known as the Nixon Shock...
The Austrian School of Economics has long held that no sound economy can long endure under fiat money, with prominent Austrian Economist Ludwig von Mises arguing in his book, Human Action, that, "What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit boom is built on the sands of banknotes and deposits. It must collapse."
So the road to our contemporary economic collapse actually started with Big Government's creation of fiat currency in order to fight World War I, was aggravated when Nixon ended the convertibility of the US dollar to gold (which allowed the federal government to deficit spend and issue credit astronomically without having to purchase gold to back up it all up.)
So what has backed the U.S. currency since the Nixon era? Well, the full faith and credit of the United States government (which essentially means its ability to tax the American people to the hilt, if need be), and the U.S. Military.
So really, it was the scheming Big Government central planners who were the first to stop treating their responsibility to protect the economy as sacrosanct by ending the discipline of pegging dollars to metal, first through the creation of bank notes, and secondly through ending the redeemability of those bank notes for gold.
The greedy, scheming bankers with their irresponsible lending and bubble creation were merely following the lead originated by lazy, greedy and irresponsible Big Government central planners who didn't want to be restrained in their warmongering, their spending, and their government takeover of society by keeping the creation of credit and currency tied down by an accompanying purchase of gold to back it.