Tuesday, July 21, 2015

Bait and switch with the Fed

Readers familiar with me know me to be a progressive. I wasn't always that way. I grew up in a conservative Republican family. I loved Reagan, but felt he wasn't enough to really change the system. By chance I went to an event sponsored by the Libertarian party as a young adult.

It was there that I was introduced to the "Patriot Movement", the entrance to a long lost weekend that I will never forget. I learned more about how government functions during that time than I ever did in school. Not because of the Libertarian Party or the Patriot Movement. It was because I took the time to write more than 300 requests for documents pursuant to freedom of information acts at state and federal levels (see FOIA).

As a member of the Patriot Movement in good standing, I learned about the history of the Federal Reserve. I read The Secrets of the Federal Reserve, by Eustace Mullins. I found websites parroting the same lines about how Congress passed the Federal Reserve Act in 1913, two days before Christmas while no one noticed. I believed the line that the Fed is a private bank and that the money making power was given to private hands that year. I also believed that the Fed loaned money to our government at interest.

What I didn't know at the time, that is, what I know now, is that the Fed actually pays more than $80 billion a year to the US Treasury in interest each year. The Fed is making money for the US government. And while it is true that the money making power has been given to the Fed, that money making power has been delegated to private banks.

Banks in the United States and around the world have the privilege of creating money with every loan that they make. They are allowed to engage in fractional reserve banking. Investopedia's definition of fractional reserve banking is as follows:
A banking system in which only a fraction of bank deposits are backed by actual cash-on-hand and are available for withdrawal. This is done to expand the economy by freeing up capital that can be loaned out to other parties. Most countries operate under this type of system.
When we hear in the news that the Fed is raising the reserve requirements for banks, they are trying to ensure that the banks don't fail when the loans go bad. The financial crisis we saw in 2008 was a result of many more loans going bad than going well. Investors who put up the capital to make those loans possible were at risk of losing their money. The banks were still on the hook for investor money, but they could pass the buck to the person who took out the loan in the first place. Fortunately for the biggest investors, the government bailed them out.

Here's the kicker: most of the loans that failed in 2008 were created using fractional reserve banking. In general, banks only need to maintain about 10% reserves to outstanding loans. Thus, banks are collecting interest on money they didn't really have - they just created it.

This is why I rolled my eyes when Congress passed yet another law that made it nearly impossible to discharge a student loan in bankruptcy. The bank enjoys numerous protections for those loans. The loans are guaranteed by the government, so even if students default, they're still backed by the government's guarantee.

Second, the bank is loaning money it created out nothing. Once that money goes into circulation, there's not getting it back. It becomes real and goes from the school that received the funds to the employees who work for the school and then back out into the general economy.

When conservatives complain about inflation, they usually point to the Fed and to the Federal government. They complain that the Fed is creating too much money and that creates inflation. What I find interesting is that the finger is being pointed at the wrong banks. The Fed doesn't create all that much money compared to the private banks. Every home loan, every car loan, every student loan, even commercial loans - they are all created by private banks using their own reserves as a basis.

That is what I mean by bait and switch. While most of us are looking at the Fed, we're missing most of the action with the private banks. The private banks get to decide if the economy should grow or not with their lending power. The private banks are not accountable to voters. They are corporations and act as if they are people, with political contributions that promote self-dealing rather than the public interest.

This is why I'm a proponent of public banking. Public banking is where the bank is owned by the government. The bank makes loans to citizens for the public interest, not the private interest. Public banks are boring. They invest in things like infrastructure, education and farms. We have one in the United States that has been around for more than 90 years: The Bank of North Dakota (BND).

The Bank of North Dakota was created for the purpose of insulating local farmers from predatory lending practices outside of the state, particularly, New York. The BND receives money from the state as deposits for the reserves. The deposits are from taxes and fees collected by the state that are in turn used to finance the operations of the state. The BND pays the interest earned back to the the treasury.

During the financial crisis, the state of North Dakota was the only state reporting a budget surplus. The BND did not contribute to inflation despite its work. In fact, the BND kept the local economy humming along despite misery in the rest of the country.

Now contrast this with the ridiculous fees earned by investment banks for CALPERS for terrible performance. Public retirement funds go to the private banks for investment guidance so that their funds can keep up with or surpass inflation. What they get is poor performance relative to a public bank.

Public banks are risk averse where private banks are not. Public banks are accountable to the public where private banks are not. Private banks serve private interests. Public banks serve the public interest. All of these characteristics are well documented at the Public Banking Institute.

If you've ever wondered why we're thrust through a boom and bust cycle every generation, ask your private bank. If you would like to see and end to the boom and bust cycle, consider agitating for a public bank. You might just get one.
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