Eating our Seed Corn: How the Financial Industry Managed to Extract Equity from Just About Everybody

One of the great illusions of late 20th century finance was that banks were profitable. On paper – investment, commercial and mortgage banks appeared extremely profitable. The percentage of total S&P 500 profits that was attributable to financial companies rose steadily from 1980 to 2000, and by 2007 reached 40%, depending on how you measured it. This meant that two out of every five dollars of profit generated by America’s 500 largest companies came from the financial function. This, by the way, understated things, since it left out the quasi-banks like General Electric and GMAC.

The illusion comes from the fact that this paper profit was not the result of selling products that allowed businesses and consumers to be more productive and more profitable in their own right. What was really happening was that financial firms were extracting equity that had been built up over nearly a century by businesses and consumers. The financial business had become a predatory business, scavenging the land for pockets of wealth to convert into cash that would be funneled in part to the banks as fees.

It’s not clear that even at the highest levels the bankers understood what they were doing, since businessmen in the heat of competitive battle do not have the time to muse over the broader social implications of what they do. This is a job for government policy wonks and business professors, most of whom spent their time enabling and cheerleading for the banks. Moreover, some of what the industry did helped their customers, such as automated bill paying, even though this was a smaller proportion of bank profits.

Since the large banks and financial companies in the U.S. have blown up ”“ in part because the equity available for mining and extraction has dried up ”“ we the taxpayers are being asked to save their hides. As taxpayers, we represent the last available, and largest pool of equity ”“ the good faith and credit of the United States as represented by the government’s taxing power. At this very moment, the financial oligarchs are at it again, looking for ways to convert stored-up wealth into cash for themselves. Don’t you think you should know who they are and what game is going on here?

Mutual Funds
The traditional form of equity mining is found in the mutual fund industry, which pays itself by extracting as much as three-quarters of a percent from your investment portfolio every year as their fee. If you put $100,000 into a mutual fund, after twenty years the fund managers will have removed $15,000 of your equity in fees. To justify this, the first thing mutual fund managers do is set the bar for their performance as low as possible. They don’t ask that you judge their performance on how much investment gains they produce for you each year; they judge themselves on how well they have performed in relation to the market’s performance. If the market declines 5% during the year, but they have put you in investments that only lost 4%, they trumpet themselves as a rousing success. Even if they do more poorly than the market, they still take their 0.75% out of your account.

You won’t notice the 0.75% so much if the market is rising, and it is very important for the mutual fund industry to have this happen. But should the market hit a rough patch, the industry is ready for you. There isn’t a mutual fund manager in the world who isn’t armed with a chart showing you the long term performance of the stock market, appreciating at an 8% rate per annum over time. This 100 year chart glosses over the rough patches that can last a decade or two, and woe to you if you are retired during this time and need money from your investment account. The industry trains its salesmen to believe that 8% p.a. returns are in the long run ordained by the heavens and therefore guaranteed to all investors, but because it is in the long run, the mutual fund industry emphasizes that you, the investor, need to invest for the long haul. They don’t want your money moving in and out of the account; they want it sitting passively with them year after year, earning 0.75% guaranteed for them. That’s the difference between you and the mutual fund industry. The 8% p.a. they imply is a guaranteed return on your money really isn’t, but the 0.75% p.a. fee guaranteed to the fund, really is.

Hedge Funds
The hedge fund industry is the mutual fund industry on steroids. Hedge funds get a much larger annual fee, usually 2% p.a., and they typically restrict participation only to wealthy individuals, so the fee is much more lucrative. To attract these individuals, hedge funds promise outsized market performance. In this sense, they are very different from mutual funds, in that they ask their investors to judge them on the positive returns they make year after year, even in down markets. Because they ”œguarantee” positive returns, they also take 20% off the investment profit each year, leaving 80% for the investor.

The markets that the hedge fund industry invests in are the exact same markets that the mutual fund industry invests in, so how do hedge funds guarantee a profit? For one, they don’t always buy stocks ”“ they sometimes go short the market, selling stocks in advance of a down move and making a profit as the stock declines. Mutual funds don’t do this. Second ”“ and much more important ”“ hedge funds employ leverage. They take your $100,000 and borrow $3,000,000, and then invest all of it. This is highly risky stuff when you only have $100,000 in real equity, which could be wiped out in just a 3% down move in the market. It becomes essential for the hedge funds to ensure they make a profit. Part of this is done in an honest-to-God way, by timing the market. Some hedge funds own stocks when the market is going up, and they go short as the market is going down. This is very difficult to do, so only a small minority of hedge funds are actually good at trading with their wits.

The rest need help. A lot of hedge funds are bullies; they have such huge amounts to invest, that the mere act of investing distorts market liquidity and forces prices to go in the direction they want (see George Soros on how to do this). Many hedge funds are momentum investors who jump on a bandwagon and ride the market for all its worth, distorting the market in the process. This is how oil was pushed up to $143/bbl and just as quickly collapsed ”“ hedge funds rushed in to push it up, and scrambled to exit at the same time. Then there are the hedge funds which skirt the edge of the law, or sometimes break the law, by seeking insider information on potential mergers or acquisitions. The easiest and cleanest way to do this is to align your hedge fund with the mergers and acquisitions department of a big bank. This way you can use your leverage to bet on the company being acquired, and more often than not, create the pressure necessary to force the acquired company to sell to their predator.

Private Equity
Established originally by Michael Milken in the 1980s as the leveraged buyout business, private equity is the practice of borrowing huge amounts of money to take over a company, liquidate its common equity so that it is entirely privately owned by the investors, and then ”œslim down and shape up” the company so that it can be brought back to the stock market in a public stock offering, at great profit to the private owners. Suppose you don’t have the money to buying something as gargantuan as a company? Easy. You borrow it from the banks, using as your collateral the very assets of the company you seek to acquire. The audacity of taking over a company you don’t own by borrowing against its assets is one of the great travesties of modern finance, but government has never seen fit to outlaw this practice.

There is a second travesty at work here. In case you are wondering why the management of a company puts up with the predatory tactics of the private equity industry, in many such buyouts the management of the company is operating secretly in cahoots with the private equity buyer. The management gets a side agreement to continue to run the company after it is taken over, and to get millions of dollars in guaranteed payouts for agreeing to do this. The losers in this game are the employees, since often 15% or more of the staff can be fired to help trim down the company for ultimate resale to the market. One other thing that is quick to go is the employee pension plan. To the extent it has any positive value, it is looted by the private equity investors. One of the earliest practitioners of private equity was Jack Welch, who was known as Neutron Jack for his practice of buying companies and leaving only the buildings standing.

Private equity reached absurd amounts of equity extraction this decade. It used to be that the private equity investors would ”œslim down” the company first and then three or five years later bring it public again by issuing common stock and getting themselves out with a huge profit. By the middle of this decade, greed couldn’t wait. In the typical deal, the private equity investors would buy a company with its own assets as collateral, then borrow billions of dollars more from banks which were promised part of the equity in the deal, and therefore part of the future, enormous profits. With this borrowed money, the investors would immediately declare a dividend for themselves. One such investor took out $500 million dollars in a dividend for himself. If you remember seeing lists a few years ago of the men in the hedge fund and private equity business who made billions for themselves, this is how it was done ”“ equity mining. No hard work; no actual profit; just gaming the system, loading up the victim with debt, and taking money out as their personal profit.

Home Equity Lines of Credit
If this private equity mining sounds familiar, it should. The exact same process went on in the home mortgage business. Our buccaneers of finance found equity to extract not just in corporate America, but among consumers and the wealth they had built up in their homes through many patient decades of paying off their mortgages. In the 1990s, banks created the tool to mine this equity ”“ the home equity line of credit, which effectively turned homes into commodities and cash machines. When the Federal Reserve lowered interest rates on these lines of credit to 1% in 2001, the doors were now wide open for the great looting of the American dream. Consumers were already in a mood to borrow against their homes, because their wages had been stagnant for nearly 20 years, especially if they worked in an industry that was subject to the rapacious destruction of the private equity investors. A great marketing campaign began to convince consumers to lower their monthly payments, and in this campaign, the word debt was rarely mentioned. Consumers were given the impression they somehow had cash locked up in their house that could now be liberated; they were rarely told the truth ”“ that this was equity being exchanged for debt. The banking and mortgage industry, in the meantime, extracted trillions of dollars in points and fees – the amounts are so staggering that you can see in the national housing statistics how home equity has collapsed while mortgage debt has soared.

The Pom-Pom Squad
You can’t go about raping and looting the wealth of this country without important help in keeping the public oblivious. This is the role of the propaganda arms of the financial industry ”“ the Wall Street Journal, the business pages of the newspapers, the television cheerleaders on CNBC, the professors at business schools, and the think tanks that glorify buccaneer capitalism. The public has to be told over and over that equity mining is a social good which cleanses out the deadwood in corporations, rewards the visionaries amongst us, and in the long run provides jobs (it helps if the government alters the official unemployment statistics to ignore the people who are underemployed). The financial buccaneers themselves are to be glorified publicly with plenty of airtime and deferential interviews. Naysayers ”“ such as people who see bubbles in the financial markets ”“ are to be kept out of the public eye and ridiculed should they somehow escape the screening process.

Nowhere was the Pom-Pom Squad more efficiently employed than at CNBC, which is owned and managed by General Electric Corporation, which itself had ceased to be a manufacturing company, and had instead derived the bulk of its profits from its finance arm. To top it off, GE was run by the most worshipful business manager of all time ”“ Jack Welch; the same Neutron Jack who made a specialty of firing people, and who made a career of extracting equity from companies GE would buy and sell. Jack Welch was lauded as the most talented business manager in America, and he still is invited to companies and seminars to dispense his wisdom for a substantial fee. Every so often he gets questions these days about why GE’s profit collapsed shortly after he left the company. The real answer is that the equity mining business at GE Capital Markets ran its course, but the public answer ignores this. Instead, we are led to believe that the people left running GE after Jack Welch lack his genius. Fortunately for these mere mortals, they own CNBC and are able to limit the amount of criticism directed at them by the business media.

The Pom-Pom Squad has come under fire lately from some astute observers like Jon Stewart, but the cheerleaders are still in business and they are all around you. Notice that while these cheerleaders acknowledge that their team has fallen down on the job, they never question the ability of the coaches to bring home ultimate victory. Worse still, the people who were so skilled at equity mining remain on TV as guest commentators, and get to write op-eds for the Wall Street Journal. Nothing of substance has changed in the cheerleading business.

Serial Acquirers
You do not need to be a banker to run a major bank these days; in fact very few CEOs of big banks are. Vikram Pandit ran a hedge fund before taking over at Citigroup for Chuck Prince, a former general counsel. He himself was anointed to the job by Sandy Weil, who spent his career buying financial companies with his sidekick Jamie Dimon, who now runs JPM Chase. It is possible that none of these men has ever made a bank loan in their life, and what they know about credit or other banking risks is what people reporting to them have told them.

Why don’t you need personal experience as a banker to run a bank? What these men all have in common is that they are serial acquirers of other banks. In this respect, they are like Jack Welch or private equity investors. The skill they are purveying is their ability to buy other banks, fire people, and dress themselves up as visionaries and heroes willing to make tough decisions. They bring to the job a narcissistic personality, because they believe themselves to be, and want to be seen, as indispensable to the bank’s future. In this age of CEO worship, they are expected to dominate their board of directors, be the ultimate public face of the bank, and reap outlandish personal rewards in the process.

It is to these men we owe the concept and the reality of ”œtoo big to fail.” In their rush to buy other banks, and their desire to be the biggest on the block, they created behemoths that touch almost all areas of the economy. At some point in the last decade, but certainly after 1999 when it was now legal to combine an investment with a commercial bank, all of the big players did just that. This alone produced financial companies so large that their failure would impact millions of Americans, but the real cost of failure showed up in something called systemic risk.

This is the risk that the failure of one bank will drag down one or more other banks to default as well, creating a cascade or daisy chain of financial destruction. In the early 1990s, there were probably 75 major banks in the world that dealt regularly with each other, so the daisy chain wasn’t as tightly wound. By 2000, thanks to the efforts of the serial acquirers running the banking industry, this number was reduced to 20 major banks. At this point it was too late. The collapse of a bank in Spain could easily drag down a bank in the U.S., Australia or elsewhere. Compounding the systemic risk is the fact that in all major industrial countries (possibly excepting Japan), housing bubbles have erupted in response to the commoditization of the housing stock, and very low interest rates. What the serial acquirers have done, other than being stewards over equity mining operations, is to make sure that if trouble should occur down the road, they have the regulators and the government there to bail them out. They have perfected the skill of holding an entire nation ransom for their own misjudgments.

The Barney Fife Fan Club
Barney Fife was the deputy sheriff of the town of Mayberry on the 1960s American television show. He was so hapless and inept he was not allowed to carry any bullets in his gun. He would have fit right at home at the Office of Thrift Supervision, or the Office of Federal Housing Enterprise Oversight, which had responsibility for regulating Fannie Mae and Freddie Mac. These understaffed and underskilled regulators operated like Barney Fife, without any bullets in their guns. They gave the illusion of protecting the country from fraud, poorly designed products, excessive risk-taking, and mismanagement.

Bigger and more respectable regulatory agencies had the bullets but their guns were confiscated. The SEC, responsible for overseeing the equity markets, was told by the Bush White House to fire dozens of regulators, and the man they put in charge of the SEC believed that regulation itself was evil in comparison to the beauties of self-regulation as practiced by the banks. At the Federal Reserve, Alan Greenspan was given the opportunity to exercise oversight powers, but declined on the same grounds: the markets knew far better how to police themselves than the government ever could. Neither agency contemplated the possibility that the markets, when left alone, might self-destruct rather than self-police.

What happened with the market’s policing function can be seen at Moody’s and Standard & Poor’s, the private rating agencies that stamped Aaa ratings on thousands of mortgage securities which have since collapsed under the foreclosure crisis in the U.S. The rating agencies were bought off by the very industry they were rating. They were suborned not just by the fact that their customers paid them for the ratings, but because the agencies were tied in very carefully to the quantitative researchers who created the models necessary to generate the ratings. The entire financial industry put its faith in perhaps a hundred or so quantitative experts prone to group think, particularly to the belief that because housing values in the U.S. had never declined since the 1930s, it was okay to use this assumption when modeling the future.

One other thing happened to the regulators: they identified with the industry they were regulating much more than with the general public or other actors in the economy. The Fed in particular has come to believe that what is good for banking is good for the economy, and that banking plays such an indispensable role in the economy that damage to the industry must be avoided at all costs. This is regulatory capture in the extreme, and it explains why the regulators have turned over the keys to the kingdom to the very people who have brought about our problems.

The Last Frontier
We come to the final stage of this process, wherein the financial industry has infiltrated the federal government itself, capturing it completely for its own purposes, and latching on to the last great source of equity ”“ the ability to tax.

You’ve no doubt noticed that the biggest and baddest of the banks ”“ Goldman Sachs ”“ the firm all other banks aspire to be ”“ has managed to position itself as the revolving door for high level employees at the U.S. Treasury. In the 1990s it began with a former chairman Robert Rubin being appointed as Treasury Secretary. Once the financial crisis hit in 2007, the existing chairman of Goldman Sachs, Hank Paulson, was brought on as Treasury Secretary. He peppered all the top positions at the Treasury with executives from Goldman Sachs. He also invited the current chairman of Goldman Sachs, Lloyd Blankfein, to join the Treasury in private discussions to decide the fate of AIG, a firm that owed billions of dollars to Goldman Sachs. President Obama has gone alone with this practice, appointing one of Bob Rubin’s protégés at Goldman Sachs ”“ Timothy Geithner ”“ as Treasury Secretary. His number two at the Treasury is a former executive at Goldman Sachs.

Stuff like this doesn’t happen by accident. Goldman Sachs has long had a program to move its executives in an out of government positions. It’s good for business. Employees are also encouraged to donate generously to Congress, which receives (no surprise here) the greatest amount of its PAC money from the financial industry, an industry that was equally generous to John McCain and Barack Obama during the 2008 campaign. We even have an ex-CEO of Goldman Sachs, Jon Corzine, a former Senator and now governor of New Jersey.

What makes this easy to do is the complexity of modern banking, especially with the derivatives and quantitative products common among the largest firms. Goldman Sachs is not selling to the government its record of success in dealing with difficult economic problems, it is selling its expertise in complex products. This is why someone like Timothy Geithner, who has no particular record of success at his various government jobs, and who is uninspiring as a Treasury Secretary, can remain in his position. He speaks the language of Wall Street and the markets, whereas career civil servants in the federal government do not.

Once ensconced at the Treasury, Goldman Sachs executives have proven adept at creating numerous programs to funnel taxpayer money to Goldman Sachs to keep it afloat. Other banks get a share of the bounty as well, but somehow Goldman Sachs seems to be first in line when they need cash, mostly indirectly to its counterparties whose failure could drag down Goldman Sachs.

A lot of this is happening behind the scenes, but not all of it. We all know enough to see that the federal government has been captured by the Wall Street interests who are at the center of our economic crisis. This part has been done out in the open, with naturally no protest from the Congress or the media. It is made easier by the fact that the Treasury is still allowed by the global bond markets to borrow gargantuan sums, though how long this will last is anyone’s guess. All we know is that no one in government has ever proposed that your taxes be raised to pay for all these bailouts. That would be impossible; the taxpayer today couldn’t afford it (the TARP program alone of $750 billion would require a near-doubling of the annual income tax). Instead, the government borrows the money, trillions and trillions of dollars in new debt each year. We are on the national installment plan; you’ll pay for this later, as will your children and grandchildren.

When the financing tap is finally shut off by the bond markets, we’ll start making our first interest payments on this new debt. It will come in the form of much higher long term interest rates, a weaker U.S. dollar, an inability to import cheap Chinese goods, and declining living standards. All this will happen because the U.S. will have eaten its seed corn. Its businesses will have been shorn of their retained earnings. Consumers will have depleted the equity in their homes. The ability of the federal government to raise taxes and protect the good faith and credit of the U.S. will be shot.

The equity mining business will have done its work well, having exhausted all the financial resources it could find. The U.S. will be approaching peak oil and water shortages at the very moment it runs out of financial equity and taxing power. It will be an ugly situation, except for the equity miners. They’ll be sitting in their gated communities with the fruits of their labor of the past 25 years. More than likely, the vast American public will never understand what exactly happened.

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Numerian is a devoted author and poster on The Agonist, specializing in business, finance, the global economy, and politics. In real life he goes by the non-nom de plume of Garrett Glass and hides out in Oak Park, IL, where he spends time writing novels on early Christianity (and an occasional tract on God and religion). You can follow his writing career on his website,

49 CommentsLeave a comment

  • Many thanks for this lucid summary of the financial death spiral of Capitalism. It appears that Marx was correct after all. Capitalism engineers its own destruction.

  • We sure can’t see how things will work out, but it is difficult to imagine enough of our infrastructure surviving to support those gated communities. At least the minor league equity miners should be in danger of being swept up whether the rest of us understand things or not. Even bigger players who haven’t arranged for locally produced supplies of food and other stuff should face difficulties. Or am I confused?

  • Do they have their own water supply? Enough land to grow sustainable crops? Electric generators for each home?

    In a real crisis, we will all be dependent on each other, and even the wealthy may have trouble arranging for the necessities of life.

  • … Financial and Economic History of out times! You contribute your hard-won wisdom for all to see. You are in the rarified class of James Grant, David Cay Johnson, Wiliam Black and Joe Stiglitz!

    The heart-breaking thing is that you and the above-mentioned individuals are not cleaning up this Augean Stable. The same characters who caused our myriad problems have been invested with our salvation. Chutzpah and cleverness have been confused with intelligence and wisdom. Do these people have to take America into Depression before Obama turns to progressive voices?

  • With constitutional law being his specialty, how can we expect Obama to know the intracacies of the corrupt financial world? Isn’t it like asking a laywer to coach a professional basketball team? What is Obama to do?

    Tolerating prostitution is tolerating abuse and torture of women and children.

  • need fuel. Takes a pretty complex system to produce an supply fuel. Let’s suppose that you are a BIG equity miner and you have thousands and acres and your own hydro-electric system so you won’t need fuel for the generators. You could still be in a difficult position. Something will break.

    Also, we might not have a clue about what happened to the country, but we will be able to see that some people are pretty comfortable. I suspect that some of us might be a little dangerous till we get used to being serfs.

  • is doing just what he is supposed to do. Making sure “the last available, and largest pool of equity” goes to the Numerian’s equity miners. Sure, it’s not what you and I expected him to do, but it appears that that is his mission.

  • … why I left the country or won’t consider coming back after the good guys finally won an election I will henceforth refer him to this write-up.

  • Not experience, not even a decent track record, but expertise. He’s also a quick learner, but by the time he learns about the markets and economics (since his background is constitutional law and he hasn’t shown complete reverence for the Constitution even at that), it will probably be too late. The guys he hired to fix things will have spent all our money fixing things for the financial industry, to no good end and with nothing left over for the rest of us.

    Now I am sure in the rarefied world of Geithner and Bernanke and Summers they truly believe what they are doing is good for the economy overall as well as the markets. Every ounce of their training tells them so and all the expertise they can summon works towards that end. It’s not evident they or Obama can think like an FDR, and devise plans to help the average person. Even here, maybe we are being unfair. FDR faced the destruction of most of the banking industry at a consumer and business level, so he really didn’t have to make the choices Obama has had to make. Still, as early as 1928, FDR was talking about the need for a social security program. He was intellectually ready for new thinking, and Obama hasn’t shown that to be the case yet.

  • really nice. just don’t forget all the equity to be extracted from carbon taxing, and hoarding all the military industrial energy technology (that easily averts carbon) & collecting huge tech license fees. Raytheon et al 0wnz ur carb0nz$$. who do you think is first in line when sneeky bastards like Enron setup energy type markets? (and their totally artificial squeeze moves-if they tense up around food like they did oil, shit will go nuts)

    also GS alum Jon Stevens Corzine is now governor of New Jersey which is actually funnier that mere Senator.

    Be sure to hit up , it’s freakin them in court with around a mere 40 posts. Halting these super zombies has to be the first order of business (put the damn thing into receivership already! yeesh)

  • This deserves to become a chapter in Jarred Diamond’s “COLLAPSE, How Societies Choose to Fail or Survive”.

    Even the language of economics has been corrupted to the point it is unsafe to use, the propaganda of politics has destroyed its utility. Without communicative tools, repair of complex systems becomes improbable. Without education, the population is incapable of reasoned decisions. The world awaits its next demagogue promising easy answers. That outlook is not pleasant; the Dark Ages will look well lighted.

    There is slight comfort in knowing the economic sharks have as the only remaining resources to feed upon, those families possessing great wealth, wonder how their gated communities will protect them then, there will be no middle class to provide protection.

  • Numerian, your indispensable voice never ceases to enlighten. This is the most comprehensive and honest review of U.S. capitalism and the financial markets I’ve read yet.

  • … that Obama may be smarter than this. But it is only hope – there is no evidence to back up the scenario. So in the best possible and most hopeful scenario of my dreams Obama just bites the bullet to buy time. In order to get world trade going again (and also counting on this getting him through reelection) his administration decides to reinflate the broken banks just to crack down on them once the danger of an complete credit freeze has passed. World trade was seriously impeded because letters of credit were no longer issued. Remove this transmission mechanism of broken financial institutions into the real world and this thing can be much better contained. My hope – and again this is only a hope – is that this is what his policies are about. Of course this doesn’t change anything about the huge price tag that the US customer will have to shoulder as you so expertly detailed.

  • Go to Juarez, Mexico and look around.

    In the midst of hundreds of thousands of shanties made of discarded pallets, pieces of tin, cardboard and tar paper, you’ll find unbelievable mansions. The latest sports cars, fancy clothes, jewelry, pretty women and slick men.

    Cops protect these zones–insure that the farms and the stores that supply them are also protected. They get the fuel, the latest machinery–the airports bring in the European luxury items. Everyone else gets priced out or denied access to these places.

    Life that would make Sodom look tame carries on outside of the safe zones. Maquilas surrounded by razor wire fences provide bare subsistence jobs to the poor but getting to the job requires navigating predators of all stripes–a veritable hell on earth.

    1600 murders in one year, and these are those they bothered to count. Believe me when I tell you there were hundreds more that went unreported.

    I did inhale.

  • Just to be sure that their heirs are protected, these filthy-rich bankers will want to do away with the estate tax. They already have it moving that direction in the Senate, step by step.

    They want to take your taxpayer money and they don’t want to give any of it back.

    Thanks for lucid, straight-forward analysis, it is set at just the right level of complexity for your audience.

  • has described this as the Tape Worm Economy. A tape worm has the ability to make the host hungry for what is best for it.

    It seems to me that GS is the goto bank because it has most intimately served the interests of the “deep state.” No president dares to ignore it or worse threaten it or else that person could not be president. Indeed, the deep state is seen as essential to what we have been used to call the American Way of Life. Without it, we go down. Obama “knows” this and believes it in his heart of hearts. It has to be preserved and maintained at all costs.

    Numerian, yours is a very nice critique, and this kind of thinking will be consigned to the “blogs” which our president has told us he does not bother to read.

  • When the financing tap is finally shut off by the bond markets

    in the context of reserve currency?
    and do it slowly, for us rubes:)
    I’m pretty sure this will be a multi-part question.

  • New Manhattan Office Building.

    Last four paragraphs:

    Both the state and city are providing financial support towards the $1.8 billion project cost. A total of $1 billion in development cost is expected to be financed through the Liberty Bond program, a joint City-State financing program. The bonds are issued by the New York Liberty Bond Development Corp., which approved an inducement resolution for the project today.

    Goldman Sachs is negotiating a ground lease for the site through 2069 with the Battery Park City Authority. The ground lease is expected to provide for up to $13.4 million NPV in sales tax exemptions to be earned through job growth in excess of 9,413 jobs, as well as a program of payments in lieu of real estate taxes offering real estate tax savings similar to those available on an as-of-right basis to other developers of commercial facilities on eligible privately-owned sites in Lower Manhattan.

    Goldman Sachs will also be eligible for Con Edison Business Incentive Rate energy discounts worth an estimated $10.3 million NPV over 15 years for use at all of its Lower Manhattan facilities.

    In addition to the building project, Goldman Sachs is eligible to apply for up to $25 million in Job Creation and Retention Program (JCRP) grant funds based on the retention of a minimum of 8,100 jobs and the creation of 800 new jobs in Lower Manhattan over the next five years.


    Does any other business get the financial support from government sources that GS does? They’ve turned fleecing taxpayers from being illegal to a respectable art form and without having to wear masks while doing so–in fact, what they wear is likely custom-tailored.

    hmmmm….that link is from 2004…it must now be occupied by thousands of GS employees and executives. Yep…the tower was built in Battery Park, New York probably at great expense to the taxpayer. The link lists some of their alumni.


    Numerian–you’ve outdone yourself! This one I’m saving for posterity.

  • Their cash flow and general financial situation is so bad that they cannot issue municipal bonds to the general public, except at extremely high and punitive interest rates. What they recently did, though, is issue bonds privately through Wall Street investment banks who found investors willing to buy them. The banks are desperate for business and they convinced California to pay a higher rate, but it would not be as high as if they went to the public market.

    The US at the moment presents conflicting impulses to the market for Treasuries. For one, so much new paper is being offered and is planned in the coming months that under normal circumstances prices would go down and interest rates would therefore go up just to get investors (who probably own more than enough Treasuries already) to fork over money to buy yet another round. Because of this, we hear major buyers like China fret publicly whether they already have enough, and if you own a lot of Treasuries, their value goes down as prices go down with each new offering. China could see its investments lose 10, 20 or 30% in value (a mark to market loss) as this new paper is sold.

    Then there is the second impulse, a flight to quality. The Treasury market is the biggest and broadest debt market in the world, with lots of liquidity. Unless you are China or Japan, most investors can liquidate their holdings pretty quickly if they wanted to. Also, the US still has a AAA rating so it is considered the safest investment out there. This impulse leads panicky investors worried about their money in banks to pull this money out and buy Treasuries for safety. In other words, just as the US starts to issue much more paper in the market, the panicky investors are there to pick it up as fast as possible. They are selling stocks, bank CDs, corporate bonds, and other risky paper to get into Treasuries.

    The financing tap is shut off when the second impulse dies out. Without the panicky investors buying Treasuries, there aren’t enough people out there to absorb the new paper. Prices for Treasuries will inevitably go down and yields will go up. The move could happen overnight really, with a sharp increase in interest rates in the US happening suddenly. This would be very bad for our economy. It is hard enough for most people to get credit, but to make the cost higher would be deadly.

  • yes. morgan stanley.
    we do have a bi-partisan system, you know. it has always been thus.

    a couple of months ago I tried to tell the investment guy at my local bank branch that I wanted to buy bonds in his company, JP Morgan Chase. you know this dumb ass could only recommend bond funds managed by Chase? I had enough that I could have got some bonds, but noooo, I gotta deal w/ the small-brained, but if I had had 100 million $, I could have talked to someone who knows something. then again, I’m not sure if $100,000,000,000 is enough to buy good information lately.
    anyhow, GS is saying it’ll be a bad summer, but I don’t know what they’re saying in public these days. plus, they trade against their own traders, the sneaky bastards 🙂

  • (what are you doing up so early?)

    this has happened before, the banks have been insolvent, former Fed Chief ?(the one before Greenspan, I can see him, but can’t remember his name), jacked interest rates sky high
    why would it be deadly this time, if it didn’t kill us last time?

    (you can skip the part about being businesses being dependent
    on credit flow, Oct 2008 should have seperated most of the wheat from the chaff, and targeted stimulus will take care of critical industries)

  • The above description is appropriate for an everyday country which does not issue and manage the reserve currency of the world – the currency which acts as a global currency for trade and investment flows.

    The theoretical benefit of the reserve currency is often described as an ability to issue the currency – in other words Treasuries – at no cost to the issuer. This is not entirely true. The current size of the Treasury market is huge partly because the world needs a reserve currency and the US can go into considerable debt to provide it. In fact, the whole dual-impulse conflict at play right now is a direct result of this reserve currency phenomenon. Foreign investors are flocking to the reserve currency for perceived safety and consistent liquidity.

    But it is not true that the US enjoys an unlimited ability to issue all the Treasuries it wants, especially if it is doing so to continue living beyond its means, rather than raise taxes on its citizens to pay for things the US desires (like a global empire, or to finance a huge persistent trade deficit). At some point, the investors of the world see that the reserve country is profligate and taking undue advantage of its reserve status to live well and stuff everybody else with Treasury paper that is inevitably going down in value due to oversupply.

    This is precisely the nature of the complaints from China, and the reason why China and Russia are exploring an alternative reserve currency. They fear the US has botched its job as steward of the world’s reserve currency, and something more stable is required.

    They are right. As long as the US keeps on this path, especially running international deficits of a trillion dollars a year, and running domestic budget deficits of a further trillion or so dollars a year, it is inevitably going to lose its status as the reserve currency issuer. How fast this occurs is a matter of how irresponsible the US remains, and what alternatives there are (not many at the moment, but you can bet China is planning on taking on this role ten or twenty years from now; it is already negotiating with its trading partners to skip the dollar and start paying for goods in Chinese yuan).

    I would add that in the long scheme of things, the US was not very responsible as a reserve currency issuer from 1970 onwards, when Reagan started us on a path of massive government deficits to pay for a bloated military empire. By 2000 the federal budget surplus left the US in a position to fix some of these deficits, which is why the lock box discussion between Gore and Bush was so important. Unfortunately, the electorate didn’t understand the importance of that argument. The collapse of all fiscal discipline once Bush got into office has with high likelihood condemned the US to losing its status as the sole reserve currency issuer. This will be another of Bush’s lamentable legacies. Once this status is lost, the final blow will be the demand by OPEC to receive payment for oil in euros or yuan, not dollars. At that point the US will face a potential double whammy, higher oil prices in the long run, and a depreciating currency that adds 10% or more to the cost of energy as the currency slips against the euro, yuan, etc.

  • whose army occupies most OPEC nations, whose navy is off their shore? hmmmmm? who’s got their foot on the throat of the largest proven oil reserves, (which isn’t saudi arabia any more)?

    question #4
    do you see where my questions are leading yet?

    to be serious for a minute (I’m going on vacation in a few hours, just in case you miss me :),
    thanks for taking the time to write it all out in such a clear and concise manner, you truly have a gift. and if you were on my itinerary, I’d bring ya a pie (if I could get it past the TSA).

  • Any time you can take a cash flow, price it, and then sell it, you equity mine in Numerian’s sense. You even do it when you trade a treasury bond. A T-bond is a cash flow, priced to yield a return.

    The problem is that we have trained a couple of generations to price all cash flows this way. Yet most cash flows are speculative. Pricing them with models does not make them any less so.

    When financial institutions first started doing treasury strips, a mind set began to develop that did this for lots of things. There appeared more and more complex instruments and derivatives on speculative cash flows.

    You now have many asset classes with varying quality. At the height of the hedge fund heyday you even had trading methods defined as asset classes with forecasted returns.

    So you arrived at the meaningless.

    The risk free asset that is a cornerstone of modern portfolio theory(along with the efficient portfolio) has become meaningless without the government guarantee, the quality of which now is itself suspect, as Numerian points out.

    You no longer have seed corn. You have husks and a financial class still trading them.

    This was not inevitable. Public pricing of all assets would have prevented the speculation from going too far. Marking to model would have been gone as a pricing force.

    Preventing off balance sheet activity, of the Enron sort, that now pervades the system, would have also prevented this. Transparency would have prevailed instead of fraud.

    All that remains now is a kind pervasive fraud, which is not capitalism and never was.

  • but- yes, other companies(if they are still in business) get it as part of the drive to keep them in NYC- job loss to New Jersey is conceived of (and may well be) as worse than no subsidies.

    Not that lots of the back office and the jobs that come with it (there are employees who are not partners or quants) hasn’t been moved to NJ anyway, perhaps including that proposed tower- I have not kept up with the very convoluted real estate locations.

    It’s a bidding war between NJ and NY basically.

    (disclosure- I used to work (in IT) for GS for many years until 2002)

    GS was much smaller and lower-profile, though never low profile, when it was a privately held company (until the millenium and acquire.acquire,acquire)

    (Sorry about all the parentheses:-) )

    Really good article, Numerian.


    I feel the American worker has been sacrificed to the capitalist idols in the ancient Mayan fashion. – Sue Lamb, NYT reader

  • When a young married couple save up for several years for a downpayment on their first home, such savings coming from their disposable income, and when the points paid on the mortgage come as well from their disposable income, the bank extending the mortgage is not equity mining. The cash flows comes from the income statement of the consumer, not from a balance sheet.

    The home equity line of credit was specifically designed to allow the consumer to exploit and convert into cash the equity built up in their home. The mortgage was a second mortgage, and banks must have been pleasantly surprised to discover how easy it was to take points at each refinancing. The consumer didn’t notice or care because the fee came from their equity. The banks even encouraged the consumer to “take some cash out” for themselves – we all heard the commercials making precisely this point. The consumer could take out $25,000, and the banks a further $5,000 or more with no pain being felt by the consumer. The additional debt they took on was buried in the documents, and what was constantly emphasized was the reduction in monthly payments on the mortgage when all was said and done, courtesy of Alan Greenspan.

    This is equity mining. The points and fees removed from US housing stock from 1996 to 2007 were in the hundreds of billions of dollars and accounted for the considerable profits of the banking industry at the time. The consumer, of course, took out trillions.

    This process applied as well to the liquidation of equity on corporate balance sheets in exchange for debt – the leveraged buyout, leaving companies drowning in debt and prone to default in a recession (as is happening now). In both cases, the banks treated the cash flows emanating from the debt as their source of fees or interest payments, and declared them as income. Equity balances converted to cash converted to income – that was the process.

    So I wouldn’t say any cash flow is equity mining, just the cash flows released from capital accounts on a balance sheet and replaced by debt. Even in a healthy economy such things happen, but most income is generated “properly” from the sale of goods and services, including employment services rendered by the consumer. In the unhealthy economy the US has been running, the cash flows emanating from equity mining began to dominate and define the economy, even setting off a spending boom and a housing bubble wherein further cash flows would be generated from the new equity created by the bubble. That’s when things really got out of hand.

  • A bubble is still a bubble, even if it sucks of the entire world’s economy.

    Yes, they have their foot on the accelerator, they can’t take it off either and an enormous pile up is going to happen, probably sooner, rather than later.

    Call me an optimist, but I think they are killing their own golden goose and some good can come of this. Essentially the model goes to the foundations of private central banking designed to siphon wealth from and bend the larger economy to do its bidding. After three hundred years, it is truly reaching the limits of wealth extraction from the entire world and the people running it are more true believers, or at least dependent on true believers, than they are the sociopaths required to do this consciously. Banking isn’t a private enterprise. It is the management of a public utility, the monetary system. If you review the history of how monetary systems evolved and how they came to be privately managed, it is quite logical, because it was effectively invented by a series of individuals, starting with the Rothchilds, but I think it will be time to simply declare that the patent on the management of money has run out and it is now a public function. Political power started as a private business and evolved into monarchy. The monarchists ranted about mob rule and while it took a few centuries, monarchy has been replaced by reasonably effective methods of making political power a public trust.
    Everyone talks about torches and pitchforks, but all that really needs to be captured is the media. If the media can be turned, the bankers are history. Obviously the powers that be know this and would resist it, but there are cracks. Jon Stewart is willing to tear John Cramer a new one, but what he needs to do, is to start offering alternatives, not just making fun of the flaws in the current system. There are a fair number of prominent thinkers and economists he could start interviewing as a way to build up momentum. Obviously Numarian would be a good choice of the members of The Agonist, but he might have to write a book to get the attention. Some more public names come to mind, Bernard Lietaer, Michael Hudson, Ellen Brown, Karl Denninger, etc. Getting a few of these people on something like the Diane Rehm show on public radio, might be another possibility. Getting some of the larger web sites, Daily Kos, TPM, etc. to join together on a forum might be another possibility. Don’t they have a big convention every year? Maybe making alternative economics/monetary systems the main theme, since it is a between election year. Take out an ad and post an editorial like Numerian’s essay in some big paper.
    Anyone else have ideas?
    There is the potential to build something better. It just takes work.

  • but we are already on the new medium. right now. get it in more hands.
    out of work people have lots of time to improve themselves. start infecting porn sites with knwoledge of calculus and history(it’s older than 300 years) and we may get somewhere.


    take over, I’m on vacation and doing a lousy job anyhow.

    btw, it’s only our perception of reality that is binary, but that’s as far I will go.

  • I did a quick readthrough of the thread. It seems to be going in the right direction. The problem is in evidence though. With any complicated topic, it’s easy to get sidetracked and lose audience. I try to stick to making simple, bumpersticker type points. They might seem facile, but when the situation really falls apart, it’s what the most people remember that counts.
    Point 1) After thirty years of supply side economics, we need to start paying attention to the demand side.
    2) Economics 101 is supply and demand. With capital, the lender is the supply and the borrower is demand. We can’t just take whatever everyone else has left to bribe the lenders to let us borrow some of the money back, so that we can pay them more interest!
    3) Money really is a public utility when it is supported by taxes and not based on commodities. Therefore the public has the right to exact whatever taxes it wishes on those holding a form of public property. Not just borrow it, at interest.
    4) This has been going on a long time. How did Volcker cure inflation with higher rates, since this raised the price on capital and caused a recession, thus reducing the demand for the over supply of capital he was trying to solve? Reagan’s deficits are what really cured inflation, as they were both direct demand for capital and indirectly created further demand for capital in the private sector. Yet all the economists of the time could think of was that the government was competing with the private sector for capital.
    4) Money doesn’t fuel the economy. It lubricates it and progressive taxation serves as an oil pump to drain surplus capital from pools of wealth to lubricate the moving parts of the economy that don’t have a natural cash flow. If we don’t tax excess wealth, than we have to keep issuing fresh money and this reduces the value of all money, as well as effectively destroying the economic process as surely as the lack of money.
    5) If its benefits don’t flow down at close to the rate which assets build up, eventually the cycle of wealth creation stops. Trickle down is not enough.
    I could go on, and on, but that’s the idea. We need the same sort of bullet points used to promote this mess in the first place, not long involved conversation. The crisis is here. We can’t let it go to waste.

    An added benefit is that if we understood money as a form of public commons, our natural greed would cause us to resist monetizing all possible value out of our communities and environment to put in a bank in the first place. That’s how to leverage a healthier society and environment out of the situation.

  • Legalized loan sharking was pushed through Congress a few decades ago by the banking lobbyists, and it has contributed to the debt enslavement of many Americans. Just what would we lose if we banned predatory interest rates? A healthy society protects its weaker members rather than feeding them into the mouths of financial sharks. It is past time for America to heal the sickness of its predatory financial “industry.”

  • it’s been a while now, right? hasn’t “money as public utility” been your mantra for some time? perhaps I think of someone else
    but this is where SP is correct about the need for education. folks need a grasp of the basics and where the basics have gone wrong, otherwise it flies over their heads or they are liable to be taken in by sophistry masquerading as education. (or worse CNBC, where they don’t even recognize that they’re lying)
    we all need to get on the same page and we all need to be heard. we learn from experience and each other.
    so you’re in, whether you want to or not 😀
    the meme (to use a linguistically challenged word) is building as we speak

  • I am not an historian but I love history and your take on history is troubling. Banking has been a part of advanced economic cultures much earlier than the Romans but it was the Romans that left the best written records, mostly preserved in their biographies of the prominent actors. Crassius, a wealthy merchant was to use “banking” to build for himself a political base that rivaled Pompey’s and Caesar’s wealth derived from military spoils and became a member of the first Triumvirate that led to the end of the Roman Republic. (Rubicon by Tom Holland provides excellent narrative of the period). As the Roman empire broke up, the resulting city states contained a Jewish population, many Jewish Quarters are still in evidence in cities throughout the region Rome ruled. The Nascent Roman Christian Church allowed “racial prejudice” to flourish at the expense of the Jewish inhabitants, Shakespeare has preserved this in his literature most adroitly. The beginnings of modern banking actually had their start amongst the Jews as a means of providing economic protection from an adverse social environment, through the loan of goods, tools and money to those falling victim to their Christian neighbors, the return of loaned goods, tools and money required no interest for the loan but an additional sum to repay the risk of loss. Later this was expanded as a means of funding mercantile adventures. If you have never read the history of the beginnings, the rise, the power, and the dominion of the Florentine Medici family it provides a brilliant example of a merchant family entering into banking and the results, one of which was the Renaissance, would not have happened without “private banking”. Much later on, another Jewish banking family you mention, various branches spread throughout the major power blocks in Europe, were able to assemble a consortium or syndicate of resources that enabled the Rothchilds to fund (privately) the military aspirations of European royalty, richly repaid for the risk being taken. The Dutch in their military adventures had a wealthy merchant class that supported and profited from the martial exercises (privately), “An Embarrassment of Riches” by Simon Schama is a good narrative for this. The Rothchilds became the (private) bankers to all of European Powers (and German princely states). Private banking paved the way for the advent of international trade on the European continent and was probably the fundamental force behind the Age of Enlightenment that the wealth brought to European societies. IIRC the Bank of England creation was a result of a South Seas (speculative) Bubble, the bank was established 1694 by a private consortium which loaned the Crown £1.2 million (read Wikipedia for the details of the contract) and look into British history for the appropriate war being financed by private subscribers. Since the bank has become the publicly owned central bank for England, but well after the private bank financed the acquisition of the British empire as a private entity.

    Your straw-man narrative of banking, “Essentially the model goes to the foundations of private central banking designed to siphon wealth from and bend the larger economy to do its bidding. After three hundred years, it is truly reaching the limits of wealth extraction from the entire world”, your beginnings, “If you review the history of how monetary systems evolved and how they came to be privately managed, it is quite logical, because it was effectively invented by a series of individuals, starting with the Rothchilds …”, and your conclusions, “Political power started as a private business and evolved into monarchy. The monarchists ranted about mob rule and while it took a few centuries, monarchy has been replaced by reasonably effective methods of making political power a public trust.”, are at best rot reserved for conspiracy theorists and display a remarkable lack of talent for understanding history, furthermore, they mislead and misdirect people away from real necessary facts in knowing the development of institutions.
    I wish you loved history more.

  • but I think it’s an idea worth repeating.

    While it occurred to me back in the ’90’s, I’ve found it’s a basic concept in economics, in that money is store of value, medium of exchange and accounting device.

    As a store of value, it is a form of private property, while as medium of exchange, it’s public utility. The problem is that by storing excess amounts, more has to be issued and a negative feedback loop starts.

    I understand why the idea doesn’t get much traction, as most people take the old meme as a given, but having watched the bubble grow for the last thirty years, I’ve given a bit of thought to what will happen when it pops. At least Hoover left Roosevelt with a solid currency, but this time the currency is being thrown in the fire as well, so we have to rebuild and therefore rethink, the monetary system as well as the financial system.

    Real growth is bottom up, not top down and grass roots movements run on basic ideas, not complex analyses. So If I seem repetitive, it’s just to seed an idea.

  • I have very thick skin.

    Actually it’s a lot older than the Romans;

    “When I began to study the economic origins of modern civilization in the ancient Near East, I was struck by the degree to which the exercises taught to Babylonian scribal students c. 2000 BC were in some ways more realistic and even more mathematically sophisticated than the neoclassical models taught today. For starters, the rate of interest was expressed as a doubling time. A model Babylonian scribal exercise from circa 2000 BC, for instance, asks the student to calculate how long it will take for a mina of silver to double at the typical Mesopotamian rate for commercial loans, one shekel per mina per month – that is, 1/60th per month, 12/60ths per year – an amount equal to 20 percent in modern decimalized terms.[1] The answer is five years. This was the normal time period for backers to lend money to traders. (Assyrian loan contracts from about 1900 BC typically called for investors to advance 2 minas of gold, getting back 4 in five years.)”

    As for the conspiracy part, I was just cribbing off Rushkoff;

  • the repetitive re-seeding worked on me!

    now might be a good time to re-post Revolution Happens in a few places about town. timing is everything? 🙂

  • you guys do the arguing. but this history of banking/lending/money interests me greatly, because there seems to be only conspiracy theories and/or victor’s history. both are very neat little packages of information. neither is very comprehensive or encompassing.

    it is unfortunate that historical economic study has been neglected in favor of teaching ‘belief in the miracles of infinite growth and maximization of profit’ .

  • and positive feedback. I haven’t been pushing it all that hard, because I feel it is an idea whose time will come, no matter who pushes it, when all else has failed and not until all else has failed, because the powers that be and those who believe in this system have to see that it really is broken. My sister is a banker, wealth management for Northern Trust, as well as some friends who work here in Baltimore and they just do not see how compromised it is. Look at Obama. It doesn’t take a total genius to see the financial sector has become a real cancer, yet he is going along because that is the system and he is a believer in the system. As it is, I’m open sourcing the idea, so if you have any thoughts on where to take it, tie it into other movements, other conversations, etc. you’re welcome to work with it.

    Besides which there is work, family and other crank projects;

  • This one comes courtesy of the Federal Reserve – ZIRP, or Zero Interest Rate Policy. Bernanke keeps extending the promise to preserve zero interest rates farther into the future. The current promise is through next year.

    I’ve been noticing more and more business writers focus in on the deleterious aspects of this policy. It is killing off all interest income for anyone who has saved any money – that would include seniors or those facing retirement, endowments, pension plans, insurance companies, and so on. With no interest income, many of these players are forced to eat into their capital to cover daily expenses, which is especially bad when inflation is over 4% p.a. in some commodities (courtesy of something else the Fed has done, which is its Quantitative Easing programs).

    The beneficiaries of this policy are the banks, and the Fed says so directly. This is a program to allow the banks to borrow at the Fed at zero percent and lend to you at 4% for a mortgage or 30% for a credit card. Unfortunately the banks aren’t lending for a lot of reasons: not enough good credit customers, too many bad debts already, not enough capital at the banks to risk expanding their loan portfolios. So the banks borrow at zero percent and invest it in US Treasuries. That gives them 2%, which is better than nothing, and it is free money totaling billions of dollars of revenue each quarter.

    This is also an indirect transfer of wealth from savers to the banks. It signals to the economy that the Fed doesn’t value savings, even though the country is running terrible deficits and is in desperate need of savings to finance growth. It encourages savers to speculate in the stock market to try and make up for the lost interest income. Of course, they are doomed to losses, especially considering how rigged the stock market has become with High Frequency Trading computers able to extract equity from each transaction.

    These are the sorts of policies that would horrify our grandparents, who learned that speculation usually ends in large losses, and debt needs to be avoided unless absolutely essential (and should never be used to finance consumption).

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