Treasury Secretary Henry Paulson’s massive bank bailout is dead on arrival. The $700 billion agreed to by Congress virtually at gunpoint in October has grown to $2.7 trillion in loans and commitments; yet despite a wall of money being thrown at the banks, in the last two weeks major financial stocks have plummeted. Citibank, always considered too big to fail, is now failing, with its stock dropping below $4 a share. In spite of a dramatic hail-Mary stock market reversal last Friday (which looked suspiciously like the handiwork of Paulson’s own Plunge Protection Team), JPMorgan Chase and Citigroup could not manage to end the day on the upside. The credit market remains frozen, the big three automakers are bankrupt, housing continues to crash, and so does the economy.
Little wonder that President-elect Obama is being compared to Franklin Roosevelt, who entered the Oval Office in similar financial straits. Even before taking office, Obama has started his version of Roosevelt’s reassuring weekly “fireside chats” (now upgraded from radio to online video). He said on November 22 that he plans to put people back to work and kickstart the economy by building roads and bridges and in other productive endeavors. All are excellent-sounding ideas, but what will they be funded with – more government debt? Fears are that the tab for this stimulus package will put America’s mushrooming debt over the top, causing foreign creditors to declare the United States itself bankrupt. If they buy our bonds at all, it could be only at much higher interest rates, breaking the backs of the taxpayers. The federal debt has not been paid off since the days of Andrew Jackson; but we do pay the interest, and it already comes to nearly half a trillion dollars annually.
Our national financial situation seems quite dire, but there is something anomalous in all this. A government has the sovereign right to create the national money supply. So why is our government groveling to private banks that are bankrupt themselves? The answer may simply be that few people understand how money creation works. Richard Russell is a respected financial analyst whose Dow Theory Letter has been in publication for nearly fifty years. In an April 2005 newsletter, he observed that the creation of money is a total mystery to probably 99 percent of the U.S. population, including the U.S. Congress. Then he proceeded to unravel the mystery in a few sentences:
“To simplify, when the US government needs money, it either collects it in taxes or it issues bonds. These bonds are sold to the Fed, and the Fed, in turn, makes book entry deposits. This ‘debt money’ created out of thin air is then made available to the US government. But if the US government can issue Treasury bills, notes and bonds, it can also issue currency, as it did prior to the formation of the Federal Reserve. If the US issued its own money, that money could cover all its expenses, and the income tax wouldn’t be needed. So what’s the objection to getting rid of the Fed and letting the US government issue its own currency? Easy, it cuts out the bankers and it eliminates the income tax.”1
In a February 2005 article titled “The Death of Banking and Macro Politics,” Hans Schicht reached similar conclusions. He wrote:
“If prime ministers and presidents would only be blessed with the most basic knowledge of the perversity of banking, they would not go onto their knees to the Central Banker and ask His Highness for loans . . . . With a little bit of brains they would expropriate all banking institutions . . . . Expropriation would bring enough money into the national treasuries for the people not to have to pay taxes for years to come.”2
“Congress shall have the power to coin money,” says the Constitution; and that is all it says about who has the power to create money. It does not say Congress can delegate to private banks the right to create 97% of the national money supply in the form of loans. Only about 3% of the U.S. money supply now consists of “hard” currency – coins issued by the government and dollar bills issued by the Federal Reserve (a private banking corporation). All of the rest exists merely on computer screens or in paper accounts, and all of this money is created by banks when they make loans. Lest you doubt that banks create money, here are some quotes from reputable authorities:
“Of course, [banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts. Loans (assets) and deposits (liabilities) both rise [by the same amount].” The Chicago Federal Reserve, Modern Money Mechanics (last updated in 1992).
“[T]he actual creation of money always involves the extension of credit by private commercial banks.” Russell L. Munk, Assistant General Counsel, Department of the Treasury.
“Money is created when loans are issued and debts incurred; money is extinguished when loans are repaid.” John B. Henderson, Senior Specialist in Price Economics, Congressional Research Service, Report No. 83-125 E.
“[T]he money that one borrower uses to pay interest on a loan has been created somewhere else in the economy by another loan.” John M. Yetter, Attorney-Advisor, Department of the Treasury.
“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.” Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, writing in 1934.
“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created -- brand new money.” Graham Towers, Governor of the Bank of Canada from 1935 to 1955.
“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.” Robert B. Anderson, Secretary of the Treasury under President Eisenhower.
If a bank can create “money” simply by writing credit into a deposit account, so can the federal government. Our money is backed by nothing but “the full faith and credit of the United States.” The government not only could but should have its own system of public banks, having the authority to issue the credit of the nation directly.
Picking up a network of public banks would be a simple matter for the government today. As banks became insolvent, instead of trying to bail them out, it could just put them into bankruptcy and take them over. Bankruptcy is designed to wipe bad debts off the books of the bankrupt entity. Under a bankruptcy reorganization, claimants satisfy their claims against available assets according to seniority. The entity then begins again with a clean set of books.
Insolvent banks are dealt with by the FDIC, which is authorized to proceed in one of three ways. It can order a payout, in which the bank is liquidated and ceases to exist. It can arrange for a purchase and assumption, in which another bank buys the failed bank and assumes its liabilities. Or it can take the bridge bank option, in which the FDIC replaces the board of directors and provides the capital to get it running in exchange for an equity stake in the bank. An “equity stake” means an ownership interest: the bank’s stock becomes the property of the government. The bridge bank option was taken, for example, when Chicago’s Continental Illinois became insolvent in 1984. Continental Illinois was the nation’s seventh largest bank, and its insolvency was the largest bank failure that had ever occurred in the United States. The bank was effectively nationalized from 1984 to 1991, when the FDIC sold its equity interest back to private owners. 3
Nationalization is an option routinely pursued in Europe for bankrupt banks. As William Engdahl observed in a September 30 article, citing economist Nouriel Roubini for authority:
“[I]n almost every case of recent banking crises in which emergency action was needed to save the financial system, the most economical (to taxpayers) method was to have the Government, as in Sweden or Finland in the early 1990’s, nationalize the troubled banks, take over their management and assets, and inject public capital to recapitalize the banks to allow them to continue doing business, lending to normal clients. In the Swedish case, the Government held the assets, mostly real estate, for several years until the economy again improved at which point they could sell them onto the market and the banks could gradually buy the state ownership shares back into private hands. In the Swedish case the end cost to taxpayers was estimated to have been almost nil. The state never did as Paulson proposed, to buy the toxic waste of the banks, leaving them to get off free from their follies of securitization and speculation abuses.”4
(You might notice another anomaly here. Why do banks need to be “recapitalized” if they can create money with accounting entries? The answer has to do with the 8% capital requirement imposed by the Bank for International Settlements, the head of the private international banking empire in Basel, Switzerland. “Capital” generally means the money that comes from shareholders, and it is wiped out dollar for dollar by bad debts on a bank’s books. But that will have to be the subject of another article.)
Advantages of a System of Truly “National” Banks
Retaining banks as public agencies has many potential advantages, and one is personal security: we would not have to worry about our own bank going bankrupt and taking our savings with it. In How Credit-Money Shapes the Economy, Professor Robert Guttman notes that our basic banking needs are fairly simple. Besides the ability to get credit, we need a safe place to keep our money and a practical way to transfer it to others. These services could be performed by a government agency on the model of the now-defunct U.S. Postal Savings System, which operated successfully from 1911 to 1967, providing a safe and efficient place for customers to save and transfer funds. It issued U.S. Postal Savings Bonds in various denominations that paid annual interest, as well as Postal Savings Certificates and domestic money orders. 5 The U.S. Postal Savings System was shut down in 1967, not because it was inefficient but because it became unnecessary after private banks raised their interest rates and offered the same governmental guarantees that the postal savings system had. The services offered by a modern system of federally-operated bank branches would need to be modified to reflect today’s conditions, but the point is that the government has done these things before and could do them again.
A system of truly “national” banks would be natural options for extending “the full faith and credit of the United States” as loans. Public banks could lend the national credit just as public libraries lend books. Consolidating the depository function of banks in a system of bank branches acting as one entity under the Federal Reserve could also simplify the banking business. Some advantages are suggested by William Hummel in an article titled “A Plan for Monetary Reform”:
“With the Fed operating as the sole depository, payments would only involve the transfer of deposits between accounts within a single bank. This would allow for instant clearing, eliminate the nuisance of checking system float [the time that elapses between when a check is deposited into a bank account and the funds are available to the depositor], and significantly reduce associated costs. Additional advantages include the elimination of any need for deposit insurance, and ending overnight sweeps and other sterile games that banks play to get around the fractional reserve requirement.”6
(The overnight sweep is a tactic for maximizing interest by “sweeping” funds not in immediate use in a low-interest account into a high-interest account, where they remain until the balance in the low-interest account drops below a certain minimum.)
Funding a Really “New” New Deal
As in any corporate acquisition, not much would need to change about these newly-acquired banks beyond the names on the stock certificates. They would just be under new management. Business could carry on as before. The banks could advance loans as accounting entries, just as they do now. The difference would be that interest on advances of credit, rather than going into private vaults for private profit, would go into the coffers of the government. The “full faith and credit of the United States” would become an asset of the United States. Instead of paying half a trillion dollars in interest with taxpayer money, the U.S. could be receiving interest on its credit, replacing or eliminating the need to tax its citizens.
In the revealing booklet “Modern Money Mechanics,” the Chicago Federal Reserve explains that under the fractional reserve system in use today, banks can fan one dollar in “reserves” into ten dollars in new loans. 7 Consider the possibilities for a system of public banks. The $700 billion already earmarked to unfreeze credit markets could serve as the reserves for $7 trillion in low-interest credit. President-elect Obama would have all the money he needed to fund his New Deal with a few trillion to spare.
1. Richard Russell, “The Takeover of U.S. Money Creation,” Dow Theory Letter (April 2005).
2. Hans Schicht, “The Death of Banking and Macro Politics,” www.321gold.com/editorials (February 9, 2005).
3. G. Edward Griffin, The Creature from Jekyll Island (Westlake Village, California: American Media, 1998), pages 63, 65.
4. “William Engdahl, “Financial Tsunami: The End of the World as We Knew It,” Global Research (September 30, 2008).
5. Robert Guttman, How Credit-Money Shapes the Economy (Armonk, New York: M. E. Sharpe, 1994)
6. William Hummel, “A Plan for Monetary Reform,” Money: What It Is, How It Works, http://wfhummel.net (December 7, 2006).
7. Chicago Federal Reserve, “Modern Money Mechanics” (1963, updated 1992), originally produced and distributed free by the Public Information Center of the Federal Reserve Bank of Chicago, Chicago, Illinois, now available on the Internet.
