by Wayne Jett, Classical Capital:
Since 2010, the biggest banks of Wall Street have accepted business risks totaling hundreds of trillions of dollars under contracts called financial derivatives. Under those contracts, the big banks indemnify other firms against risks of losses, accept payments of “premiums” in exchange for taking the risks, and book the profits, making executives look good and the banks appear profitable. But, if the risked losses ultimately are realized a bank, the accounts of the bank’s ordinary depositors are subject to total loss!
Who on Earth has permitted this potential financial and social atrocity to exist? The answer, thanks to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, is the Federal Reserve.
Financial Reform By Friends of Wall Street
Under Dodd-Frank, the Fed was made regulator of banks in the U. S. The Fed is a private corporation with majority interests owned and controlled by Wall Street’s banks. What could go wrong?
During most of the nine years since 2010, the Fed has treated regional and small banks like red-headed step-children. Those banks don’t have the multi-national corporations as depositors or borrowers. Their clientele traditionally are Main Street, industrial and medium-to-small businesses.
Once becoming regulator of these banks, the Fed increased their reserve requirements so high that many were driven out of business or nearly so. To disguise the problem, the Fed actually began paying interest on un-invested reserves, so the smaller banks could maintain a degree of profitability. But these banks were weakened and the business community was less well served as consequences of the Fed’s actions.
While those smaller borrowers starved for credit, the Fed’s TBTF Wall Street banks and their hedge fund satellites were awash in liquidity for use in investment tactics of every design. Hedge funds, for example, love to find low-margin transactions and then multiply their profits by replicating the same deal with “lots and lots and lots of leverage.”
That kind of borrowing blows profits into the financial sector while vacuuming available credit away from productive businesses. Even overnight repurchase credit is consumed almost entirely by the financial sector’s suction, creating risks of a liquidity calamity that can do great damage quickly. This explains partly the Fed’s recent activities greatly increasing lending activities through repurchase agreements.
The Existing Crisis
In the aftermath of Dodd-Frank (enacted when the House, the Senate and the White House were controlled by the Democrat Party), financial risks taken on by TBTF banks have soared to become the worst nightmares of bank depositors. Failure of only one such bank could wipe out the Federal Deposit Insurance Corporation reserves for all banks without fully covering losses of the single big one.
In this context, did the Federal Reserve safeguard the interests of American depositors by requiring banks to segregate and insulate its banking business involving depositors’ funds from the high risk financial derivatives business? No, nothing of that sort. But the Fed actually did create and lend more than $350 billion to a single, badly run European bank – Deutsche Bank of Germany.
By the end of 2018, DB had taken on risks totaling $49 trillion under derivatives contracts. At year-end 2018, J. P. Morgan Chase Bank had derivatives risks of $48 trillion, Citigroup had derivatives risks of $47 trillion, and Goldman Sachs had derivatives risks of $42 trillion. The Fed contends that its $350 billion loan to DB reduced the likelihood that DB would default in its financial obligations to Morgan Chase, Citi and GS under their mutual dealings under derivatives contracts. Perhaps good for TBTF banks; not good for Americans, including bank depositors.
End The Fed – Regulate Banks Wisely
The truly alarming picture of financial instability reflected in these statistics proves to a certainty that the Federal Reserve should not have been appointed as regulator to guide Wall Street banks towards lower risk profiles than those existing during the financial crisis of 2008. Indeed, the results prove that both the House and Senate of 2010, plus the president, were puppets of the Wall Street banks, as is the Federal Reserve.
What ought to be done at the earliest date possible is to require by law that bank deposits be classified as first priority financial obligations of every bank doing business in the U. S., whether the bank is chartered as a national bank or a state bank. No bank should be permitted to accept deposits from the public and make those deposits subject to risks taken by the bank in financial derivatives or in any other contractual obligation.