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When in Doubt, Blame the Asians

In a rush to explain the current economic conundrums facing the United States, an increasingly popular rationale is to shield policy makers and collectively blame Asia's huge rate of savings and large productive capacity.

For instance, former Treasury Secretary Henry Paulsonthinks that global trade imbalances with Asia pushed interest rates down and drove "investors towards riskier assets."

Brad Setser of the Council on Foreign Relations believesthat Americans borrowed too much and Asians saved and lent too much to Americans — that Asian money consequently flooded the US economy and drove down interest rates.

Michael Pettis, an American finance professor in China,suggests that China overproduces and underconsumes, an imbalance that ultimately recycled large amounts of savings back into the US housing and securities markets, creating an unsustainable bubble.

However, the main problem with the explanations provided by Paulson and the burgeoning establishment line is that none of the Asian countries sits on the Federal Reserve board, the prime instigator of this effervescent predicament. And as influential as the China or Japan lobbies are seen to be by many, neither country sets the federal-funds rate or conducts open-market operations.

Who's Who

Americans at the Federal Reserve alone are responsible for setting interest rates. And stoked in part by the financial specter of Mexico and other external phantoms beginning in July of 1995, Chairman Greenspan began a series of rollercoaster rate cuts — and temporary increases — culminating in a perversely low 1% rate in mid-2003. This, along with expanding the monetary base — provided by the Fed and coordinated with other central banks — arguably spurred speculative malinvestment globally in areas such as technology and, later, real estate.

Beginning in 2002, the Bush administration began a protracted campaign of deficit spending to fund wars and welfare. In addition, government-sponsored housing agencies (GSEs), including Fannie Mae, Freddie Mac, Ginnie Mae, and the FHLBs, enacted a series of loose-lending standards — in part to comply with the Community Reinvestment Act — and consequently guaranteed and accumulated trillions of dollars in what are now viewed as deleteriously risky mortgage-backed securities.

In establishment terms, these are the "known knowns."

Some other "knowns" that are undisputable: Americans ran the housing GSEs; Americans occupied the Bush administration; and, to the best of our knowledge, Alan Greenspan is an American. And while many of these decision makers may be immigrants, none of them was then simultaneously an executive member of the CCP, LDP, GNP, KMT, or PAP.Finger Pointing up the Chain of Command

The above exercise reveals those who are responsible for enacting particular legislation and executing specific policies.

At no point did Asian savers force Fannie Mae to reduce down payments on houses or reduce mortgage rates. At no point did Asian savers force American banks to allow consumers to use their home equity as ATM machines. At no point did Asian savers force the Bush administration to run deficits to pay for foreign wars and domestic welfare. At no point did Asian savers force government-sanctioned ratings agencies to rubber stamp risk assessments. And at no point did Asian savers force Alan Greenspan to lower interest rates.

Neither the US government nor its federally controlled housing agencies had to spend the money it received from Asia. In fact, they could have refused the money altogether. No means no, right?

In addition, the government could have paid off its obligations and maintained a balanced budget. Instead it spent it all and continued borrowing. As a consequence, it is pure balderdash to insinuate that the uptick in Asian savings somehow coerced the House Committee on Ways and Means to appropriate billions in extra liabilities. No one in Asia pointed chopsticks, bamboo, or a gun at Larry Summers, Paul O'Neall, Dennis Hastert, Bill Thomas or American consumers and told them to spend the money.

True enough, Asian countries produced relatively cheap goods that Americans wanted to buy, but it was the Federal Reserve alone that created the "cheap" money that was then lent to Americans who in turn bought products from China.

In fact, the only "hot" money in the global system was that created by the Federal Reserve. Every dollar that the Chinese and Japanese used to buy US Treasury bonds originated from the Federal Reserve. And as much as they would have liked to do it, no evidence has surfaced to suggest that China, Japan, South Korea, or any other Asian country was involved with counterfeiting money. That responsibility is left solely with the Federal Reserve's own printing press.

The Politically Incorrect Narrative

As illustrated by Robert Murphy, the most recent bubble began in 2001, when the Fed dramatically increased the money supply, temporarily making American banks and financial institutions artificially wealthier (i.e., they received funds first). These firms, in turn, lent to American consumers at extraordinarily low rates. Americans, believing they were rich, spent the money on products made in places such as Asia. Asians, for various reasons, saved more than they spent. And, looking to diversify and participate in the global economy, many Asians parked their earned savings in purportedly safe assets.It so happens that the US Treasury during this time was trying to fund large deficit spending and sold large amounts of bonds — which are dubiously rated AAA. Similarly, in an attempt to satisfy congressionally mandated universal homeownership goals, GSEs such as Fannie Mae loosened home-financing standards for millions of Americans and sought financing on the international credit markets — and also held a dubiously AAA-rated bond. As a consequence, a substantial portion of the Asian savings was used to purchase these seemingly safe bonds.

So to review, the "imbalance" did not start because of too much savings in Asia but rather because of a huge expansion of credit by the Federal Reserve and imprudent welfare handouts by the federal government.Stop Being So Productive

As noted above, professor Michael Pettis thinks China has a chronic problem with overproduction and he is right in one respect: American consumers purchased too much from China. He correctly notes that, around 1998, Americans stopped saving and "diverted a rising share of their income to consumption." Pettis then constructs a framework in which self-serving fiscal policies of China and America became self-reinforcing and ultimately led to unsustainable growth.

This phenomenon eventually peaked — in housing prices in 2006, in stock prices in 2007, in corporate-bonds prices in 2008, and arguably in sovereign-bond prices in 2009–10.

But instead of connecting the dots to the only institution capable of expanding the credit supply — the Federal Reserve — Pettis seeks a bilateral, politically crafted solution that does not involve the abolition (or even admonishment) of the Fed. This is the same Fed that did not see a housing bubble coming.

And by insisting that it was overzealous Manchurians concocting trade policies in smoke-filled rooms of the Forbidden City, American policy makers are setting up future generations for a monetary disaster.

Three years from now, the American political class will be begging for Asian savings, but it is unlikely that many Asians will be interested in coming to their rescue — in part because they were unfairly blamed for a phenomenon they did not create and in part because they see how the political class will spend their money.

By Tim Swanson

Tim Swanson is a graduate of Texas A&M University and currently lives in mainland China. Send him mail.

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In Praise of Bankruptcy

Article by Henry Thompson

In one word, the market approach to the financial problem is bankruptcy. Firms go bankrupt when they do not have enough revenue to pay their bills. Banks make money by borrowing from lenders at a low interest rate and lending to borrowers at a higher interest rate. If banks make bad loans and borrowers quit repaying, banks go bankrupt.

Insurance firms help people avoid risk, collecting premiums to pay those who suffer bad luck. If the premiums collected by an insurance firm are less than what it has to pay, it goes bankrupt. AIG sold insurance policies to stockholders that banks and other firms would not go bankrupt and could not pay the policies when that happened.

Bankruptcy is a normal part of economic life, covered by laws that guarantee stockholders will be compensated as much as possible. More efficient firms move in to take over what is left of bankrupt firms, buying what can be put to productive use. There is no crime in bankruptcy and, if handled quickly, little economic harm. When the largest US energy company Enron went bankrupt a few years ago, there was not even a ripple in the energy markets, much less the economy. Bankruptcy is not criminal and should not be a surprise, but it can be unnerving if large, well-known firms go bankrupt.

Banks and insurance firms are careful when lending or selling policies because they want to ensure their revenue will pay their bills. Government involvement, however, provides a cushion for failure and allows banks and insurance firms to be careless. This carelessness occurred with the government-sponsored mortgage bank, the Federal National Mortgage Association.

Fannie Mae provides backing to mortgage banks, more or less encouraging them to make bad loans. Fannie Mae makes subsidized loans to mortgage companies when they are short of cash. Freddie Mac is a government mortgage bank that sells mortgages without the usual worry of making a profit, given its taxpayer backing. The government has taken over these two losing mortgage banks, and losses will be paid by taxpayers.

The government provides subsidized mortgage insurance in case home buyers cannot pay. This insurance lets commercial mortgage banks relax and make loans to people who might not be able to pay. Government support for people wanting to buy a house elevated demand for houses and pushed up prices. Rising prices made home buyers confident they could buy a house they could not afford and sell it soon for a profit, counting on a "greater fool" to come along. Realistically, people should only buy a house when they plan to live in it and can actually pay for it. Greater fools do not always come along.

The result of government meddling in the mortgage market is that people have bought houses they cannot afford. When prices quit going up, people were left owing more on their house than it was worth in the market. With their subsidized mortgage insurance and little penalty, people defaulted on their mortgages. The mortgage banks are left without income. This mortgage mess is the root cause of the present financial crisis.

One part of the evolving financial bailout is the government using taxpayer money to help people who have not been able to pay their mortgage. The government is taxing those who have paid their mortgages and transferring the money to those who have not. It is not a good idea to reward inefficiency.

The government is also giving money to select financial and insurance firms, rewarding their poor performance with taxpayer money. Better advice is, "Don't throw good money after bad." The failed firms should go bankrupt.

Another part of the bailout plan is that the Treasury will actually buy houses with defaulted mortgages that the failing banks are holding — the overpriced mortgages that people quit paying. The Treasury has become a realty speculator, hoping to sell these overpriced houses sometime in the future for an even higher price. It is much more likely that taxpayers will pay the losses. The bailout money will purchase 6% of the houses in the United States — not such a large amount and only a very small part of the total real-estate market. The bailout money, as large as it is, will have little effect on the aggregate housing market.

As another part of the bailout, the Federal Reserve will make short-term loans to troubled banks and insurance companies to meet their payroll or other bills. The Fed's job is to make loans to banks and buy or sell bonds to control the money supply. Certainly the bankrupt firms will be first in line to borrow such short-term funds. These loans are likely to go unpaid and be written off at taxpayer expense. It is easy for the Fed to make loans since it is in charge of the money supply.

In the bailout, the Treasury also plans to buy a stake in the failed firms, using taxpayer money to become part owner of second-rate mortgage banks and insurance firms — your tax dollars at work.

The underlying goal of the financial bailout is not to keep the economy "healthy" but to keep a few Wall Street firms, mortgage banks, and insurance firms in business. Never mind that most mortgage and insurance firms in the country are profitable; the government wants to support the inefficient, large, high-profile firms. If these firms were allowed to go bankrupt, the economy would recover quickly. Other firms, not necessarily with an address on Wall Street, would step in and buy them out. Wall Street is much less important now than in the past, due to national and global financial competition.

Profit motives in business are clear, but governments have no profit motive and are able to collect taxes, print money, and borrow against future taxpayer money to pay their bills. Mortgage and other financial-market firms will wait to see what the government agencies do in the market and then generally do the opposite, playing against taxpayer money. The rules are changing with more government involvement, but competition will continue. The situation would be like the government making delivery of packages less than 5 pounds illegal except by the US Post Office.

The present financial problems would disappear quickly if the government let the markets operate and let inefficient firms go bankrupt. The irony is that the government is stepping in to solve the problems it created. The solution might "work," but the underlying disincentives in the mortgage and insurance markets will persist. Increased government meddling in the financial markets will only make the financial problems linger.

Americans blamed for crisis

BEIJING - CHINESE state media on Sunday lambasted reckless US consumers addicted to spending money they don't have for being partly to blame for the current financial crisis, suggesting such a thing couldn't happen in prudent China.

The official Xinhua news agency said in an opinion piece datelined from New York that Americans love spending 'tomorrow's money' on credit, preferring to 'eat the corn while it is still on the stalk", even if this spending is beyond their means.

'Many people think that you cannot delink the consumer concept of 'eating the corn while it is still on the stalk' and this financial crisis which has had a deep impact,' the commentary said.

'After the US financial storm spread around the world, some Americans are making self-criticisms and reflecting on their spending ideas and behaviour,' it said.

The report cited an American it said had been protesting on Wall Street against a US government bail-out plan as praising Chinese people for knowing how to live within their means.

'Most Chinese people know how to have a good life and are used to making their money go further,' it paraphrased the person as saying.

The piece also quoted an ethnically Chinese currency trader on Wall Street as saying China should learn the lessons of this crisis.

'Chinese people should see from the US financial crisis where the value lies in traditional spending concepts, or preparing for a rainy day,' it paraphrased the trader as saying.

'Only if people have a constant sense of crisis can they discover potential risks in time and overcome them,' the commentary added.

The Chinese government has insisted it is able to weather the economic storm, but is also trying to stimulate domestic consumption in the face of a slowing in the economies of its main export markets in the United States and Europe.

China has one of the highest savings rates in the world due to limited alternative investment options and a poor social security safety net.

While Chinese people, especially in cities, are increasingly able and willing to use credit cards and take out personal loans, many still have a cultural aversion to debt, or are simply too poor to qualify for bank loans or other forms of credit. -- REUTERS

Who is Behind the Financial Meltdown?

Market Manipulation and the Institutional Speculator

The market is heavily manipulated. The driving force behind the meltdown is speculative trade. The system of "private regulation" serves the interests of the speculators.

While most individual investors loose when the market falls, the institutional speculator makes money when there is a financial collapse.

In fact, triggering market collapse can be a very profitable undertaking.

There are indications that the Security Exchange Commission (SEC) regulators have created an environment which supports speculative transactions.

There are several instruments including futures, options, index funds, derivative securities, etc. used to make money when the stock market crumbles.

The more it falls, the greater the gains.

Those who make it fall are also speculating on its decline.

With foreknowledge and inside information, a collapse in market values constitutes a lucrative and money-spinning opportunity, for a select category of powerful speculators who have the ability to manipulate the market in the appropriate direction at the appropriate time.

Short Selling

One important instrument used by speculators to make money out of a financial meltdown is "short selling".

"Short selling" consists in selling large amounts of stocks which you do not possess and then buying them in the spot market once the price has collapsed, with a view to completing the transaction and cashing in on the profits.

The role of short selling in bringing down companies is well documented. The collapse of Lehman, Merrill Lynch and Bear Stearns was in part due to short selling.

Short selling has also been used extensively in currency markets. It was one of the main instruments used by speculators during the 1997 Asian Crisis to bring down the Thai baht, the Korean won and Indonesian rupiah.

Speculation in major currency markets also characterizes the ongoing financial crisis. There have been major swings in currency values with the Canadian dollar, for instance, loosing 10% of its value in the course of a few trading days.

Temporary Ban on Short Selling

Following the stock market meltdown on Black Monday September 15, the Security Exchange Commission (SEC) introduced a temporary ban on short selling. In a bitter irony, the SEC listed a number of companies which were "protected by regulators from short sellers". The SEC September 18 ban on short selling pertained largely to banks, insurance companies and other financial services companies.

The effect of being on a "protected list" was to no avail. It was tantamount to putting those listed companies on a "hit list". If the SEC had implemented a complete and permanent ban on short selling coupled with a freeze on all forms of speculative trade, including index funds and options, this would have contributed to reducing market volatility and dampening the meltdown.

The ban on short selling was applied with a view to establishing the protected list. It expired on Wednesday October 8 at midnight.

The following morning, Thursday 9th of October, when the market opened up, those companies on the "protected list" became "unprotected" and were the first target of the speculative onslaught, leading to a dramatic collapse on of the Dow Jones on Thursday 9th and Friday 10th.

The course of events was entirely predictable. The lifting of the ban on short selling contributed to accentuating the downfall in stock market values. The companies which were on the hit list were the first victims of the speculative onslaught.

The shares of Morgan Stanley dropped 26 percent on October 9th, upon the expiry of the short-selling ban and a further 25 percent the following day.

Financial warfare

There are indications that the downfall of Morgan Stanley was engineered by financial rivals. A day prior to the September 18th ban on short selling, Morgan Stanley was the object of rival speculative attacks:

John Mack, chief executive of Morgan Stanley, told employees in an internal memo Wednesday [September 17]: “What’s happening out there? It’s very clear to me – we’re in the midst of a market controlled by fear and rumours, and short sellers are driving our stock down.”' (Financial Times, September 17, 2008)

Morgan Stanley was also the object of doubts expressed by the ratings agency Moody's, which contributed to investors dumping Morgan Stanley stock.

Moody's cited an expectation that "an expected downturn in global capital market activity will reduce Morgan Stanley's revenue and profit potential in 2009, and perhaps beyond this period".

The winners of financial warfare are JP Morgan Chase and Bank America. Both banking institutions have consolidated their control over the US banking landscape. They have used the financial crisis to displace and/or take over rival financial institutions.

The concentration of wealth and the centralization of financial power resulting from market manipulation is unprecedented.

Regulators Serve the Interests of Speculators

The SEC was fully aware that the ban on short selling would serve to exacerbate the downfall.

Why did they carry it out? How did they justify their decision? Who's interests are they serving?

In a twisted logic, the SEC, which largely serves the interests of institutional speculators, contends, quoting the results of an academic research paper, that short selling contributes to reducing market instability, thereby justifying the repeal of the September 18 short selling ban.

by Michel Chossudovsky

Financial Meltdown: The Greatest Transfer of Wealth in History

How to Reverse the Tide and Democratize the US Monetary System

"Admit it, mes amis, the rugged individualism and cutthroat capitalism that made America the land of unlimited opportunity has been shrink-wrapped by half a dozen short sellers in Greenwich, Conn., and FedExed to Washington, D.C., to be spoon-fed back to life by Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson. We’re now no different from any of those Western European semi-socialist welfare states that we love to deride."– Bill Saporito, "How We Became the United States of France," Time (September 21, 2008)

On October 15, the Presidential candidates had their last debate before the election. They talked of the baleful state of the economy and the stock market; but omitted from the discussion was what actually caused the credit freeze, and whether the banks should be nationalized as Treasury Secretary Hank Paulson is now proceeding to do. The omission was probably excusable, since the financial landscape has been changing so fast that it is hard to keep up. A year ago, the Dow Jones Industrial Average broke through 14,000 to make a new all-time high. Anyone predicting then that a year later the Dow would drop nearly by half and the Treasury would move to nationalize the banks would have been regarded with amused disbelief. But that is where we are today.¹

Congress hastily voted to approve Treasury Secretary Hank Paulson’s $700 billion bank bailout plan on October 3, 2008, after a tumultuous week in which the Dow fell dangerously near the critical 10,000 level. The market, however, was not assuaged. The Dow proceeded to break through not only 10,000 but then 9,000 and 8,000, closing at 8,451 on Friday, October 10. The week was called the worst in U.S. stock market history.

On Monday, October 13, the market staged a comeback the likes of which had not been seen since 1933, rising a full 11% in one day. This happened after the government announced a plan to buy equity interests in key banks, partially nationalizing them; and the Federal Reserve led a push to flood the global financial system with dollars.

The reversal was dramatic but short-lived. On October 15, the day of the Presidential debate, the Dow dropped 733 points, crash landing at 8,578. The reversal is looking more like a massive pump and dump scheme – artificially inflating the market so insiders can get out – than a true economic rescue. The real problem is not in the much-discussed subprime market but is in the credit market, which has dried up. The banking scheme itself has failed. As was learned by painful experience during the Great Depression, the economy cannot be rescued by simply propping up failed banks. The banking system itself needs to be overhauled.

A Litany of Failed Rescue Plans

Credit has dried up because many banks cannot meet the 8% capital requirement that limits their ability to lend. A bank’s capital – the money it gets from the sale of stock or from profits – can be fanned into more than 10 times its value in loans; but this leverage also works the other way. While $80 in capital can produce $1,000 in loans, an $80 loss from default wipes out $80 in capital, reducing the sum that can be lent by $1,000. Since the banks have been experiencing widespread loan defaults, their capital base has shrunk proportionately.

The bank bailout plan announced on October 3 involved using taxpayer money to buy up mortgage-related securities from troubled banks. This was supposed to reduce the need for new capital by reducing the amount of risky assets on the banks’ books. But the banks’ risky assets include derivatives – speculative bets on market changes – and derivative exposure for U.S. banks is now estimated at a breathtaking $180 trillion.² The sum represents an impossible-to-fill black hole that is three times the gross domestic product of all the countries in the world combined. As one critic said of Paulson’s roundabout bailout plan, "this seems designed to help Hank’s friends offload trash, more than to clear a market blockage."³

By Thursday, October 9, Paulson himself evidently had doubts about his ability to sell the plan. He wasn’t abandoning his old cronies, but he soft-pedaled that plan in favor of another option buried in the voluminous rescue package – using a portion of the $700 billion to buy stock in the banks directly. Plan B represented a controversial move toward nationalization, but it was an improvement over Plan A, which would have reduced capital requirements only by the value of the bad debts shifted onto the government’s books. In Plan B, the money would be spent on bank stock, increasing the banks’ capital base, which could then be leveraged into ten times that sum in loans. The plan was an improvement but the market was evidently not convinced, since the Dow proceeded to drop another thousand points from Thursday’s opening to Friday’s close.

One problem with Plan B was that it did not really mean nationalization (public ownership and control of the participating banks). Rather, it came closer to what has been called "crony capitalism" or "corporate welfare." The bank stock being bought would be non-voting preferred stock, meaning the government would have no say in how the bank was run. The Treasury would just be feeding the bank money to do with as it would. Management could continue to collect enormous salaries while investing in wildly speculative ventures with the taxpayers’ money. The banks could not be forced to use the money to make much-needed loans but could just use it to clean up their derivative-infested balance sheets. In the end, the banks were still liable to go bankrupt, wiping out the taxpayers’ investment altogether. Even if $700 billion were fanned into $7 trillion, the sum would not come close to removing the $180 trillion in derivative liabilities from the banks’ books. Shifting those liabilities onto the public purse would just empty the purse without filling the derivative black hole.

Plan C, the plan du jour, does impose some limits on management compensation. But the more significant feature of this week’s plan is the Fed’s new "Commercial Paper Funding Facility," which is slated to be operational on October 27, 2008. The facility would open the Fed’s lending window for short-term commercial paper, the money corporations need to fund their day-to-day business operations. On October 14, the Federal Reserve Bank of New York justified this extraordinary expansion of its lending powers by stating:

"The CPFF is authorized under Section 13(3) of the Federal Reserve Act, which permits the Board, in unusual and exigent circumstances, to authorize Reserve Banks to extend credit to individuals, partnerships, and corporations that are unable to obtain adequate credit accommodations. . . .

"The U.S. Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the New York Fed in support of this facility."⁴

That means the government and the Fed are now committing even more public money and taking on even more public risk. The taxpayers are already tapped out, so the Treasury’s "special deposit" will no doubt come from U.S. bonds, meaning more debt on which the taxpayers have to pay interest. The federal debt could wind up running so high that the government loses its own triple-A rating. The U.S. could be reduced to Third World status, with "austerity measures" being imposed as a condition for further loans, and hyperinflation running the dollar into oblivion. Rather than solving the problem, these "rescue" plans seem destined to make it worse.

The Collapse of a 300 Year Ponzi Scheme

All the king’s men cannot put the private banking system together again, for the simple reason that it is a Ponzi scheme that has reached its mathematical limits. A Ponzi scheme is a form of pyramid scheme in which new investors must continually be sucked in at the bottom to support the investors at the top. In this case, new borrowers must continually be sucked in to support the creditors at the top. The Wall Street Ponzi scheme is built on "fractional reserve" lending, which allows banks to create "credit" (or "debt") with accounting entries. Banks are now allowed to lend from 10 to 30 times their "reserves," essentially counterfeiting the money they lend. Over 97 percent of the U.S. money supply (M3) has been created by banks in this way.⁵ The problem is that banks create only the principal and not the interest necessary to pay back their loans. Since bank lending is essentially the only source of new money in the system, someone somewhere must continually be taking out new loans just to create enough "money" (or "credit") to service the old loans composing the money supply. This spiraling interest problem and the need to find new debtors has gone on for over 300 years -- ever since the founding of the Bank of England in 1694 – until the whole world has now become mired in debt to the bankers’ private money monopoly. As British financial analyst Chris Cook observes:

"Exponential economic growth required by the mathematics of compound interest on a money supply based on money as debt must always run up eventually against the finite nature of Earth’s resources."⁶

The parasite has finally run out of its food source. But the crisis is not in the economy itself, which is fundamentally sound – or would be with a proper credit system to oil the wheels of production. The crisis is in the banking system, which can no longer cover up the shell game it has played for three centuries with other people’s money. Fortunately, we don’t need the credit of private banks. A sovereign government can create its own.

The New Deal Revisited

Today’s credit crisis is very similar to that facing Franklin Roosevelt in the 1930s. In 1932, President Hoover set up the Reconstruction Finance Corporation (RFC) as a federally-owned bank that would bail out commercial banks by extending loans to them, much as the privately-owned Federal Reserve is doing today. But like today, Hoover’s plan failed. The banks did not need more loans; they were already drowning in debt. They needed customers with money to spend and to invest. President Roosevelt used Hoover’s new government-owned lending facility to extend loans where they were needed most – for housing, agriculture and industry. Many new federal agencies were set up and funded by the RFC, including the HOLC (Home Owners Loan Corporation) and Fannie Mae (the Federal National Mortgage Association, which was then a government-owned agency). In the 1940s, the RFC went into overdrive funding the infrastructure necessary for the U.S. to participate in World War II, setting the country up with the infrastructure it needed to become the world’s industrial leader after the war.

The RFC was a government-owned bank that sidestepped the privately-owned Federal Reserve; but unlike the private banks with which it was competing, the RFC had to have the money in hand before lending it. The RFC was funded by issuing government bonds (I.O.U.s or debt) and relending the proceeds. The result was to put the taxpayers further into debt. This problem could be avoided, however, by updating the RFC model. A system of public banks might be set up that had the power to create credit themselves, just as private banks do now. A public bank operating on the private bank model could fan $700 billion in capital reserves into $7 trillion in public credit that was derivative-free, liability-free, and readily available to fund all those things we think we don’t have the money for now, including the loans necessary to meet payrolls, fund mortgages, and underwrite public infrastructure.

Credit as a Public Utility

"Credit" can and should be a national utility, a public service provided by the government to the people it serves. Many people are opposed to getting the government involved in the banking system, but the fact is that the government is already involved. A modern-day RFC would actually mean less government involvement and a more efficient use of the already-earmarked $700 billion than policymakers are talking about now. The government would not need to interfere with the private banking system, which could carry on as before. The Treasury would not need to bail out the banks, which could be left to those same free market forces that have served them so well up to now. If banks went bankrupt, they could be put into FDIC receivership and nationalized. The government would then own a string of banks, which could be used to service the depository and credit needs of the community. There would be no need to change the personnel or procedures of these newly-nationalized banks. They could engage in "fractional reserve" lending just as they do now. The only difference would be that the interest on loans would return to the government, helping to defray the tax burden on the populace; and the banks would start out with a clean set of books, so their $700 billion in startup capital could be fanned into $7 trillion in new loans. This was the sort of banking scheme used in Benjamin Franklin’s colony of Pennsylvania, where it worked brilliantly well. The spiraling-interest problem was avoided by printing some extra money and spending it into the economy for public purposes. During the decades the provincial bank operated, the Pennsylvania colonists paid no taxes, there was no government debt, and inflation did not result.⁷

Like the Pennsylvania bank, a modern-day federal banking system would not actually need "reserves" at all. It is the sovereign right of a government to issue the currency of the realm. What backs our money today is simply "the full faith and credit of the United States," something the United States should be able to issue directly without having to draw on "reserves" of its own credit. But if Congress is not prepared to go that far, a more efficient use of the earmarked $700 billion than bailing out failing banks would be to designate the funds as the "reserves" for a newly-reconstituted RFC.

Rather than creating a separate public banking corporation called the RFC, the nation’s financial apparatus could be streamlined by simply nationalizing the privately-owned Federal Reserve; but again, Congress may not be prepared to go that far. Since there is already successful precedent for establishing an RFC in times like these, that model could serve as a non-controversial starting point for a new public credit facility. The G-7 nations’ financial planners, who met in Washington D.C. this past weekend, appear intent on supporting the banking system with enough government-debt-backed "liquidity" to produce what Jim Rogers calls "an inflationary holocaust." As the U.S. private banking system self-destructs, we need to ensure that a public credit system is in place and ready to serve the people’s needs in its stead.

Ellen Brown, J.D., developed her research skills as an attorney practicing civil litigation in Los Angeles. In Web of Debt, her latest book, she turns those skills to an analysis of the Federal Reserve and "the money trust." She shows how this private cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Her eleven books include the bestselling Nature’s Pharmacy, co-authored with Dr. Lynne Walker, and Forbidden Medicine. Her websites are www.webofdebt.com and www.ellenbrown.com.