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How the Federal Reserve Rules the World (part I)

I originally wrote this in 2009 as I reeled from the aftermath of the '08 crisis and grew tired of rehashing it's causes with my friends and colleagues. I figure if ever there was a place where this piece should be posted its the DP so here it is...

What is the Federal Reserve?

The common misconception is that the Federal Reserve is a government entity, it is not. It is a corporation created by the Federal Government. Just like any privately owned corporation the Federal Reserve has a board of directors and share holders. The Federal Reserve Act requires any bank that conducts interstate trade to send a portion of the deposits they hold to their regional Federal Reserve Bank; in return for those deposits the Bank receives shares in the Federal Reserve Corporation and voting rights. Essentially this means that if you deposit $1,000 dollars in the bank, the bank is then required to send $50.00 to the Federal Reserve.

The idea behind this is to prevent Bank Runs, or a situation where a bank cannot meet the amount of withdrawals requested by its customers because it does not have immediate access to the money (because they’ve invested it). The Fed can then lend them money temporarily until the bank can liquidate (sell) their holdings and return the money to the Fed and its customers. This is where the term “Lender of last resort” comes from. The Federal Reserve act also empowers the Fed to distribute new currency after the Secretary of the Treasury authorizes it’s being printed. Any profits the Federal Reserve makes as a result of performing these duties are then supposed to be returned to the Treasury.

Which Banks own the Federal Reserve?

When the Federal Reserve System was created there were laws in place limiting the size to which a bank could grow, this was done by limiting the percentage of national deposits a bank could hold. The Federal Reserve was given the responsibility of analyzing and approving bank mergers so as not to allow one bank or one banking cartel from gaining control over our financial system. In November of 1999 after heavy financial industry lobbying the Glass-Steagall act was repealed. What followed immediately thereafter was the massive consolidation of banks into the gigantic conglomerates we have with us today.

Presently nine US banks control more than 50% of the deposits held by all US banks. With those deposits comes the control of more than 50% of the voting shares in the Federal Reserve System. Essentially these nine banks now control the body designed to regulate them. The nine banks are Citigroup, JP Morgan Chase, Bank of America, Wachovia, Wells Fargo, HSBC, US Bancorp, and Bank of New York Mellon Corp.

How did the Fed cause the “Financial Crisis of 2007-2009”?

This is a highly debatable topic and so it is doubtful that you’ll find a consensus on the cause. To be fair there were many contributing factors from ratings companies issuing incorrect assessments of investment risk, to government interference in mortgage issuance, to investment firms leveraging themselves to an unfathomable degree (borrowing 1000 dollars to invest for every one dollar they had in assets). Essentially though, you can trace the root of the catastrophe to the Federal Reserve’s decision in 2004 to increase the overnight rate from 1% to 4.25 % over the course of 18 months.

The overnight interest rate is the Federal Reserve’s main tool for controlling the economy. Simply put it is the interest rate that the Fed charges for an overnight loan to another banking institution. Banks that are members of the Federal Reserve System then charge the same interest for short term lending to each other. This single interest rate adjustment eventually trickles down through almost every kind of financial activity that exists.

Here is an overly simplified example of how this works in practice. Bank of America borrows money at 1% interest. In order to make a profit with that money Bank of America needs to invest it in something that will generated more than a 1% return, for example mortgages. Bank of America can lend a customer $300,000 at 5% interest and make a 4% profit on that loan. If the rate at which Bank of America borrows money increases to say 4% then they in turn need to charge their customers 8% on a mortgage in order to maintain the same level of profit. Since it’s harder to afford an 8% loan payment, less people borrow, fewer mortgages are issued, the demand for new homes drops, and accordingly the price of homes decline. This same scenario plays itself out in all areas of our economy.

When the Fed increased the overnight rate they essentially made it harder for Banks to earn a profit through lending. This triggered the downward spiral that led to the default of hundreds of Banks in the US, and globally. Businesses that had become dependent on readily accessible and affordable debt were forced out of business and as a result millions of American jobs were lost. The average American was affected in the three ways that matter most, their homes value declined, their investments value declined, and many lost their jobs. With this destruction of wealth came the destruction of our ability to purchase goods and services or decreased demand. This meant that responsible businesses that hadn’t depended on affordable debt to survive were now in jeopardy of going bankrupt.

How was the Financial Crisis “Fixed”?

Many believe that the Federal Government’s stimulus packages such as TARP halted the spiral and averted the collapse of the Global economy. This is simply a misrepresentation of the truth by the Media. In fact the Federal government’s role in both the creation of the crisis, and its resolution is dwarfed in comparison to that of the Federal Reserve.

The Federal reserve’s response to the crisis consisted of the following actions:

1) They lowered the overnight interest rate to 0% making it essentially free for Banks to lend money, making it easier for them to make a profit and cover their losses.

2) They facilitated further consolidation of the Banking industry by orchestrating some of the largest mergers (at huge discounts for the purchaser) in American history. For example Bank of America purchasing Country Wide and Merrill Lynch, and JP Morgan’s purchases of Bear Sterns and Washington Mutual.

3) They guaranteed more than 11 trillion dollars of debt for their member banks and some of the largest corporations in America, for example GE who had more than 300 billion dollars of its debt guaranteed by the Fed.

4) They approved the conversion of non-banks into bank holding companies so that those corporations would have access to Fed lending and the federal governments TARP program, for example GE, and American Express.

5) They allocated 2 trillion dollars to purchase United States Treasuries, effectively making it cheaper for the Federal government to borrow money to give to the banks.

In total the Federal Governments stimulus packages totaled less than 2 trillion dollars, while the Federal Reserve’s response totaled more than 13 trillion dollars. The affect of all of this lending was to dramatically re-inflate the economy allowing the financial industry to make record profits and resume lending to American and International businesses. Ironically the solution to the financial crisis is effectively the same as the initial cause of the financial crisis, setting us up for the very same results in the future.

Let’s review

The Federal Reserve System was created to foster stability in the financial system. Over a period of 30 years the laws governing the financial system were changed to allow nine banks to gain control of the financial system and the Federal Reserve. These nine banks proceeded to borrow $1000 dollars for every dollar they had in assets. The Federal Reserve then triggered the financial crisis by raising the overnight interest rate and helped the same nine banks become even bigger through 13 trillion of dollars of lending which allowed them to buy their larger competition and eliminate hundreds of smaller banks. In order to fix the economic crisis caused by inflation and debt, they inflated our currency more and created more debt. They have no accountability to Congress or the President and will not tell us anything about their operations yet control our economy.

This scenario may seem familiar because it is largely what happened during the great depression. Amazingly in both cases the biggest bank in the country, JP Morgan profited massively off of the economic collapse emerging bigger stronger and with less competition each time.

What have we learned from history?

Following the Great Depression the Federal Government instituted a host of reforms to protect the American economy from future financial collapse. The Glass Steagall Act was passed creating the FDIC, savings and loan banks were separated from investment banks to eliminate conflicts of interest. Regulations were imposed regarding how much cash a bank must keep in reserve and to what degree they could borrow against their assets. The SEC was created to prosecute illegal trades in the market place. These systems were all effectively dismantled over the course of the last 30 years in response to heavy lobbying by the financial industry.

Current reform proposals include giving the Federal Reserve more power to regulate the derivatives markets and grants the FED the power of Systemic risk regulator. Allowing them to step in and take over any business that poses a systemic risk to the financial system, be it an insurance company, bank or private investment firm. It amounts to giving the Federal Reserve even more power than it already has. Never in the history of the United States has so much power been consolidated in the hands of so few.

What would real reform look like?

To end the boom bust cycle several things must take place, most of which simply requires the enforcement of existing laws.

• Antitrust laws must be enforced to disassemble the banking oligarchy that controls our economy. This is the only way that sanity and competition will return to the financial markets.

• Glass-Steagall should be reinstated immediately. Repealing the Glass-Stegall act was a short sighted folly pushed upon us by financial industry lobbyists. It needs to be reinstated to ensure that the conflicts arising from having both an investment bank and a savings and loan bank under the control of the same entity, all the while being back stopped by the FDIC, no longer exist.

• The Federal Reserve System should be abolished or at the very least audited and severely limited in power. Presently the FED has almost no accountability to our government and is controlled by banks whose interests are International, not American!

• Ultimately the Fiat dollar needs to be replaced:A serious dialogue should be undertaken for how to back the currency of the United States of America. No nation in the history of the world has ever survived using a fiat currency. If we don’t fix the dollar the world will find a replacement, and indeed our trading partners are increasingly turning to China and Russia to do so.

Additional Reading:

Alan Grayson questions the Inspector General about the FED’s 13 trillion in lending.

http://www.youtube.com/watch?v=PXlxBeAvsB8

RonPaul.com Audit the Federal Reserve

http://www.ronpaul.com/on-the-issues/audit-the-federal-reser...

Did Bill Clinton Cause the Financial Crisis?

http://voices.washingtonpost.com/ezra-klein/2009/05/did_bill...

The Glass Steagall Act

http://en.wikipedia.org/wiki/Glass-Steagall_Act

Life after Alan Greenspan

http://money.cnn.com/2006/01/26/news/economy/fed_preview/ind...

JP Morgan Acts to Buy Ailing Bear Sterns at Huge Discount

http://www.nytimes.com/2008/03/16/business/16cnd-bear.html

Is Obama’s Financial-Reform Plan Bold Enough?

http://www.time.com/time/business/article/0,8599,1905314,00....

Fed Signals No Rush to Curtail Stimulus as Slump Ends

http://www.bloomerg.com/apps/news?pid=20601068&sid=ae.3n4bOsQYc

Fed Refuses to Disclose Recipients of $2 Trillion

http://www.bloomberg.com/apps/news?pid=20601087&sid=apx7XNLn...

Fiat Money

http://en.wikipedia.org/wiki/Fiat_money

HR 1207 “Audit the Federal Reserve”

http://www.govtrack.us/congress/bill.xpd?bill=h111-1207