Lawson for Congress

When I started this campaign last November, the national debt was tipping the scales at $9.3 trillion. Today it is over $10.1 trillion.

To add insult to this obvious injury, our Senate and then House just passed a juiced-up bailout package that includes an additional $150 billion of random acts of fiscal irresponsibility beyond the $700 billion revolving credit line to be used by our Treasury to buy questionable assets from troubled banks.

The vast majority of Americans were against this bailout, and for good reason — it is not going to work. Economists and those who understand the banking system understand that the administration’s plan will not fix the underlying problems of trust and solvency. Instead, it simply allows our Treasury secretary to pay above-market prices for troubled assets to bailout out foreign and domestic banks. It creates no jobs, gives no significant relief to struggling homeowners, and severely threatens our sovereign credit rating.

Why, then, did Congress commit this act of gross negligence? Why did our incumbent vote twice to support a measure that is ineffective, unconstitutional, and overwhelmingly despised?

He, and they, just followed orders.

I happened to be in Washington this past Wedensday, and was attending a breakfast with a number of other “conservatives” (whatever that means). Among the people at this breakfast were fresh-faced twentysomething staffers playing the power game, including staffers from the White House as well as various political campaigns and think tanks. These staffers know nothing about economics or banking, yet they are sent on a mission to amplify the administration’s message. In particular, they each stood up to address the group and said that the bailout plan was “as good as it was going to get,” and that everyone needed to get behind it for the “good of the country.”

Of course, attempts to engage in discussion were futile — the staffers don’t know the topic, they’re just carrying a message.

Keep in mind that our twenty-year incumbent also voted for this bailout — twice. Yet despite his expressed disagreements with this administration, he continually takes orders from them on critical issues like the bailout and our declining civil liberties.

What conclusion can we draw from these troubling events? We do not live in a Constitutional Republic. At this point, we do not even live in a totalitarian democracy, as the overwhelming majority of constituents were vehemently opposed to this trillion-dollar boondoggle. At best, we are living in a mild form of corporate socialism with a ruling oligarchy that is completely unresponsive to the people.

So where does this leave us?

We’re in a tough spot, and Friday’s economic data left little to the imagination. We had our ninth straight month of job losses, and further corporate consolidations and layoff announcements show further challenges ahead.

Our challenges don’t end in Washington, either. States like California and New York are approaching insolvency, to the point that California is asking for a $7 billion rescue package from the federal government so they can make payroll. More locally, I had the opportunity to interview our North Carolina auditor, Les Merritt, to discuss our state’s situation:

If you live in North Carolina, pay attention to this interview — especially Auditor Merritt’s warnings about so-called “COPs”, or Certificates of Participation. It seems that our state legislators have figured out how to violate our state Constitution by using a means of debt financing for pet projects that avoids the hassle of getting voter approval.

COPs are troubling, as our state Constitution in North Carolina requires that all debt (such as general obligation bonds) be specifically approved by voter referendum. How have they done this? Like our federal representatives, they apparently just don’t care. Unfortunately, things are about to get rough as we continue to live beyond our means in North Carolina, as well as the United States. It’s up to us to remind our representatives at every level how important it is that they follow the rules.

Finally, I’d like to make one more observation about this “new and improved” bailout that was railroaded through the Senate and then passed back through the House. Not only were there $150 billion in new enticements, but CNET is reporting that the bailout bill expands and makes permanent IRS surveillance capabilities, as well:

IRS undercover operations: Privacy invasion?
The bailout bill also gives the Internal Revenue Service new authority to conduct undercover operations. It would immunize the IRS from a passel of federal laws, including permitting IRS agents to run businesses for an extended sting operation, to open their own personal bank accounts with U.S. tax dollars, and so on. (Think IRS agents posing as accountants or tax preparers and saying, “I’m not sure if that deduction is entirely legal, but it’ll save you $1,000. Want to take it?”) That section had expired as of January 1, 2008, and would now be renewed.

Starting with the so-called Anti-Drug Abuse Act in 1988, the IRS has possessed this authority temporarily, with occasional multiple-year lapses. A 1999 internal report said the IRS had 126 “trained undercover agents” working in field offices at the time. This is the first time that such undercover authority would be made permanent.

Sens. Max Baucus (D) and Chuck Grassley (R) have been pushing to make it permanent for a while, claiming (PDF) in April that: “Undercover operations are an integral part of IRS efforts to detect and prove noncompliance. The temporary status of this provision creates uncertainty, as the IRS plans its undercover efforts from year to year.”

There’s another section of the bailout bill worth noting. It lets the IRS give information from individual tax returns to any federal law enforcement agency investigating suspected “terrorist” activity, which can, in turn, share it with local and state police. Intelligence agencies such as the CIA and the National Security Agency can also receive that information.

The information that can be shared includes “a taxpayer’s identity, the nature, source, or amount of his income, payments, receipts, deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax withheld, deficiencies, overassessments, or tax payments, whether the taxpayer’s return was, is being, or will be examined or subject to other investigation or processing, or any other data received by, recorded by, prepared by, furnished to, or collected by the Secretary with respect to a return.”

That provision had already existed in federal law and automatically expired on January 1, 2008.

What’s a little odd is that there’s been little to no discussion of the IRS sections of the bailout bill, even though they raise privacy concerns. Treasury Secretary Henry Paulson said this week: “I will continue to work with congressional leaders to find a way forward to pass a comprehensive plan to stabilize our financial system and protect the American people by limiting the prospects of further deterioration in our economy.” He never mentioned the necessity of additional IRS undercover operations.

Last week was a historic, but bad, week for our nation. It’s time to Be the Change, vote Lawson for Congress, and insist on principled representation in Washington.

I corresponded with many voters regarding the bailout package yesterday. Here is my typical response, with some points to consider:

Those folks who are just interested in rising asset prices (CNBC talking heads and stock newsletter writers) generally like the plan, which those who are concerned with the foundation of the banking and economic system don’t like it.

The Paulson plan might deal with “liquidity”, but liquidity *isn’t* the problem. The problems are trust and solvency. There are a number of feasible options to deal with the fundamental issues — trust (among banking institutions) and solvency (of banking institutions).

Responsible plans focus specifically on recapitalizing viable banks instead of just allowing banks to offload questionable assets. But before you can even recapitalize a viable bank, you need to “drain the swamp” and figure out exactly what’s on the balance sheet — that’s key to restoring trust.

I’ve detailed/summarized these points, and more responsible approaches, here:

http://blog.lawsonforcongress.com/2008/09/27/the-height-of-arrogance/

What should also be concerning is the *way* in which this legislation was put forth — complete subversion of the typical legislative process, although they wasted over a week from initial proposal to vote:

http://blog.lawsonforcongress.com/2008/09/28/a-bipartisan-drama-resuscitating-a-dying-republic/

Also, the conflicts of interest present in the current administration are staggering:

http://www.nakedcapitalism.com/2008/09/mussolini-style-corporatism-in-action.html

The media chorus in favor of the bailout continues to grow. Interestingly enough, much of the chorus is international. This makes sense when you understand that Paulson’s legislation encourages us to bail out foreign investors, and foreign banks as well:

European Central Bank President Jean- Claude Trichet said U.S. lawmakers must pass a $700 billion rescue package for banks to shore up confidence in the global financial system.

“It has to go, for the sake of the U.S. and for the sake of global finance,” Trichet said in an interview in Frankfurt with Bloomberg Television late yesterday. “I am confident, but of course it is the decision of the U.S. Congress.”

Trichet said a pan-European approach to the banking crisis was unlikely, saying “we are not a fully-fledged federation with a federal budget.”

“Each country has to mobilize its own efforts,” said Trichet. “But of course there is a European spirit and that is the spirit of the single market.”

This point was hammered home by California Rep. Brad Sherman in an interview with Larry Kudlow, as documented by Mike Shedlock:

Rep. Brad Sherman, D California:

Larry I am glad you have a few seconds to talk to someone who voted against this bill. I am not changing my mind. I want to thank my colleagues who stood up to the purveyors of panic and voted against a very bad bill and voted with 400 eminent economists including three Nobel laureates who wrote to us and said don’t panic, don’t act hastily, hold hearings, work carefully. The fact is Larry if you read this bill, even you would have voted against it.

It provides hundreds of billions of dollars of bailouts to foreign investors. It provides no real control of Paulson’s power. There is a critique board but not really a board that can step in and change what he does. It’s a $700 billion program run by a part-time temporary employee and there is no limit on million dollar a month salaries.

Larry Kudlow:

Let me just ask you one question. I think you are referring to foreign banks headquartered in the United States. I do not see how foreign investors get bailed out.

Rep. Brad Sherman:

Larry you have to read the bill. It’s very clear. The Bank of Shanghai can transfer all of its toxic assets to the Bank of Shanghai of Los Angeles which can then sell them the next day to the Treasury. I had a provision to say if it wasn’t owned by an American entity even a subsidiary, but at least an entity in the US, the Treasury can’t buy it. It was rejected.

The bill is very clear. Assets now held in China and London can be sold to US entities on Monday and then sold to the Treasury on Tuesday. Paulson has made it clear he will recommend a veto of any bill that contained a clear provision that said if Americans did not own the asset on September 20th that it can’t be sold to the Treasury.

Hundreds of billions of dollars are going to bail out foreign investors. They know it, they demanded it and the bill has been carefully written to make sure that can happen.

We don’t just need to “do something” here, folks. We need to do something that will work.

First, Rep. Marcy Kaptur, Democrat from Ohio:

Next, Rep. Michael Burgess, Republican from Texas:

The rule of law and process of good government are taking a beating this weekend.

I’ve reviewed the “Discussion Draft” of bailout legislation, available here.

Any Representatives or Senators feeling pressured to accept this power grab by our Treasury and Federal Reserve need to understand that they are negotiating with terrorists. It was my recollection that we do not negotiate with terrorists.

Again, what should we do?

First, we should embrace every effort to restore transparency, trust, and the rule of law to our capital markets.

But we must also remember that we are at a critical inflection point, and the banking institutions hold all the cards. Bernanke and Paulson are predicting terrible things if we do not bail out the banks at our expense. Their predictions are well on their way to becoming self-fulfilling prophecy, since the banks ultimately control access to credit.

Many have documented why the bailout plan is unlikely to work as proposed. It is time for principled leaders in Congress to go on offense. So Paulson wants $700 billion to buy toxic assets, “restore confidence”, and get banks lending again?

Why not just round up to $1 trillion, but issue it in United States Notes directly from the Treasury, instead of Federal Reserve Notes?

What’s a United States Note? That’s debt-free currency printed by our Treasury that carries the same legal tender status as the private debt money issued by the Federal Reserve. Except our government doesn’t need to borrow from foreign lenders or the Federal Reserve to put it into circulation. We’d just create it, and exchange this debt-free paper money for the banks’ toxic assets.

Sound odd? It’s not unprecedented — check out how Lincoln funded the Civil War when foreign lenders were only offering financing at usurious interest rates. That’s how U.S. Notes were born, at which time they were given the popular name “greenbacks”. They circulated alongside Federal Reserve Notes from 1913 until 1971.

It’s basically a way to be “helpful” and go along with what the Fed and Treasury are suggesting, but make them play by our rules. In other words, “Sure, we’ll give you the money you’re asking for, but we’re absolutely not going to pay you interest for the privilege of bailing you out.”

Put it this way — having Congress empower the Treasury to issue our nation’s own fiat currency is more Constitutional than delegating the issuance of our currency to a private central bank where all money is created through the people and our government(s) taking on debt.

We’ve used public money to preserve the union before, maybe it’s time to try again.

I think Dennis Kucinich (D-OH) would agree:

Key quote:

“Why aren’t we helping homeowners directly with their debt burden? Why aren’t we helping American families faced with bankruptcy. Why aren’t we reducing debt for Main Street instead of Wall Street? Isn’t it time for fundamental change in our debt-based monetary system, so we can free ourselves from the manipulation of the Federal Reserve and the banks?“

The proposed $700 million bailout is unlikely to increase trust between banks, will threaten our sovereign credit rating, and may even collapse our currency.

It only attempts to protect favored banks, and ignores the reality that trillions of dollars in bad debt must be liquidated before we can recover from this crisis. For every lender there is a borrower, and our borrowers have simply assumed too much debt relative to their income.

Objections from a variety of perspectives are expressed by others:

• Dallas Federal Reserve Governor Richard Fisher - Bank Rescue Plan Would Worsen Fiscal Chasm
• Former Treasury Secretary Paul O’Neill - Bush Doesn’t Get Financial Crisis
• Former FDIC Chair William Isaac - A Better Way to Aid Banks
• BB&T CEO John Allison - Paulson Plan Aimed at Helping “Poorly Run” Banks
• NYU economist Nouriel Roubini - Why the Treasury TARP Bailout is flawed
• New IMF Study Contradicts Bailout Bill Premise and Details
• Over 150 economists - Hundreds of Economists Urge Congress Not to Rush on Rescue Plan

Of particular interest are comments in the last article about the game theory implications of vastly increased central bank lending as well as expectations of a bailout. In short, we’re making the problem worse:

Advocates for a rescue plan this week point to a seizing up of credit markets, reflected in elevated inter-bank lending rates, as reason for action. Some economists are unconvinced.

“I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

Makes sense, doesn’t it? As also stated by Yves Smith:

Now consider the bailout version of this problem. Yes, the market for bad bank assets wasn’t so hot, but the big reason is not lack of buyers, but unwillingness of banks to accept the lousy realistic prices on offer.

But the government is now moving towards a plan to buy that paper for something closer, maybe a heck of a lot closer, to your price. You now have no incentive to try to unload those assets, so what little trading there was in them has probably gone into a deep freeze.

In other words, “We need a bailout, or else lending is going to freeze up and the financial system is going to collapse” becomes “We expect a bailout, so we’re going to just sit here until we get one.” It’s a self-fulfilling prophecy. Depending on your level of cynicism, one might also consider it a hostage crisis with our economy as the hostage.

Most importantly, also at stake is trust in our nation’s financial system and capital markets. Karl Denninger eloquently makes that point here:

The government cannot simply keep changing the rules to benefit a privileged few.

Focusing on the banks, the current crisis has four related ingredients: liquidity, solvency, capital, and trust. There is plenty of central bank liquidity available for threatened institutions, and due to lack of trust and transparency, banks will not lend to each other — each prefers to go to the central bank for relief. This tendency to look to the central bank for relief appears to be finally threatening the balance sheet at the Fed itself, according to Brad Setser:

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.

For another look at the Fed’s balance sheet, see this visual map provided by Cumberland Advisers.

Solvency is a problem as threatened institutions are finding it difficult to access additional financing and service their debt. Capital is a problem because creative accounting and assets of unknown value have led to balance sheets (and off-balance-sheet vehicles) that encouraged wishful thinking and reduced trust.

The administration’s proposal to buy toxic assets doesn’t address all of these problems, may make solvency issues worse, and most importantly, it does not address the lack of trust between market participants:

Non-financial private debt is $32.4 trillion dollars as of 2Q 2008. Household debt is $14.0 trillion. Households lost 400 billion dollars last quarter. You wish to add $700 billion more in losses (via government obligations that taxpayers must cover) this quarter; this package is insignificant against the total bad credit outstanding. Federal capacity to “bail the system out” is insufficient.

It will not and cannot work because the issue is trust, not money. There is lots of money (and credit) but it is being hoarded throughout the system. Consumer savings have gone from nothing to the highest rate ever in American history – in the space of a few months. Money is flying into Treasuries because of lack of trust, not lack of money. You must fix the cause of the problem, not apply band-aids.

Despite all this evidence to the contrary, this evening’s New York Times article shows to what lengths our elected representatives will go to do the wrong thing. Allow me to translate:

Officials said there were still more than a dozen points of disagreement, though the centerpiece of the rescue effort remained intact: a plan for the government to purchase up to $700 billion in troubled assets from financial firms as a way to free their balance sheets of bad debts and to help restore a healthy flow of credit through the economy. It could become the largest government bailout in the nation’s history.

We’ve been pretending to object to the administration’s plan, and we’re making a lot of noise, but we’re not really changing anything. We’re still going to pistol-whip the American taxpayer to bail out poorly-run banks, and we hope credit starts flowing again even though this bailout does nothing to support property markets, improve the ability of borrowers to service their debt, or increase trust in the integrity of the capital markets. But hey, we’re all about hope.

Republicans, under pressure from Democrats to deliver 70 to 100 votes from their side, were scouring the ranks and focusing on the two dozen Republicans who were retiring this year.

Both parties were also scouring the political map to identify lawmakers who face little or no opposition for re-election in November, knowing they would be more willing to vote yes.

We’re looking for representatives who can afford to blow off their constituents.

Democratic officials said that despite having control of both chambers in Congress, they were far from having a majority sufficient to pass the measure just from their ranks. And they also warned that Democrats in potentially tough races could not be counted on to provide the votes to put the package over the top when, and if, it reaches the floor.

If David Price ends up voting against this bailout, it will be because he’s getting the message that 4th District voters are ready for principled representation that serves the people instead of corporate interests.

The ultimate cost of the rescue plan to taxpayers is virtually impossible to know. Because the government would be buying assets of value — potentially worth much more than the government will pay for them — there is even a chance the rescue effort would eventually return a profit.

We’re calling it a “rescue plan” because folks don’t like the word “bailout”. There’s no chance this rescue will return a profit, since banks are only going to dump the most toxic of their assets — they’ll hold on to the good stuff. Furthermore, if there was a reasonable chance of a profitable investment, Warren Buffett would be all over the deal himself.

The administration had initially requested nearly unfettered authority to run the rescue program. But in negotiations over the last week, the White House agreed to accept strict oversight of the program by an independent board, as well as a requirement that the government increase its efforts to prevent home foreclosures.

We’ll give the impression of resisting tyranny with empty gestures of “oversight” and some empty pandering about bailing out borrowers. But we allocated the big money to bail out lenders.

I should mention that I tried to visit David Price’s Chapel Hill office on Thursday to express my sentiments as a constituent, not even as a candidate. But when I arrived, the office was closed:

I received word from folks calling his Durham office that there was no one available to answer the phone, and no way to leave a message.

The behavior of so-called Congressional leaders, our deeply-conflicted administration, and my opponent demonstrate supreme arrogance and disrespect for the rule of law.

Washington, you’re fired.

The terrorists we must fight are not crouched in caves thousands of miles away.

The terrorists we must fight are threatening us with financial weapons of mass destruction that are destroying our economic system.

As described by Warren Buffet in his 2003 letter to Berkshire Hathaway shareholders, the financial industry has created new types of derivatives that he described as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

As summarized in this BBC article:

Contracts devised by ‘madmen’

“Derivatives generate reported earnings that are often wildly overstated and based on estimates whose inaccuracy may not be exposed for many years” - Warren Buffett

“Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers … which can trigger serious systemic problems.” - Warren Buffett

Derivatives are financial instruments that allow investors to speculate on the future price of, for example, commodities or shares - without buying the underlying investment

Derivates like futures, options and swaps were developed to allow investors hedge risks in financial markets - in effect buy insurance against market movements -, but have quickly become a means of investment in their own right.

Outstanding derivatives contracts - excluding those traded on exchanges such as the International Petroleum Exchange - are worth close to $85 trillion, according to the International Swaps and Derivatives Association.

Some derivatives contracts, Mr Buffett says, appear to have been devised by “madmen”.

He warns that derivatives can push companies onto a “spiral that can lead to a corporate meltdown”, like the demise of the notorious hedge fund Long-Term Capital Management in 1998.

Does any of this sound familiar? It should. We’re living it.

How is Congress reacting to this clear and present danger, which is sitting right across the table from them as it testifies in Washington?

They’re ignorant and scared:

WASHINGTON — It was a room full of people who rarely hold their tongues. But as the Fed chairman, Ben S. Bernanke, laid out the potentially devastating ramifications of the financial crisis before congressional leaders on Thursday night, there was a stunned silence at first.

Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped,” said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

How did we get into this situation? This is the endgame for an inherently unstable system that has been forever destined to fail. As I noted in a previous post:

If asked to pick one word to describe why I’m running for Congress, that word is sustainability. Sustainability doesn’t mean stability, it doesn’t mean safety, and it doesn’t mean protection from life’s inevitable uncertainties. Sustainability does mean recognizing and obeying the natural laws that govern of our world.

Every branch of science has certain laws: Objects in motion tend to stay in motion; force equals mass times acceleration; every action has an equal and opposite reaction; energy in a closed system cannot be created or destroyed but merely changed in form; and closed systems tend towards increased entropy are a few good examples.

These laws of motion and conservation of energy are not limited to high school physics class. Every system in nature must obey these underlying principles — including our financial and monetary systems.

Let’s start with Newton’s laws of motion — it’s a short hop from there to defining leverage as the ability to move a large object a short distance using a small force exerted over a long distance. Leverage is a concept in finance, as well — using borrowed money to increase returns based upon small underlying price movements. Just as the car lifted with a hydraulic jack can hurt you if it falls, a small price movement in an imprudently leveraged investment can wipe out a lifetime of savings.

Next consider conservation of energy and open versus closed systems. Since energy within a closed system cannot be created or destroyed, and since closed systems tend towards increasing entropy, every growing system must be open to an external energy source. In this setting, one can immediately see problems with our debt-based monetary system.

What is debt-based monetary system? It’s where money is debt, and every dollar in circulation exists because a bank created it out of nothing based upon someone’s promise to pay it back, with interest.

Our economy is an open system relative to money, which is created and destroyed by banks. Banks create the money through loans — but they only create the amount you borrow. They don’t create the interest that you also promise to repay. Where do you get the interest? You have to earn it, but first it has to be created — yes, by someone else borrowing more money that they promise to repay with still more interest.

In the end, our monetary system is like a game of musical chairs — the banks create money based upon someone’s willingness to borrow, and the bank’s ability to lend. The constant demand for new money to repay interest on existing money compels growth and new money creation at an accelerating rate.

Refer to the chart of America’s total debt, which raises obvious questions about sustainability. Trees do not grow to the sky — and when banks cannot lend, or people are no longer willing to borrow, the music stops. When the music stops, there are more loans outstanding than money to repay, so everyone left standing loses whatever they pledged in exchange for their loans. Even worse, money that was created out of nothing through borrowing just as easily disappears back into nothing as asset values plummet — so when the music stops, the chairs start disappearing from the room.

Leverage, debt-based money, fractional reserve banking, and interest are fundamental features of our economic system. Our economic history of boom/bust cycles and decisions dominated by short-term gain as opposed to long-term stewardship are fundamental consequences of this underlying system. In short, our system has undesirable consequences and is fundamentally unstable — but it’s working as designed.

Interestingly, now we have the terrorists who created and detonated these weapons holding us hostage. They’re asking us for more power, and to punish us with more debt, only to further enable the corrupt system to which we are hopelessly enslaved in the first place.

In other words, they’ve thrown a massive brick through the window, and are asking us to assume a crippling debt so that we can hire and pay them to “fix” it:

As noted by many, including Kentucky Senator Jim Bunning and Texas Representative Ron Paul, the Federal Reserve and the banking system that controls it are the cause of our systemic risk. Even the Federal Reserve’s own Harvey Rosenblum emphasizes that the Federal Reserve’s job is to create moral hazard, which enables systemic risk:

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Of course, it’s a bit disingenuous to say that the Fed’s job is to “cushion the blow” when the Fed threw the brick that caused the economic shock.

Gary Larson’s classic Far Side cartoon says it all. The Federal Reserve has heaved a gigantic brick through the window of our nation’s economy. Jobs are getting scarce, retirement savings and housing values are declining, and basic necessities are less affordable. Using the current crisis as an opportunity to further empower the Federal Reserve at the expense of the people is not the answer.

We need to restart past conversations, and restore a Constitutional money and banking system that removes moral hazard from the equation entirely. We cannot allow a private monopoly to create money out of nothing to loan to us at interest. The Federal Reserve is welcome to compete in a free market, but accepting private debt-based currency should not be compulsory — it should be voluntary, and other forms of money that facilitate trade and local economic growth should be welcomed.

Alan Greenspan noted that our money system is not a free market — the power over our money is centralized in the hands of the Federal Reserve. That fact, along with the Federal Reserve’s support for the inherently unstable process of fractional reserve banking,  create the bricks that break our windows.

Our founders intended for our money and banking system to be democratized. Our ability to create wealth in our communities is one of our unalienable individual rights. The government is only authorized to establish a level playing field with accurate “weights and measures.” In particular, Congress was given the authority to coin money, and regulate its value — it is not authorized to delegate monopoly authority over our money to a private central bank.

Since 1913, however, our money comes from a monopoly run for the benefit of private banks. The banks have the power to create money through debt, and the people and our governments thus accumulate debt instead of wealth.

So what is Congress going to do? Let’s continue reading about their negotiations with the terrorists:

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”

Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.

“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”

As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky …” he said as his voice trailed off. “Well, I’ll leave it at that.”

Folks, we’re in trouble. When Republicans and Democrats are both ignorant and scared, we do horrible things.

Don’t believe me? Turn off Faux News and read Roubini. Read Denninger. Read Shedlock. This is not a drill, and our elected representatives need to hear our anger at this unprecedented hostage crisis.

In this setting of ignorance and fear, a proposed “fix” is being circulated that will authorize our government to go further into debt to buy toxic debt from failing banks. Note that the “fix” will not work — it will simply push the system further out of equilibrium. Karl Denninger succinctly dissects it here. Key quote:

The claim is that this is intended to “promote confidence and stability” in the financial markets.

It will do no such thing.

It will instead strike terror into the hearts of investors worldwide who hold any sort of paper, whether it be preferred stock, common stock or debt, in any financial entity that happens to be domiciled in the United States, never mind the potential impact on Treasury yields and the United States sovereign credit rating.

What should Congress do? Follow the Constitution: eliminate the money monopoly that is crippling our country. As I noted here:

Return our money to the people, for starters. Do people want to exchange and transact in gold and silver? Great. Do people want to do business in private local currencies that build self-sufficient communities? Great. Affirm that all barter transactions between individuals are tax-free, and let individuals build wealth by helping each other.

Eliminate fractional reserve banking, eliminate legal tender laws, and eliminate our private money monopoly. Our government can use its sovereign power to create currency that is not based upon debt, and based upon how responsibly our government creates that currency, people can choose to accept it or discount it appropriately.

This idea is not new, it’s in fact how we originally grew into a prosperous nation — colonial scrip. Scrip is fine for domestic trade, and specie or other commodities can be used for international trade. Competition between different money systems keeps people honest, and elimination of fractional reserve banking and fraudulent “deposit insurance” keeps banks honest.

Relentlessly seeking another hit of debt will not cure our unsustainable addiction. The poison is not the cure.

It’s time to look around and reassess our national priorities. Republican, Democrat, Libertarian, Constitution, Green, Unaffiliated, Catholic, Protestant, Jewish, Muslim, Hindu, Atheist, Straight, Gay… none of these labels matter. We are all on the same boat. When the boat hits the iceberg, we all sink or swim together.

It’s time to get off the treadmill of a collapsing debt-based currency and empower local economic growth through an honest, Constitutional money system that will strengthen communities by empowering local producers of real goods and services.

Here’s the bottom line: we may or may not be able to prevent a a misguided bailout. Ultimately, however, self-sufficient communities are the only lasting antidote to the current crisis. There is one thing that Congress could do to provide a safety net that would empower individuals to build self-sufficient communities:

Congress must unambiguously affirm that all voluntary barter transactions between individuals are tax-free.

What do I mean by “barter transactions”? They may be transactions exchanging time for time, time for goods, goods for goods, time for dollars or private barter currencies (paper or specie), or goods for dollars or private barter currencies. The key point is that human individuals (not corporations or other creatures of the legal system) need to be free to create wealth in their communities.

Again, If the banks get bailed out, the people need to be bailed out. People must again have the ability to serve each other as individuals to recreate the wealth that is being destroyed all around us.

It’s time to focus on hometown security, instead of homeland security.

This has been a historic week in our financial services industry, and markets. Last night I was joined by David Williams, a financial planner and long-time student of the markets, to discuss the current turmoil and the root causes behind them.

This episode will air as Taking the Pulse, but we wanted to make it available immediately as this situation continues to unfold.

Finally, tonight, as we sail towards economic catastrophe, a glimmer of hope. Honesty:

The U.S. Congress is unlikely to pass new legislation to overhaul financial regulations this year because “no one knows what to do,” Senate Majority Leader Harry Reid said today.

Well, that’s not exactly true. Ron Paul knows what to do. Michael Shedlock knows what to do. But at least we’re finally at the place where Congress is ready to admit its relative ignorance.

Not only do they not know what to do, they don’t even know what the problem is.

First, it’s time to admit the real problem — fractional reserve banking (where banks lend out more money then they have on deposit for lending) and debt-based money (where money is created through loans that must be paid back with interest). These two ingredients are amphetamines for our economic system.

Read that again — amphetamines. Easy credit is a dangerous, addictive drug. Our economy becomes hooked on easy credit. When we first get access to cheap credit the economy accelerates, but eventually we develop a tolerance. Eventually we need more and more cheap credit to get the same stimulatory effect.

But since credit equals debt  (for every lender there is a borrower), more credit equals more debt. And since debt must be paid back with interest, as borrowers take on more debt, the burden of compound interest continues to grow.

In fact, you can think of interest payments as a one reason we develop “tolerance.” Cheap credit initially leads to economic stimulation, which fees good. But assuming more debt by creating more money causes more interest payments, thus increasing future costs.

Where do we get the money for additional interest payments? We need to create it through yet more borrowing. More of the new borrowing goes to pay interest, not to pay for real growth — so we need yet more borrowing.

Do you see the problem yet? It’s a system that is inherently unstable, and tends to grow exponentially as we seek bigger and bigger “hits” of credit to keep the growth machine humming. Until, finally, one of two things happen. If we can’t get a big enough hit, and credit starts to contract, we crash. Hard. Or we might be able to arrange just one more massive hit, which we hope will satisfy our craving, but which simply kills us.

This problem is ancient, yet our elected representatives are either ignorant or unwilling to learn.

At the showing of I.O.U.S.A. last month, we distributed the following handout:

We cannot borrow our way out of debt.
We cannot borrow our way to prosperity.
Collectively, we have borrowed so much that by 2016, the interest on our debts at 6% interest will be greater than the total consumer income.

Debt on this chart is defined as all U.S. debt (sum debt of federal and state & local governments, international, and private debt, including households, business and financial sector debts, and federal debt to trust funds).

Most people don’t understand the sinister nature of interest. Many understand they pay interest directly when making house, car and other installment plan payments. Very few, however, realize that is only a small part of the interest bill they pay. They don’t realize that most businesses have huge debts, and the interest on those debts is passed on to the consumer though higher prices. They don’t realize that the federal, state, county, city governments and school districts have huge debts, and that the interest on those debts is passed on to the consumer though higher taxes and fees.

“If all the bank loans were paid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture the tragic absurdity of our hopeless position is almost incredible, but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.”
- Robert Hemphill, Federal Reserve Bank of Atlanta.

The defect in our money system is that “The actual creation of money always involves the extension of credit by private commercial banks”  (Russell Munk, U.S. Treasury). Therefore, when banks create new money through new loans, there is no way to create the money needed to pay the interest charged on those extensions of credit.

As this debt and its accompanying interest grow, it is obvious that the consumer has less and less discretionary income, businesses have less profit, and more individuals, businesses, state and local governments will be forced into filing bankruptcy.

Sources:
http://www.wealthmoney.org/
http://mwhodges.home.att.net/

We are living through the unwinding of this system. The compensatory measures being proposed by Congressional leaders and presidential candidates to keep this system afloat are entirely insufficient, and will do nothing to remedy the system’s inherent injustice and instability.

What to do?

Return our money to the people, for starters. Do people want to exchange and transact in gold and silver? Great. Do people want to do business in private local currencies that build self-sufficient communities? Great. Affirm that all barter transactions between individuals are tax-free, and let individuals build wealth by helping each other.

Eliminate fractional reserve banking, eliminate legal tender laws, and eliminate our private money monopoly. Our government can use its sovereign power to create currency that is not based upon debt, and based upon how responsibly our government creates that currency, people can choose to accept it or discount it appropriately.

This idea is not new, it’s in fact how we originally grew into a prosperous nation — colonial scrip. Scrip is fine for domestic trade, and specie or other commodities can be used for international trade. Competition between different money systems keeps people honest, and elimination of fractional reserve banking and fraudulent “deposit insurance” keeps banks honest.

Relentlessly seeking another hit of debt will not cure our unsustainable addiction. The poison is not the cure.

It started last week with the Freddie and Fannie bailout, where our Treasury ignored our national interests and bailed out foreign central banks, PIMCO, and other sophisticated investors. What was wrong with this story? Most importantly, the Treasury offered public funds to guarantee debt that has never had any government guarantee, implicit or explicit:

Read the bold print on that prospectus. Should there be any confusion here? If homeowners start falling into default and not paying their mortgages, and the rate of default exceeds Fannie’s ability to make payments to its lenders, is there any reason to believe that the holders of those mortgages should expect our Treasury to make up the difference?

As Jim Rogers notes, in the wake of our Treasury volunteering our liability for Freddie and Fannie’s debt, we are perfecting the art of welfare for the rich:

While some well-meaning Americans attempt to rationalize this bailout as a “necessary evil,” the unintended consequences are beginning to reverberate. First, our government’s destruction of Freddie and Fannie’s preferred stockholders has closed the door on preferred stock for other at-risk organizations who might have wanted to use that route in attempts to raise capital. As Denninger noted:

If you’re a bank or other financial and need to issue (or have outstanding) preferred stock, you’ve got a problem - a serious problem.  The Federal Government just declared out loud that it will declare that stock essentially worthless any time they think there’s an accounting irregularity, and they will value things as they - not GAAP - sees fit.

Here’s what happened to you if you held just one of the many series of Fannie Mae preferred (the others are all essentially identical)

How about that - $13 to $2.50 in one fell swoop.

That’s an instantaneous 80% loss.

Now think about this from the perspective of, say, Lehman.  You have a capital problem.  You’d like to go out and issue some preferred stock - essentially a junior debt issue, where you pay interest in exchange for money, and perhaps its convertible into common stock at some point in the future.

However, you have a bunch of Level III assets, which might include mortgage bonds - not Agencies, but private-label stuff and commercial real-estate backed.

As a potential buyer of these securities, are you going to take this sort of risk?  Remember, Fannie and Freddie did not file bankruptcy; even in a bankruptcy, you’d likely get something as a preferred stockholder!

But in this case you got essentially nothing as a result of an (arguably) unlawful “taking” of your ownership interest in the firm!

My opinion?  This move just destroyed all preferred stock issues going forward for financials in the United States.

Paulson attempted to argue just the opposite in his press release:

Preferred stock investors should recognize that the GSEs are unlike any other financial institutions and consequently GSE preferred stocks are not a good proxy for financial institution preferred stock more broadly. By stabilizing the GSEs so they can better perform their mission, today’s action should accelerate stabilization in the housing market, ultimately benefiting financial institutions. The broader market for preferred stock issuance should continue to remain available for well-capitalized institutions.

Right. Well-capitalized institutions. That obviously doesn’t include Lehman, which is on the chopping block this weekend.

So now what?

Well, many observers believe that this unwinding of our banking and financial system is just getting started, with damaging consequences. Representatives from the New York Fed and major banks are working this weekend to orchestrate an orderly resolution for Lehman Brothers. Such meetings sound refined and sophisticated, although the situation is best described as a giant game of “chicken,” with our banking system hanging by a thread.

If Lehman fails suddenly, it is likely that its collapse would bring down its trading partners, as well. As Roubini notes:

If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.

The potential for a widespread meltdown has brought banks to the table, each eager to avoid a similar fate. However, while banks are collectively motivated by self-preservation, no one individually wants to pay scarce money for Lehman’s questionable assets. So the “chicken” comes in when the banks look (again) to the Treasury and U.S. taxpayer to guarantee their purchase, thus bailing out the system and allow the status quo to continue:

But suitors like Bank of America, worried about the risk of buying an ailing financial institution like Lehman, want the government to step in with a package similar to what was offered to J.P. Morgan when it bought Bear. Then, the federal government agreed to absorb as much as $29 billion in losses. In seeking a Lehman deal, Bank of America Chairman and Chief Executive Kenneth D. Lewis is likely to face a tough sell to investors if he doesn’t secure some federal government backing.

As of this evening, no deal has been reached. Of course, the goal will be to reach a definitive plan by Sunday evening, before Asian markets open. We wouldn’t want to upset the new owners.

What can Americans do about our current predicament?

The first thing we need to do is educate ourselves about how we arrived at this precipice. It’s taken us a long time to get to this point, but the pressures have been gradually building since our current money and banking system were established in 1913.

One must first understand the system itself: a debt-based money system combined with fractional reserve banking. Once one understands how the system works, it becomes clear that our entire economy rests on an unstable foundation — and that the turmoil we’re experiencing is not unexpected. In fact, the system is working exactly as designed. As was noted by Robert Hemphill of the Atlanta Federal Reserve Bank in 1936:

“If all the bank loans were paid, no one would have a bank deposit and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture the tragic absurdity of our hopeless position is almost incredible, but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.”
- Robert Hemphill, Federal Reserve Bank of Atlanta.

Our money and banking system is the antithesis of a “free market” — it is a private monopoly managed for the benefit of the banking system itself. Are you surprised that inflation has been attacking American families, and that even two jobs are often insufficient to pay for gas, groceries, healthcare, and save for retirement? Are you surprised that our goverment, in attempting to “help,” has taken on a $9.6 trillion national debt with over $50 trillion in long-term liabilities that we cannot afford?

Based upon understanding the system, we shouldn’t be. Again, it’s working exactly as designed — although it’s been pushed past the limits of sustainability, and is nearing tragic absurdity.

It’s time to change the system. Congress unconstitutionally delegated control of our money to the Federal Reserve, a private central bank, in 1913. Congress can, and must, return control of our money to the people.

Today’s New York Times has an Op-Ed piece by Roger Altman, formerly with Lehman Brorthers, Blackstone Group, and the U.S. Treasury, regarding the role of the Federal Reserve in the current financial crisis. This article deserves critical scrutiny by every American. Here are some key excerpts:

SMALL rallies notwithstanding, we are experiencing the most dangerous financial period since the 1930s. In the year since this crisis erupted, huge losses have threatened the solvency of our largest financial institutions. As a result, the Federal Reserve has been forced into increasingly difficult emergency actions, including the rescues of the investment firm Bear Stearns and the mortgage companies Fannie Mae and Freddie Mac, to prevent the entire system from collapsing.

Our entire regulatory system, conceived long ago for a different financial world, must be rebuilt. The next president will have no choice but to undertake this task next year.

The next president must first create a single framework for the major financial borrowers, administered by the Federal Reserve alone.

It usually takes a severe crisis to bring about systemic change. The upside to the punishing turmoil in our financial system is the growing probability that regulatory overhaul is at hand. And that’s good, because without it the Fed might be unable to save the system next time.

I agree with two of Mr. Altman’s key points: our current position is dangerous and unsustainable, and that the regulation of our monetary and financial system, based upon the Federal Reserve’s monopoly of our debt-based currency, must be rebuilt.

I disagree, however, with the assertion that we need to further centralize power in the Federal Reserve. As noted by many, including Kentucky Senator Jim Bunning and Texas Representative Ron Paul, the Federal Reserve and the banking system that controls it are the cause of our systemic risk. Even the Federal Reserve’s own Harvey Rosenblum emphasizes that the Federal Reserve’s job is to create moral hazard, which enables systemic risk:

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Of course, it’s a bit disingenuous to say that the Fed’s job is to “cushion the blow” when the Fed threw the brick that caused the economic shock.

Gary Larson’s classic Far Side cartoon says it all. The Federal Reserve has heaved a gigantic brick through the window of our nation’s economy. Jobs are getting scarce, retirement savings and housing values are declining, and basic necessities are less affordable. Using the current crisis as an opportunity to further empower the Federal Reserve at the expense of the people is not the answer.

We need to restart past conversations, and restore a Constitutional money and banking system that removes moral hazard from the equation entirely. We cannot allow a private monopoly to create money out of nothing to loan to us at interest. The Federal Reserve is welcome to compete in a free market, but accepting private debt-based currency should not be compulsory — it should be voluntary, and other forms of money that facilitate trade and local economic growth should be welcomed.

Alan Greenspan noted that our money system is not a free market — the power over our money is centralized in the hands of the Federal Reserve. That fact, along with the Federal Reserve’s support for the inherently unstable process of fractional reserve banking,  create the bricks that break our windows.

Our founders intended for our money and banking system to be democratized. Our ability to create wealth in our communities is one of our unalienable individual rights. The government is only authorized to establish a level playing field with accurate “weights and measures.” In particular, Congress was given the authority to coin money, and regulate its value — it is not authorized to delegate monopoly authority over our money to a private central bank.

Since 1913, however, our money comes from a monopoly run for the benefit of private banks. The banks have the power to create money through debt, and the people and our governments thus accumulate debt instead of wealth.

Please help us teach David Price the importance of debt-based versus asset-based money, and the importance of returning the power to create wealth to the people.

I just watched an instructive interview between CNBC’s Steve Liesman and Harvey Rosenblum, a 38-year Federal Reserve veteran who is currently Director of Research at the Dallas Fed. The entire interview is available here, but let’s start with a brief excerpt:

Liesman: One of the concerns out there right now is that actions by the Federal Reserve and the government will increase what we call “moral hazard.” What are your thoughts on that?

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Liesman then asks Rosenblum an interesting question:

Liesman: You’ve been at the Fed thirty eight years. Do you feel as if some of things being discussed and some of the things the Fed has had to do recently have stretched the Federal Reserve too far?

Rosenblum: No. I think it’s stretching the Federal Reserve in the direction that it needs to be stretched, and we just have to get the laws to catch up with where we ultimately have to be if we’re going to be a 21st century Fed deaing with 21st century financial markets. And if you’re going to be a lender of last resort, you have to have the tools to deal with the thing, and you need more regulatory power. Will regulation ever be perfect? Will it solve all the problems? Absolutely not. At best it will be one step behind the market, but even if you’re two steps behind the market, you’re doing pretty darn good.

There you have it. An insider’s description of a system that is perfectly designed to steal from the poor and middle class, to the benefit of those who control the supply of money and credit. Banks who control the supply of money and credit constantly engineer new ways to exploit the system for their benefit. Importantly, they can push the system past its limits knowing that profits will be privatized during the good times, while losses during crises will be socialized.

Cue my favorite banking video (long-time supporters will have seen this already, but it’s always worth reviewing):

Does it make sense to give the Federal Reserve more power, when in fact it is the cause of our systemic instability, and a key ingredient of an economic system that institutionalizes corporatism, poverty, and injustice?

Fortunately, more people in Washington such as Kentucky Senator Jim Bunning are realizing that the Federal Reserve is the problem instead of the solution:

Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed.

Indeed, the Federal Reserve has been scrambling over the past year to prevent a collapse of our banking and money system with a variety of “lending facilities” that let various players in the financial markets exchange assets of questionable values for Treasury debt at low interest rates, for an extended period of time. These lending facilities are the reason that the Fed itself is running out of Treasury debt — it’s lending Treasury debt so that banks don’t have to put a value on illiquid and difficult-to-value (read: questionable) assets. Does such a shell game, or a system that encourages it, make any sense at all?

Well, it might make sense, and money, for the banks. Take last week, for instance. Freddie Mac’s shares soared last Monday after a reportedly successful auction of $2 billion in new debt. One might ask who is buying Freddie’s bonds in the current environment — a recent Financial Times article reports that foreigners are scaling back their GSE holdings:

Bank of China this week revealed it had cut its portfolio of securities issued or guaranteed by the two government-sponsored enterprises by a quarter, or $4.6bn, since the end of June. The sale underscored signs of nervousness among foreign buyers of Fannie and Freddie’s debt.

Might domestic banks be picking up the slack? John Carney of Dealbreaker raises an intriguing possibility:

We don’t know who bought the Freddie notes today. But buyers of Freddie notes who have access to borrowing from the Federal Reserve would have found the decision to bid relatively easy. That’s because the ability to exchange the Freddie debt for Fed cash means banks can buy Freddie debt with a huge amount of leverage, dramatically increasing the return on their capital.

Here’s how it works. A bank that bought the six month notes from Freddie this morning could also bid to borrow from the Fed’s Term Facility, which held an $75 billion auction today. As collateral for the borrowing, the bank could offer the newly purchased Freddie notes, for which the Fed would give them credit for 97% of their market value. Recently, the TAF pricing topped out at 2.35 percent for 28-day borrowing. So a bank buying $100 million of Freddie paper yielding 2.858% could flip it to the Fed, borrowing $97 million at around 2.4% (assuming the pricing will be slightly higher this time around).

At the end of the day, a credit desk could buy $100 million of Freddie debt for just $3 million down. On that $3 million, the desk would receive a 17.7% annualized return, or 8.8% over six months, for paper that is thisclose to being explicitly backed by the Treasury Department. Not a bad deal at all.

Ah, the ingenuity of the markets.

Keep in mind that the same banks with access to these borrowing facilities charge usurious interest rates for credit cards, load up customers with penalties and fees, profit by creating money out of nothing to lend to the public with interest, and seize underlying assets when folks can’t pay.

Why can’t we all sign up for a taxpayer-financed carry trade? Thank you, Mr. Chairman: