The Fed Fueled Today’s Liquidity Crisis with One Key Moral Hazard Action

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by Pam Martens and Russ Martens, Wall St On Parade:

The Federal Reserve Bank of New York (New York Fed) made the astonishing announcement last Thursday that it will be pumping a cumulative $2.93 trillion into Wall Street trading houses (primary dealers) between December 16 and January 14. That’s on top of the $360 billion of liquidity it is pumping into the markets by buying back $60 billion a month in Treasury bills from its primary dealers.

The Fed’s excuse for opening its self-created money spigots to the tune of trillions of dollars to Wall Street’s trading houses – a replay of what it did secretly during the financial crisis of 2007 to 2010 – is that this is simply a technical fix for allowing bank reserves at the Fed to shrink too far. But that is merely a symptom – not the actual disease afflicting the U.S. financial system.

The facts on the ground strongly support the argument that the Fed itself created this mess by rubber-stamping bank mergers that allowed five banks (out of 5,000 in existence in the U.S.) to now constitute the core of the U.S. financial system.

In a 2015 report, researchers at the federal Office of Financial Research found that the health of the entire U.S. financial system rested on the financial health of just five mega banks: Citigroup, JPMorgan, Morgan Stanley, Bank of America and Goldman Sachs. Each one of those banks, with the exception of Bank of America, is “supervised” by the New York Fed. Bank of America is supervised by the Federal Reserve Bank of Richmond. (See These Are the Banks that Own the New York Fed and Its Money Button.)

According to the Office of the Comptroller of the Currency (OCC), the bank holding companies of those same five mega banks, as of March 31, 2019, were sitting on obscene levels of derivative risk: in notional (face amount) of derivatives, JPMorgan Chase held $58.7 trillion; Citigroup had $51.5 trillion; Goldman Sachs Group reported $50.8 trillion; Bank of America held $37.9 trillion while Morgan Stanley sat on $35 trillion. At the time, these five banks represented 86 percent of all derivatives held by the more than 5,000 Federally-insured banks and savings associations in the U.S. Derivatives played a key role in the financial collapse of 2008 and yet neither the Fed nor Congress have reined in the risks.

And there is growing awareness that nothing useful or productive in terms of the U.S. economy is being done with these hundreds of trillions of dollars in derivatives. There is instead substantive evidence that the derivatives are simply being used to provide questionable profits and to manipulate capital requirements at the behemoth banks.

The key moral hazard act by the Federal Reserve that set the epic financial collapse of 2008 in motion, and lit the fuse for the Fed’s latest multi-trillion-dollar money spigot to Wall Street, was the Federal Reserve’s approval on September 23, 1998 of the merger of Travelers Group (a large insurance company that owned the investment bank Salomon Brothers and the retail brokerage firm Smith Barney) with Citicorp, the parent of the large, federally-insured commercial bank, Citibank, to form the mega Wall Street “universal” bank, Citigroup. (Just 10 years after the Fed approved this merger, Citigroup would implode and receive the largest, secret, infusion of cash from the Fed in U.S. banking history. From December 2007 through at least July 2010, the New York Fed secretly funneled a cumulative $2.65 trillion into Citigroup to shore up its sinking hull. (See page 33 of the Levy Economics Institute study at this link.)

The Federal Reserve approved that merger in stark violation of the Glass-Steagall Act that had prevented federally-insured, deposit-taking banks from merging with investment banks engaged in underwriting and trading in stocks and bonds. The Glass-Steagall Act was passed in 1933 by the U.S. Congress. The 1933 U.S. Senate had held public hearings for more than two years and ferreted out that it was self-dealing and corruption on the part of Wall Street investment banks that had collapsed the stock market in 1929 and unleashed the Great Depression. The 1933 legislation created federal insurance for bank deposits and barred Wall Street’s casino investment banks from ever again getting their hands on mom and pop deposits in commercial banks and using those to make high-risk gambles in the stock market.

The Federal Reserve forced the hand of Congress in 1999 to repeal the Glass-Steagall Act by approving the merger of Travelers and Citicorp – creating the mega bank Citigroup that flaunted the law. (The editor of Wall Street On Parade, Pam Martens, then managing the life savings of moms and pops, could barely contain her outrage when she testified at the New York Fed against the merger on June 26, 1998. See video below.)

The New York Times, which has remained curiously silent over the past few months as the New York Fed has thrown trillions of dollars at a Wall Street problem it has yet to credibly explain, did not remain silent about the repeal of the Glass-Steagall Act. Instead of responsibly joining the public interest groups that warned of the dangers, the New York Times became a major cheerleader for the repeal, using its editorial page as a lobbying platform.

A 1988 Times editorial read: “Few economic historians now find the logic behind Glass-Steagall persuasive.” In 1990 the Times editorial board downplayed the idea that “banks and stocks were a dangerous mixture,” writing that separating commercial banking from Wall Street trading firms “makes little sense now.”

On April 8, 1998, the editorial board of the New York Times again waved its pom poms for a bank merger that would end up devastating Wall Street and the U.S. economy. The Times wrote:

“Congress dithers, so John Reed of Citicorp and Sanford Weill of Travelers Group grandly propose to modernize financial markets on their own. They have announced a $70 billion merger — the biggest in history — that would create the largest financial services company in the world, worth more than $140 billion… In one stroke, Mr. Reed and Mr. Weill will have temporarily demolished the increasingly unnecessary walls built during the Depression to separate commercial banks from investment banks and insurance companies.”

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