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Dr. Kalinda Rose Stevenson
Governments Are Buying Banks : Will They Ever Let Them Go?
Welcome back!
In response to the global credit crisis, governments are buying ownership in banks. Often, we don’t recognize significant moments when they happen. We don’t see the events that change things forever. But the economic events of the last few days are a clear sign of enormous systemic changes that are underway around the world.
For weeks, we have heard about the proposed “$700 billion bailout” for banks passed by the United States Congress. On Monday, October 13, European governments topped that amount with a plan to invest $2.3 trillion into European banks.
European governments overcame their differences to put $2.3 trillion on the line Monday in guarantees and other emergency measures to save the banking system in their most unified response yet to the global financial crisis. “Europe puts $2.3 trillion on line for banks”
http://www.msnbc.msn.com/id/27137551/
Today, Tuesday, October 14, the United States government announced that it will buy shares in the largest banks.
The government put itself four-square into the country’s banking business Tuesday, resorting to what President Bush conceded was the unwelcome choice of massive government investments in the banking system in order to loosen paralyzed channels of credit.
The president said the decision to buy shares in the nation’s leading banks – a kind of federal intervention not seen since the Depression era – was “not intended to take over the free market but to preserve it.” “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
From a long term perspective, these actions to nationalize banks, both in the United States and Europe, raise several issues.
First, is this a temporary response to a global crisis or are we witnessing a fundamental change in the relationship between governments and banks?
In both Europe and the United States, governments are stressing that the actions are temporary.
The government said its stake in each of the banks is strictly temporary, but the subsequent transformation of the sector is on the massive scale of the postwar bank nationalizations in the 1940s and the privatization of the industry in 1980s. “Europe puts $2.3 trillion on line for banks” http://www.msnbc.msn.com/id/27137551/
Under the new multifaceted stabilization program described Tuesday, the government will initially buy stocks in major banks. When financial markets stabilize and recover, the banks are expected to buy the stock back from the government, Bush said in brief remarks from the White House Rose Garden. “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
However urgent the crisis, and however necessary this response, temporary solutions, made under crisis conditions, have a way of becoming permanent. Under crisis conditions, people and their leaders will agree to conditions that they would reject under non-crisis conditions.
Said Treasury Secretary Henry Paulson: “We regret having to take these actions. Today’s actions are not what we ever wanted to do – but today’s actions are what we must do to restore confidence to our financial system.” “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
History shows all too often that when governments receive temporary powers under crisis conditions, they are often not willing to surrender those powers when the time of crisis has passed. This plan does not make clear how the government will get out of the banking business after the time of crisis has passed.
It’s far from clear what the government’s exit strategy will be. The history of financial panics shows that they are rarely resolved in a single moment by a single measure. The loss of confidence that underlies the current panic took years to develop; it will be months at least before some measure of confidence is restored. “Massive bailout won’t work overnight” http://www.msnbc.msn.com/id/27181364/
Another notable issue is that the United States government will buy these bank shares with part of the $700 billion bailout fund that was supposed to buy up bad mortgage debt. In other words, however urgent and however necessary this action to buy bank shares, the government is already veering away from the stated purpose of the $700 billion bailout. This means that the bill that was passed with enormous conflict and drama is already being modified by actions without the approval of Congress.
The administration plans to spend $250 billion this year on the stock purchases and the president certified Tuesday that another $100 billion would be needed in connection with covering bad assets. That would leave $350 billion of the $700 billion program, presumably to be spent by the next president.
The action represents a remarkable turnaround for a rescue program that was already the largest bailout in U.S. history. As the plan sped through Congress, the administration said the money was needed to purchase bad mortgage-related assets that are weighing on the books of financial institutions, never mentioning direct stock purchases. “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
A final issue concerns Bob Hope’s observation:
“A bank is a place that will lend you money if you can prove that you don’t need it.”
The government is following a similar strategy. The banks that don’t need the money are the ones that will get the government’s money. The United States government is going to appropriate half of the money appropriated for the $700 billion bailout to buy shares in banks that are stable.
Nine major banks will participate initially, including all of the country’s largest institutions. The first bank to take advantage of the new program was Bank of New York Mellon which announced Tuesday that it would sell $3 billion in preferred shares to the Treasury.
Some of the nation’s largest banks had to be pressured by to participate by Paulson, who wanted healthy institutions that did not necessarily need capital from the government to go first as a way of removing any stigma that might be associated with banks getting bailouts. “Administration unveils revamped bank bailout”
http://www.msnbc.msn.com/id/27161138/
These are perilous times and government leaders around the world are in full crisis mode. Each day brings more proposals, more challenges, and more fear, as leaders around the world make decisions that are intended to prevent a global economic collapse.
There is an old proverb—reputed to be an ancient Chinese curse—that says:
”May you live in interesting times.”
We are certainly living in interesting times. No one knows what the remade economic system will be like when this current time of crisis is over. What is clear is that banking will never be the same, whether the banks are owned by governments, held privately, or some combination of the two. We are witnessing the end of an era of economic growth fueled by uncontrolled debt owed to banks.
Dr. Kalinda Rose Stevenson
For more on how economic growth is fueled by debt created by banks, see Chapter 9 of No Money Limits For Real Estate Investors
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When Banks Go Broke
The heart of the economic crisis right now is that the banks are unwilling to make loans. Even though governments are pouring money into the banking system, the banks are hanging onto the money.
The rescue program originally was sold to Congress and the public as a plan to buy mortgage-related loans from financial institutions. The goal was to remove troubled assets from those institutions’ books and inspire them to restart more normal lending operations.
Congress passed the massive and hard-fought legislation, and Bush signed it. The government raised the amount of bank deposits it insured. Billions of dollars of reserves have gone into banking systems in the U.S. and other countries. Yet credit, the economy’s lifeblood, has remained virtually frozen. “IMF warns of global financial meltdown” http://www.msnbc.msn.com/id/27129830/
Why are the banks so unwilling to lend? The heart of the current economic crisis is that banks are going broke. This is very different from the Monopoly Game, which is the most popular board game in the world. In Monopoly, a bank cannot go broke. In Monopoly, if the bank runs out of money, the banker can make more money by the simple act of writing an amount on a piece of paper.
But the global economy is not Monopoly. Banks around the world are going broke and being bought up by other banks. Banks are also being bought by governments, in an effort to stabilize the economic system that cannot function without banks.
Banks are in the middle of the economic system because they control the flow of money between creditors and debtors. At the same time, banks are also creditors and debtors themselves.
The economic system includes several types of banks, including central banks, national banks, commercial banks, and thrifts. These different types of banks have charters to serve different functions within the economic system, but the essential point is that the flow of money is controlled by banks.
The critical point is that the current economic crisis is not a money crisis. It is a credit crisis. Banks are cutting or canceling credit limits for home equity lines of credit. Banks are reducing credit card limits. Banks are extremely reluctant to make real estate mortgages.
But there is more to the credit freeze than the effect on consumers. The real crisis is the credit freeze for the banks themselves. This is a brief introduction to borrowing within the banking system, from No Money Limits For Real Estate Investors.
In the United States, the Fed is the central bank, which controls the amount of money in the economic system. The Fed is a shadowy institution, formerly called the Federal Reserve. The Fed is a strange hybrid of private banks with federal authority, but not really under government control. It operates mostly out of sight, to keep the money flowing between the extremely rich, the financial markets, the banks, and the consumers, all the while responding to political pressures, both nationally and internationally, and demands by the extremely rich to increase their wealth even more. It holds its meetings in private, making decisions that affect the economic well-being of all of us.The Fed has the power to increase or decrease the amount of money available in the economic system. They can do this by raising and lowering interest rates.
……When the Fed wants to increase the money in the money supply, it lowers the interest rates the commercial banks pay for borrowing money. When it wants to decrease the amount of money, it raises interest rates the commercial banks must pay. When there is too much money, the Fed begins to increase interest rates. This shrinks the amount of money in the system, and the shrinkage continues down to the amount of money available for you to borrow for your mortgage.
….
Let’s say that the Fed pumps a billion dollars into the economy through the commercial banks. The commercial banks do what banks do. They loan out that money. By the time the commercial banks get through loaning the billion dollars, the commercial banks have created more money. Let’s say, five billion. And the commercial banks loan out the five billion to the “thrifts,” which are the savings banks, savings and loan banks, corporate banks, and credit unions. The thrifts take those five billion dollars and make loans, creating who knows how many more billion dollars. Chapter 9, “How Banks Use Debt To Create Money,” No Money Limits For Real Estate Investors.
The fact is, the banks don’t trust each other. Recent events have demonstrated how much the banking industry as a whole has thrown much of its traditional bankerly caution to the wind, not only providing credit that has mired millions of consumers in debt, but also plunged banks into massive debt.
For instance, Lehman Brothers failed because it carried a debt ratio of 35:1.
To keep profits growing, Lehman borrowed huge sums relative to its size. Its debts were about 35 times its capital, far higher than its peer group’s ratio. And it plunged heavily into real estate ventures that cratered.
Here’s how leverage works in reverse. When things go well, as they did until last year, Lehman is immensely profitable. If you borrow 35 times your capital and those investments rise only 1%, you’ve made 35% on your money. If, however, things move against you – as they did with Lehman – a 1% or 2% drop in the value of your assets puts your future in doubt. “How Financial Madness Overtook Wall Street”
http://www.time.com/time/business/article/0,8599,1842123-3,00.html
The banks that have failed have been debtors that could not repay their debts. This is why banks are so reluctant to make any loans. The credit squeeze is not primarily about you and me. It is about banks being unwilling to loan to other banks.
The actions being taken by governments around the world are an effort to stabilize the banks and induce the banks to start lending to other banks, as well as consumers.
The International Monetary Fund warned Saturday that debt-ridden banks were pushing the global financial system to the brink of meltdown and rich nations had so far failed to restore confidence. “IMF warns of global financial meltdown ” http://www.msnbc.msn.com/id/27129830/
The critical point is that the first priority of the IMF is to restore confidence in the banks about other banks.
Seized-up credit markets began to see the first small signs of easing Friday, but anxiety over the long-term prospects for recovery is keeping lenders mostly sidelined.
The overnight interbank lending rate, known as Libor, fell by half, suggesting that banks are becoming more willing to lend to each other in the very near term. The longer-term 3-month rate, however, continued to rise, hitting its highest level this year.
When banks show a willingness to lend to each other, it makes it easier for consumers and business to obtain loans. The financial crisis that caused Wall Street to buckle has spread around the globe, pushing panicky investors to sell stocks and sit on their capital.
“There is still an awful lot of fear driving this market and a preference to hoard cash rather than lend it out because you don’t know if you will get it back,” said Kim Rupert, fixed income analyst at Action Economics. “Credit freeze sees small cracks”
http://money.cnn.com/2008/10/10/markets/bondcenter/credit_markets/index.htm?postversion=2008101017
What we have seen so far is that the ”rescue” efforts by governments have involved pouring massive amounts of money into a banking system that is hoarding the money, from lack of confidence in the banking system itself.
Finance leaders from the world’s top economies, the Group of Seven, pledged Friday night to take steps to keep leading institutions afloat, unfreeze credit, ensure banks have enough capital to kick start lending and safeguard depositors’ funds and restart the secondary markets for mortgages and other securitized assets. “Global response” http://money.cnn.com/2008/10/11/news/economy/bush_group_of_seven/index.htm?postversion=2008101114
This credit crisis is by no means resolved, but already we see the direction that resolution will take—more government ownership of banks.
Bush did not mention any specific action that prompted his call. But Ireland recently moved to guarantee all bank deposits, triggering similar actions in Germany and other countries concerned that nervous depositors would move their bank accounts to Ireland.
The president barely referenced a significant new step from his administration – partial nationalization of some banks. After days of speculation this move was coming, Treasury Secretary Henry Paulson announced late Friday night that the government would buy part ownership in an array of American banks. “IMF warns of global financial meltdown” http://www.msnbc.msn.com/id/27129830/
So, at this point, it seems that the “bailout” or “rescue” plan, intended to buy mortgages, will be used to buy the banks themselves.
Dr. Kalinda Rose Stevenson
Find out more about the essential role of banks in the creation of money in No Money Limits For Real Estate Investors: Discover The Money-Making Secret In The Real Estate Game That Transforms Your Money Struggles Into Financial Abundance.
Award Winner of National Best Books 2007 Awards
Business: Real Estate Category
And Finalist in Business: Personal Finance Category
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The Credit Crisis Of 2008: Fear and Panic When The Banks Stop Lending Money
The world is in economic crisis. So far, nothing has stopped the crisis from spreading. It started with subprime mortgages, and has grown into a hydra-headed monster that is creating fear around the world as banks cut off credit.
“With global stock markets continuing their sickening plunge and the credit system all but shut down, efforts by the Federal Reserve, Treasury and global leaders have been overwhelmed by global panic.
The wide-ranging, unprecedented actions to cure the illness may yet prove effective. But until the fever breaks, fear has the upper hand.”
John Schoen, “Fear trumps efforts to solve crisis” http://www.msnbc.msn.com/id/27119159/
In the time of crisis everyone wants to know why. Why did this happen? Who caused it? Was it greed on Wall Street? Lack of regulation that let investment banks get away with shoddy lending practices? Too much regulation that forced banks to lend money to deadbeats? You will hear many explanations, along with many accusations. But the most basic reason has to do with lack of trust in the value of money. This is why every effort to fix the problem increases fear.
When trust in money dies, economic systems go broke, fortunes are destroyed, retirement portfolios are decimated, stock markets fall, and even banks go broke.
What happens when people are afraid that they will not get the full value of their money? They tend to hoard money. People who lost money when banks collapsed in the Great Depression hid their money under their mattresses.
In a very real sense, the banks are also hiding their money under mattresses. This is the real cause of the economic crisis. We don’t have a lack of money. We have a lack of credit. Credit and debt are two sides of the same coin. The banks won’t loan money on credit, which has dried up the amount of money available to borrow.
The following is an excerpt from my book, No Money Limits For Real Estate Investors, in which I use the Monopoly Game as a way to talk about the nature of money.
Now imagine what would happen if every one suddenly became debt free. The entire economic system would collapse. The lifeblood of the economy is borrowed money. Governments depend on borrowed money. Businesses depend on borrowed money. Consumers depend on borrowed money. And with borrowed money, investors can create more money. Debt is the mechanism that has allowed substantial numbers of real estate investors to make fortunes in the real estate market, especially in recent years.
Monopoly teaches a fundamental misunderstanding of the role of debt in our economic system. The Monopoly winner and the Bank continue to take money out of circulation, until there is not enough left for the game to continue.
If the handful of extremely rich people did what the Monopoly winner does, which is to gather almost all of the money in circulation and hang onto it, the result would be the collapse of our economic system.
Chapter 9, No Money Limits For Real Estate Investors
The bankers are unwilling to loan money because they don’t trust that they will be paid back. Considering that the banks have lost billions of dollars, the lack of trust is justified. The banks have made so many bad loans—extended credit to buyers who could not repay the loans-that the banks are awash with bad debts. Some of the largest banks have even collapsed because they had so much bad debt.
So what was the remedy that was supposed to resolve the credit crisis? The $700 bailout for the banks. The expectation behind the bailout was that the government would relieve the banks of the staggering burden of bad debts so that that the banks would have enough trust to start to offer credit again. But so far, the banks are still unwilling to offer credit. Instead, the banks are tightening credit lines and reducing credit limits.
The result is that credit is not flowing freely. Everyone who depends on borrowed money is being squeezed. When credit stops flowing, the money supply shrinks. The cascading effect puts the entire global economy at risk because the whole house of cards depends upon borrowed money.
As the system of credit dries up, the more fear is created, and the more banks and other institutions will treat credit as something to hide under the mattress.
“Right now it’s a measure of trust between the banks,” said James Reed, a money manager at the UMB Scout Stock Fund. “It’s continuing to move up, and that shows less and less trust in the system. That’s what you have to restore, is trust. That’s when you know you have a bottom, and that’s when the (credit) markets finally loosen up a little bit. ”
With so little trust among bankers, the Treasury may ultimately have to move to guarantee all lending between banks. That would help reduce the risk of lending again and help unfreeze the system. John Schoen, “Fear trumps efforts to solve crisis” http://www.msnbc.msn.com/id/27119159/
Every effort to restore the economy is primarily an effort to restore trust in a system that has violated trust. This is the challenge and this is the opportunity. The challenge is to recognize that there is no shortage of money. Money is created by trust and destroyed by lack of trust. We have a shortage of trust that results in a shortage of money.
In 1933, during the economic crisis of the Great Depression, Franklin Delano Roosevelt began his inaugural address with these words about fear.
I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our people impel. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our country today. This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself-nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. In every dark hour of our national life a leadership of frankness and vigor has met with that understanding and support of the people themselves which is essential to victory. I am convinced that you will again give that support to leadership in these critical days. “Only Thing We Have to Fear Is Fear Itself”: FDR’s First Inaugural Address. http://historymatters.gmu.edu/d/5057/
I’ll end by the way I began, by repeating the words of John Schoen.
The wide-ranging, unprecedented actions to cure the illness may yet prove effective. But until the fever breaks, fear has the upper hand.
John Schoen, “Fear trumps efforts to solve crisis” http://www.msnbc.msn.com/id/27119159/
Dr. Kalinda Rose Stevenson
Discover the true nature of money as a belief in value in
Award Winner, National Best Books 2007 Awards
Business: Real Estate Category
And Finalist Business: Personal Finance Category
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