End Fractional Reserve Banking--Send Bankers to the Hoosegow

Everyone blames the current economic volatility on credit default swaps and similar kinds of derivatives. Sub-prime loans were "stripped", securitized and sold. Rights to payment in the event of default were purchased. The buyers and sellers weren't able to value the risk. The profits from the sales were recorded as profit...

Wait a minute! Let me understand this. Banks were registering profits on derivative instruments whose risks they did not understand? If that is so, then the profits they recognized during the years when they were buying and selling the derivatives were fraudulent, and criminally so. What the banks did was the equivalent of a fire insurance company's telling investors that insurance premium money needed to cover payments for losses due to fires was profit. If that occurred, the firms and the executives were engaging in outright fraud, no different from what Ken Lay and Jeffrey Skilling did at Enron. If Andy Fastow rightly ended up in jail, the heads of the money center banks that engaged in derivatives-related fraud belong there as well.

Oddly, though, both the Bush and Obama administrations view the bank presidents' fraud not as a matter of criminal enforcement, but as an activity that warrants subsidization. The pissant propagandists at Fox, CNN and the Times all agree. Henry Paulson, friend of the perpetrators, has succeeded in effecting a near trillion dollar bailout. Ben Bernanke, whose job includes stopping reckless banking practices, has tripled the monetary base in order to subsidize the fraud. Like a horde of drooling morons, the progagandists applaud.

The complaint among many of the propagandists is that there needs to be "regulation". In fact, regulation already exists. The Federal Reserve Bank is empowered to oversee commercial banking, and can tell commercial bankers anything it wishes to tell them. Chairmen Greenspan and Bernanke could have hired experts to evaluate the risks and degree of fraud involved in the derivatives trading. But they did not. Nor did Congress even hint that that they should do so in light of Warren Buffett's public statements over the past few years that the derivatives were leading to trouble. That wouldn't have anything to do with all those Goldman Sachs contributions to the Democrats last year, would it?

In 1913 the nation adopted a specific approach to banking that lacked justification. The nineteenth century was a period of increasing real wages among workers, far greater levels of innovation than in the 20th, and increasing immigration as millions around the world aimed to come to America to participate in the real wage growth. There were three groups who suffered during this period: capitalists, landowners and farmers. The reason these groups suffered was that the gold standard era was characterized by deflation because the greenbacks that had been created during the Civil War were retired in the 1870s and innovation created highly intense competition. So prices were declining and stockholders, landowners and farmers were hurting. Innovation came from the free economy, absence of income taxes and increasing real wages, which permitted many new business start ups. Thus, this was a land of opportunity but pressure was on those who speculated in stock and held wealth in land.

Family farmers combine two elements. They are property owners and workers. Richard Hofstadter, in the book Age of Reform, has argued that 19th century American farmers were in large part land speculators. They sold land in New England and pushed into the midwest and then into what we now call the west in part to make gains on land values that were increasing due to increased population. This process was stalled by deflation during the post Civil War gold standard era. Hence, William Greider's claim that the Populist movement, which argued for inflation in the 1880s and 1890s, was a working class movement is mistaken. Although farmers were often workers, in this role they were benefiting from deflation. Real wages were rising across the board. It was as capitalists and landowners who were facing declining asset values and prices that farmers were hurting. Lower food prices are good for workers, but Greider omits this consideration in his discussion of the Populist movement. Deflation is good for workers but bad for capitalists, sellers and landowners. In claiming to be workers' friend, Greider somehow makes an argument that supports real estate speculators and bankers. He does this while saying hard money helps bankers. (Funny how the left manages to say that they help the poor while they are helping the rich, and then turn around and get donations from George Soros!)

Because of the massive gains to workers during the late nineteenth century (due to increasing real wages) the Democrats' attempt to introduce an inflationary economy was voted down in 1896 by popular vote. William Jennings Bryan ran three times altogether and was voted down each time. However, when JP Morgan approached death, bankers realized that in order to maintain fractional reserve banking as a system there would need to be a replacement for Morgan, who frequently arranged loans that provided liquidity to rescue banks. This was accomplished by the establishment of the Fed in 1913, which Wilson, a gold standard advocate, introduced with little fanfare or debate.

There is no evidence that fractional reserve banking was essential to the dynamic economic growth of the nineteenth century. Other countries had fractional reserve banking but did not grow to the same degree that America did. Other countries had more frequent wars and had more inflation, though. Nor is there evidence that the key growth areas of the economy, manufacturing and innovation, received more funding from banks than would have been available without fractional reserve banking. In the case of Standard Oil, which revolutionized the oil industry, Rockefeller and his partners financed the business from their own savings and then profits. Bondholders and investors were brought in and over time a "trust" was formed. Although banks played a role, there is no evidence that fractional reserve banking was necessary to this or any other important business.

The public has accepted the need for a money supply managed and controlled by commercial banks. But is such a system essential? "Progressives" (the very name is laughable) argue staunchly for the 1913 system based on the conservative argument that it's been that way for 95 years. But since 1971 real wages have been declining, not rising. The 20th century has seen some innovation, but much less than the nineteenth. Fractional reserve banking facilitates allocation of credit to incompetent investment schemes, derivatives and crackpot investments such as Enron, the tech bubble and the sub-prime bubble. Redlining, excessive real estate development and the rape of cash savers and Americans on fixed incomes (the lower middle class) in favor of William Greider's* favored elements, millionaire construction firm owners, big banks, Wall Street investors, stockholders and major borrowers like billionaire hedge fund managers have all resulted from fractional reserve banking and from the Fed.

There is no evidence that bankers are or were better at allocating capital than a free market would be. With a trillion dollar bailout whose costs may mount to five trillion, a tripling of the money supply in order to subsidize the mistakes of the commercial banks, and large scale economic dislocation purely because of fraudulent and incompetent investment and profit-recognition practices in which the money center banks have engaged, people who claim that fractional reserve banking creates surplus for the economy have begun to look like delusional cranks.

The declining real wage of the past 36 years is evidence enough that fractional reserve banking has failed. Add the two bubbles of the past ten years to the mix, and the claim that fractional reserve banking contributes to the economy becomes laughable. Now that the banking system aims to absorb trillions of dollars from the productive economy in order to subsidize fraud, the time has come to consider scrapping it--and sending the money center bank CEOs to the hoosegow.

*See William Greider, Secrets of the Temple.