Opinion: Is the Federal Reserve for real?

POSTED: 07/18/11 11:46 AM

By Emilio Kalmera

In his 2002 Berkshire Hathaway (NYSE: BK) letter to shareholders, company chairman and CEO Warren Buffett expressed his concern with derivatives, referring to them as “weapons of mass destruction.” One of my favorite quotes from Buffett is “It’s only when the tide goes out that you learn who’s been swimming naked.” Well the tide is going out and what are being discovered beneath is not looking too pretty.

Recently I read an article on yahoo finance written on July 13, 2011 entitled: “Bernanke: Fed May Launch New Round of Stimulus.” The beginning of the article goes on to say: Federal Reserve Chairman Ben Bernanke told Congress Wednesday that a new stimulus program is in the works that will entail additional asset purchases, the clearest indication yet that the central bank is contemplating another round of monetary easing. Bernanke said in prepared remarks that the economy is growing more slowly than expected, and should that continue the central bank stands at the ready with more accommodative measures.

“Once the temporary shocks that have been holding down economic activity pass, we expect to again see the effects of policy accommodation reflected in stronger economic activity and job creation…””

Now it does not take a rocket scientist to figure out that the last bail out did nothing to increase jobs or help the common American. The bail out money went into the coffers of banks that propped up their shady credit default swaps insurance deals and went into paying out bonuses and in some cases even the purchase of private jets. The real reason for the bail out will become a little clearer further in this article.

Clinton is responsible for repeal (cancellation) of the Glass-Steagall act a.k.a. the Banking Act of 1933 as the legislation was signed into law by him on November 12, 1999. The banking industry had been seeking the repeal of Glass–Steagall since at least the 1980s. The act prohibited commercial banks from engaging in investment banking activities, among other things. The act was passed in the time of deep depression to supposedly prevent future crisis. The meaning of the act was that bankers could not use money for investment purposes, only for commercial activities. When you go to a bank to get funds for a business, student loan, or a mortgage, the bank is doing a commercial activity. It is not an investment into your business, your education, or your house. However, when banks are allowed to do investments with the deposited monies, crazy things usually follow simply because greed doesn’t have limits. Greed was again manifested with the subprime (making loans to people who may have difficulty maintaining the repayment schedule) debacle. What happened was the banks gave mortgages with one hand and packed and sold American mortgages as investment derivatives called collateralized debt obligations (CDOs) or mortgage backed securities with another hand. On top of that the banks purchased credit default swaps insurance if the borrower goes into default for his mortgage) from each other and AIG against defaults of these same products. As a result, a huge bubble in real estate took off and obscene returns and bonuses for banksters due to the big commissions collected for selling the derivative products. With the repeal of Glass-Steagall, creditor banks can bet against their own debtors by using short sales (see: http://en.wikipedia.org/wiki/Short_sale_(real_estate)), putting them in position to profit more if the debtors go down then by trying to save them.  This is why financial literacy is so important and I think Obama is gravely lacking in this regard. He should have left the banks and insurance companies that caused the mess to fail and then have the Federal Deposit Insurance Corporation (FDIC) take them over and nationalized them.  Then he should have reenacted the Glass-Steagall act, make derivatives illegal, forbade short-selling, and gotten rid of the Federal Reserve (Fed) or make them really a Federal institution. The fact that these things were never done is why I question if Obama is really interested in any change.

There are big commissions on derivatives (a.k.a. structured products). But they were never stress-tested in a declining market (Stress testing is a form of testing that is used to determine the stability of a given system or entity. It involves testing beyond normal operational capacity, often to a breaking point, in order to observe the results). Greed seems to be the pure motivation for such “weapons of mass destruction” as well as the assumption that markets would continue rising.  The lenders were gambling that they could avoid liability by selling risky loans (Subprime) packed as investments to investors by also buying and selling credit default swaps, and the bond insurers were gambling that they would never have to payout claims. It is suggested that the real reason for the subprime bailout schemes by the U.S. Treasury Department was not to keep strapped borrowers in their homes but to prevent a spate of lawsuits against the banks by investors who purchased the mortgaged backed securities and credit default swaps. This suggestion makes so much sense because securitized mortgage debt was made so complex that is was very hard to trace who owned the underlying mortgages in a typical mortgage pool; and without a legal signatory (party) to the bond note, there was no one with standing (The legal right to initiate a lawsuit) to foreclose on the collateral. The pool lacked standing because it was nowhere stated in the documents that the title of the property will pass to. If large numbers of defaulting homeowners were to contest their foreclosures on the ground that the plaintiffs lacked standing to sue, trillions of dollars in mortgage-backed securities could be at risk. Very angry mortgaged backed security holders might then respond with litigation (lawsuits) that could well threaten the existence of the banking giants and the “all-important” insurers who did not have the money to pay up on potential claims. The bailout helps prevent owners of mortgage backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value which are many more times their market worth.

Unlike in the 1920s, the financial system is now precariously perched atop hundreds of trillions of dollars in derivatives dominoes, which will come crashing down when the gamblers try to cash in their bets. And since there are trillions in credit default swaps still out there and no real economic growth prospects for America in sight if they keep the status quo, I am urging the common man to prepare for the financial Armageddon.  Compromising truth and fundamentals to make the world comfortable for a few has always been a bad idea. When money is not used for the purpose for which it was intended then what should have given “life” ends up giving “death=debt”.

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