The 2015 Financial Meltdown & More

This week, I had the pleasure of being interviewed by Greg Hunter at USA Watchdog regarding my thoughts on the state of the global markets, economies and commodities into 2015.  Here are some key points we covered. For more detail, please check out the video of our interview here.

1) On the Market Meltdown: When I spoke with Greg about 9 months ago, I said that based on logic and the political-economic history I had explored for All the Presidents’ Bankers, there should have already been another major implosion following the 2008 financial crisis. However, there is an element of history that is unprecedented and which has acted as a barrier, albeit tenuous and fabricated, to another full-blown, transparent crisis. The scope of the zero-interest-rate policy and QE programs that emanated from the US Federal Reserve and have unfolded throughout the world are artificially bolstering market and financial interests as populations falter. In the US, this has been greeted by proclamations of economic victory from the Obama administration. In Europe, it’s harder to tweak the employment stats enough to declare the same thing, and hence, official QE programs there are ongoing. At any rate, this prolonged policy of injecting cheap money into the banks and markets, funded by the public due to the very nature of debt-creation and the purchasing of government and asset-backed debt securities, now surpasses any past measures of such activities in terms of scope and length.

The fact that these policies lasted for six years has inflated and distorted bond and stock markets, as well as the books of the world’s largest financial institutions to such an extent, that inherent ‘value’ in any of these areas is impossible to determine. We are living with the instability of a system that is supported by central bank maneuvers and the leveraging of them, not by anything organic or independently sustainable. Because rates are so low, any establishment with access to this cheap capital, or that has other people's money to burn, is creating bubbles by reaching for returns anywhere - in government bonds, stock markets, leveraged loans in debt-intensive firms like oil and gas, and in complex derivative products consisting of currency, commodity and credit elements.

The idea of funding the entire financial system with no exit plan for any non-crisis producing dissolution or resolution for such support boggles the mind.  This global QE period is larger and more insane that ever in history.  Because SO much cheap money is sloshing around the system at its top echelons, not through the real economy, the false appearance of stability has been perpetuated longer than logic would dictate.  But since global QE is not yet over, its benefits will continue to accrue to the same institutions that are already benefitting from it (the ones that leverage capital or sell bonds) until all the QE plans are over - not tapered, but unwound and done. While this transpires, a meltdown will unfold, but slowly. Meanwhile, this next phase of ECB QE will provide markets and banks more temporary solvency. So will the Bank of Japan’s money supply expansion and the People’s Bank of China version. 

2) On Volatility:  Market and economic volatility will increase this year – punctuated with media headlines like ‘unexpected’.  Last year, we had volatility spikes in August, October and December.  This year, we’ve already had spikes in January.  So, the shocks are coming in more closely and the downsides are deeper.  That’s why we are in a transitioning down period.  At the end of this year, we will have a lower bond and stock market.  The financial system will start to unravel more visibly and in a more sustained manner. The Federal Reserve won’t raise rates (or if they do, it will be at the end of the year, and only once, as it will have a brutal impact) because there is no reason to. Real inflation of people’s costs of living might be higher, but with global QE keeping a lid on rates and a boost on bonds, and with the dollar still strong, Janet Yellen will just continue using terms like ‘patiently.’ Every time major market participants get remotely nervous, the market will dump, and the next FOMC meeting’s language will be conciliatory to assuage the nerves of this flawed system.

3) On the US Dollar: The reason the dollar has remained strong, and the reason it will continue to stay strong for now is not because the ZIRP and QE policies are good, not because so much debt on the books of the country is prudent, and not because our debt to GDP ratio is cost-effective.  Printing cheap money to sustain a system for six years is a negligent policy.  Using money to plaster over a banking system that doesn’t work and has only become more concentrated is not a stability-increasing policy.  Nor has any of this cheap money trickled down to the average person. All those things are horrific.  But, what the dollar has going for it is the unique collaboration and power-position of the US government, private banks and the Fed.  The US had a first mover advantage compared to the rest of the world.  Its QE policies were biggest.  The dollar is propped up artificially by these alliances and ongoing maneuvers. Every other country is doing so badly and will continue to, that the dollar has, and will have, a relatively better value for now.  Eventually, this madness has to play out and the dollar will weaken, but we won’t see a “plunge” in the near term because every other country is struggling. Any downside to the dollar will thus be part of a slower meltdown punctuated by extra volatility.

4) On Gold: The same reason the dollar has stayed strong is why gold hasn’t had a major outbreak to the upside. With so much artificial stimulus and systemic manipulation, the paper-dollar and hard-asset gold are behaving in a zero-sum game relationship where real value or economic measures are meaningless. That said, gold prices will increase this year– but also only gradually, just as the dollar will not dump but will decrease gradually, as all of these QE maneuvers continue to play out.  Again, the stock and bond markets will decline as this artificial aid eventually does, and the movements will be marked by volatility to the downside. But since the artificial aid isn’t actually over, the price direction of everything will remained tempered. We have been underestimating the effect of all the support that has been lavished on the markets and into the banks.  That’s why considering the timing of this next phase is critical. There’s going to be a downward impact on markets.  There’s going to be an upward impact on gold.  It’s just not going to be as huge this year.  It’s going to be a more gradual kind of a year.

5) On the Swiss Central Bank Float Move: The Swiss deciding to detach from pegging to the Euro must be looked at from two perspectives that together characterize the kind of volatility and stab in the dark policies in operation this year. On the one hand, the Swiss rejected the idea of increasing gold reserves last year (indicating, among other things, hesitancy and uncertainty in general,) and the SCB has imposed negative interest rates (as has the ECB.) Both of these move are related to global QE. On the other hand, the Swiss don't want to be pegged to a declining Euro that will result from the next round of more ECB bond buying to be announced by Mario Draghi on January 22nd.  In general, these central banks don’t really know what will happen in the short or long term as these QE and bank-supportive policies play out.  The Swiss can opt out of part of these measures, but have no choice on the rest.  To a large extent, their move was a way to balance both sides.

6) On Ongoing Bank Risk and Concentration: The largest 30 global banks (dubbed “GSIB’s” or globally systemically important banks) control 40 percent of lending and 52 percent of assets worldwide. In the US, since the financial crisis, the Big Six banks’ share of assets has increased by 41.4 percent and their share of deposits has increased by 82.4 percent. Because of the largesse of government and Fed policy, that gets spun as economically beneficial to the American population. The Big Six stockpile of cash meanwhile, which is doing nothing for the public, has nearly quadrupled in size. 

In addition, just 10 US banks hold 97 percent of all bank-trading assets. Of those, JPM Chase holds 43.8 percent and Citigroup holds 24.5 percent.  Then, there’s leveraged loans, the 2010s equivalent of subprime loans. The 2014 issuance of collateralized loan obligations, or CLOs, eclipsed that of pre-crisis 2006, run by the same cadre of big banks. In November 2014, regulators found that 1/3 of the $767 billion loans they examined in their annual bank loan review showed “lax reviews of potential borrowers and poor risk management.” Nothing was done about it. Oil and gas loans ($250 billion of them) remain primed for defaults and catalyzing more volatility. Adding to the risk, the top four US derivatives trading banks (JPM Chase, Citigroup, Goldman Sachs and Bank of America) hold $219 trillion of $237 trillion, or 93 percent, of US derivatives. 

That kind of consolidation, nationally and globally is why we’ve had six years of artificially stimulated markets. Those figures are why the benefits of these policies go to the most powerful players but not to anyone else. They are why instability is here to stay and grow.

Why the Financial and Political System Failed and Stability Matters

The recent spike in global political-financial volatility that was temporarily soothed by European Central Bank (ECB) covered bond buying and Bank of Japan (BOJ) stimulus reveals another crack in the six-year-old throw-money-at-the-banks strategies of politicians and central bankers. The premise of using banks as credit portals to transport public funds from the government to citizens is as inefficient as it is not happening. The power elite may exude belabored moans about slow growth and rising inequality in speeches and press releases, but they continue to find ways to provide liquidity, sustenance and comfort to financial institutions, not to populations.

The very fact - that without excessive artificial stimulation or the promise of it - more hell breaks loose - is one that government heads neither admit, nor appear to discuss. But the truth is that the global financial system has already failed. Big banks have been propped up, and their capital bases rejuvenated, by various means of external intervention, not their own business models.

In late October, the Federal Reserve released its latest 2015 stress test scenarios. They don’t even exceed the parameters of what actually took place during the 2008-2009-crisis period. This makes them, though statistically viable, completely irrelevant in an inevitable full-scale meltdown of greater magnitude. This Sunday, the ECB announced that 25 banks failed their tests, none of which were the biggest banks (that received the most help). These tests are the equivalent of SAT exams for which students provide the questions and answers, and a few get thrown under the bus for cheating to make it all look legit. 

Regardless of the outcome of the next set of tests, it’s the very need for them that should be examined. If we had a more controllable, stable, accountable and transparent system (let alone one not in constant litigation and crime-committing mode) neither the pretense of well-thought-out stress tests making a difference in crisis preparation, nor the administering of them, would be necessary as a soothing tool. But we don’t. We have an unreformed (legally and morally) international banking system still laden with risk and losses, whose major players control more assets than ever before, with our help.  

The biggest banks, and the US and European markets, are now floating on more than $7 trillion of Fed and ECB intervention with little to show for it on the ground and more to come. To put that into perspective – consider that the top 100 global hedge funds manage about $1.5 trillion in assets. The Fed’s book has ballooned to $4.5 trillion and the ECB’s book stands at $2.7 trillion – a figure ECB President, Mario Draghi considers too low. Thus, to sustain the illusion of international systemic health, the Fed and the ECB are each, as well as collectively, larger than the top 100 global hedge funds combined. The BOJ has joined the fray wit its own path to QE. 

Providing ‘liquidity crack’ to the global financial system has required heightened international government and central bank coordination to maintain an illusion of stability, but not true stability. The definition of instability is this epic support network. It is more dangerous than in past financial crises precisely because of its size and level of political backing.

During the Panic of 1907, President Teddy Roosevelt’s Treasury Secretary, Cortelyou announced the first US bank bailout in the country’s history. Though not a member of the government, financier J.P. Morgan was chosen by Roosevelt to deploy $25 million from the Treasury. He and a team of associates decided which banks would live or die with this federal money and some private (or customers’) capital thrown in.

The Federal Reserve was established in 1913 to back the private banking system in advance from requiring future such government injections of capital. After World War I, a Laissez Faire policy toward finance and speculation, but not alcohol, marked the 1920s. before the financial system crumbled under the weight of its own recklessness again. So on October 24, 1929, the Big Six bankers convened at the Morgan Bank at noon (for 20 minutes) to form a plan to 'save' the ailing markets by injecting their own (well, their customer’s) capital.  It didn’t work. What transpired instead was the Great Depression.

After the Crash of 1929, markets rallied, and then lost 90% of their value. Liquidity froze. Credit for the masses was as unavailable, as was real money. The combined will of President FDR and the key bankers of the day worked to bolster people’s confidence in the system that had crushed them - by reforming it, by making the biggest banks smaller, by separating bet-taking arms from those in which people could store, and borrow money from, safely. Political and financial leaderships collaboratively ushered in the reform measures of the Glass-Steagall Act.  As I note in my most recent book, All the Presidents' Bankers, this Act was not merely a piece of legislation passed in spirited bi-partisan fashion, but it was also a means to stabilize a system for participants at the top, middle and bottom of it. Stability itself was the political and financial goal.

Through World War II, the Cold War, and Vietnam, and until the dissolution of the gold standard, the financial system remained fairly stable, with banks handling their own risks, which were separate from the funds of citizens. No capital injections or bailouts were required until the mid-1970s Penn Central debacle. But with the bailout floodgates reopened, big banks launched a frenzied drive for Middle East petro-dollar profits to use as capital for a hot new area of speculation, Third World loans.

By the 1980s, the Latin American Debt crisis resulted, and with it, the magnitude of federally backed bank bailouts based on Washington alliances, ballooned. When the 1994 Mexican Peso Crisis hit, bank losses were ‘handled’ by President Clinton’s Treasury Secretary (and former Goldman Sachs co-CEO) Robert Rubin and his Asst. Treasury Secretary, Larry Summers via congressionally approved aid.

Afterwards, the repeal of the Glass Steagall Act, the mega-merging of financial players, the explosion of the derivatives market, and the rise of global ‘competition’ amongst government supported gambling firms, lead to increase speculative complexity and instability, and the recent and ongoing 2008 financial crisis.  

By its actions, the US government (under both political parties) has chosen to embrace volatility rather than stability from a policy perspective, and has convinced governments in Europe to follow suit. Too big to fail has been replaced by bigger than ever.

Today, the Big Six US banks are mostly incarnations of the Big Six banks in 1929 with a few add-ons due to political relationships (notably that of Goldman Sachs, whose past partner, Sidney Weinberg struck up lasting relationships with FDR and other presidents.) 

We no longer have a private financial system responsible for its own risk, regardless of how it’s computed or supervised. We have a system whose risk is shouldered by the federal government and its central bank entities, and therefore, the people whose deposits seed that risk and whose taxes and futures sustain it.

We have a private financial system that routinely commits financial crimes against humanity with miniscule punishments, as approved by the government. We don’t even have a free market system based on the impossible notion of full transparency and opportunity, we have a publicly funded betting arena, where the largest players are the most politically connected and the most powerful politicians are enablers, contributors and supporters. We talk about wealth inequality but not this substantial power inequality that generates it. 

Today, neither the leadership in Washington, nor throughout Europe, has the foresight to consider what kind of real stress would happen when zero and negative interest rate and bond-buying policies truly run their course and wreak further havoc on their respective economies, because the very banks supported by them, will crush people, now in a weaker economic condition, more horrifically than before.

The political system that stumbles to sustain the illusion that economies can be built on rampant financial instability, has also failed us. Past presidents talked of a square deal, a new deal and a fair deal. It’s high time for a stability deal that prioritizes the real financial health of individuals over the false one of financial institutions.

APB Excerpt: Woodrow Wilson & Jack Morgan July 2, 1913 Secret WWI Prep

This excerpt from ALL THE PRESIDENTS’ BANKERS: The Hidden Alliances that Drive American Power originally appeared on Zerohedge. Reprinted with permission from Nation Books. It discusses Woodrow Wilson and Jack Morgan’s collaboration to finance the Allies in the early days of World War I, illuminating one of the strongest examples of the intimate cooperation between the presidency and the highest levels of private banking.

The Mid-1910s: Bankers Go to War

“The war should be a tremendous opportunity for America.”

—Jack Morgan, personal letter to President Woodrow Wilson, September 4, 1914

On June 28, 1914, a Slavic nationalist in Sarajevo murdered Archduke Franz Ferdinand, heir to the Austrian throne. The battle lines were drawn. Austria positioned itself against Serbia. Russia announced support of Serbia against Austria, Germany backed Austria, and France backed Russia. Military mobilization orders traversed Europe. The national and private finances that had helped build up shipping and weapons arsenals in the last years of the nineteenth century and the early years of the twentieth would spill into deadly battle.

Wilson knew exactly whose help he needed. He invited Jack Morgan to a luncheon at the White House. The media erupted with rumors about the encounter. Was this a sign of tighter ties to the money trust titans? Was Wilson closer to the bankers than he had appeared? With whispers of such queries hanging in the hot summer air, at 12:30 in the afternoon of July 2, 1914, Morgan emerged from the meeting to face a flock of buzzing reporters. Genetically predisposed to shun attention, he merely explained that the meeting was “cordial” and suggested that further questions be directed to the president.

At the follow-up press conference, Wilson was equally coy. “I have known Mr. Morgan for a good many years; and his visit was lengthened out chiefly by my provocation, I imagine. Just a general talk about things that were transpiring.”Though Wilson explained this did not signify the start of a series of talks with “men high in the world of finance,” rumors of a closer alliance between the president and Wall Street financiers persisted.

Wilson’s needs and Morgan’s intentions would soon become clear. For on July 28, Austria formally declared war against Serbia. The Central Powers (Germany, the Austro-Hungarian Empire, the Ottoman Empire, and Bulgaria) were at war with the Triple Entente (France, Britain, and Russia). While Wilson tried to juggle conveying America’s position of neutrality with the tragic death of his wife, domestic and foreign exchange markets were gripped by fear and paralysis. Another panic seemed a distinct possibility so soon after the Federal Reserve was established to prevent such outcomes in the midst of Wilson’s first term. The president had to assuage the markets and prepare the country’s finances for any outcome of the European battles.

Not wanting to leave war financing to chance, Wilson and Morgan kicked their power alliance into gear. At the request of high-ranking State Department officials, Morgan immediately immersed himself in war financing issues. On August 10, 1914, Secretary of State William Jennings Bryan wrote Wilson that Morgan had asked whether there would be any objection if his bank made loans to the French government and the Rothschilds’ Bank (also intended for the French government). Bryan was concerned that approving such an extension of capital might detract from the neutrality position that Wilson had adopted and, worse, invite other requests for loans from nations less allied with the United States than France, such as Germany or Austria. The Morgan Bank was only interested in assisting the Allies.

Bryan was due to speak with Morgan senior partner Henry Davison later that day. Though Morgan had made it clear that any money his firm lent would be spent in the United States, Bryan worried that “if foreign loans absorb our loanable money it might affect our getting government loans if we need.” Thus, private banks’ lending decisions could affect not just the course of international governments’ participation in the war but also that of the US government’s financial health during the war. Not much had changed since the turn of the century, when government functions depended on the availability of private bank loans.

Wilson wasn’t going to deny Morgan’s request. He approved the $100 million loan to finance the French Republic’s war needs. The decision reflected the past, but it also had implications for the future of political-financial alliances and their applications to wars. During the Franco-German war of 1870, Jack’s grandfather, J. S. Morgan, had raised $50 million of French bonds through his London office after the French government failed to sell its securities to London bankers to raise funds. Not only was the transaction profitable; it also endeared Morgan and his firm to the French government.

Private banking notwithstanding, on August 19, 1914, President Wilson urged Americans to remain neutral regarding the combat. But Morgan and his partners never embraced the policy of impartiality. As Morgan partner Thomas Lamont wrote later, “From the very start, we did everything we could to contribute to the cause of the Allies.”

Aside from Jack Morgan’s personal views against Germany and the legacy of his grandfather’s decisions, the Morgan Bank enjoyed close relations with the British and French governments by virtue of its sister firms—Morgan, Grenfell & Company, the prestigious merchant bank in London; and Morgan, Harjes & Company in Paris. The bank, like a country, followed the war along the lines of its past financial alliances, even to the point of antagonizing firms that desired to participate in French loans during periods of bitter fighting.

Two weeks after Wilson’s August 19 speech, armed with more leverage because of the war, Jack Morgan took it upon himself to approach Wilson about his domestic concerns. “This war . . . has thrown a tremendous and sudden strain on American money markets,” Morgan wrote. “It has increased the already pronounced tendency of European holders of American securities to sell them for whatever prices they could obtain for them, and the American investor has got to relieve the European investors of these securities by degrees and as he can.” Market tensions were exacerbated by the fact that European investors were selling securities to raise money. That was a problem whose only solution required the provision of more loans. But there was something else, with more lasting domestic repercussions echoing the trustbusting of the Morgan interest in US Steel.

Morgan argued that rather than encouraging investors to feel safe, the government’s Interstate Commerce Commission, formed to regulate national industry in 1887, was doing the opposite by restricting eastern railroad freight rates and investigating railroad companies. In Morgan’s mind, war was definitely not a time for enhanced regulations against business. And if railroad securities fell in value relative to the loans secured by them, banks would not be able to lend enough to make up the difference. The whole credit system could freeze.

As Morgan further warned, “Great depreciation in the value of these securities” would “throw back to the bank loans secured by them” and lead to a “great tieing up of bank funds, which will interfere with the starting of the new Federal Reserve System, and produce panic conditions.” He concluded that the war “should be a tremendous opportunity for America,” but not “as long as the business of the country is under the impression of fear in which it now labors.” Levying such serious threats, Morgan became the first banker to reveal that credit, the Federal Reserve, the big banks, the US economy, and the war were inextricably linked. Wilson knew this too.

Morgan was especially concerned about the Clayton Antitrust Act, which Congress was considering to strengthen the restrictions against monopolies and anticompetitive practices laid out in the 1890 Sherman Antitrust Act. Having passed the Senate, the bill was headed to a conference committee. Should it pass in its current form, libertarian Morgan believed, it would demonstrate that “the United States Government does not propose to allow enterprises to conduct normal business without interference.”

Wilson took Morgan’s concerns seriously. He knew the last thing the United States needed was a credit meltdown. To avoid such a crisis and placate the bankers, he was already rewriting the Clayton Antitrust Act, but he didn’t admit it to Morgan. Wilson calculated that there had to remain some areas of negotiation to better one’s hand. Though the two argued over interpretation of the bill, a white flag flew between Wall Street and Washington for the time being. Such periods of strife called for allied, not adversarial, relationships between the president and the bankers, and friendly relations would also promote the global power positioning of both parties.

In general, the war meant that the goodwill extended to bankers and business from the president continued, lending protocols included. An October 15, 1914, news report proclaimed, “American Bankers May Make Loans to War Nations.” It was a government decision pushed by the banking contingent that would reverberate throughout the war and afterward, drawing clearer lines of competition among the various Wall Street powerhouses. Though the pro-Allies Morgan Bank sought cooperation with the British, for instance, National City Bank set up international branches around Europe and Russia to compete for future financial power, causing a rift between two of the three biggest New York banks that financed the war. Partly, that rift had to do with the change of leadership at these firms.

Jack Morgan’s friend James Stillman, head of National City Bank, had ideas about the war that closely reflected Morgan’s own: though the war presented numerous expansion opportunities, old ties to the British and French banks had to be respected in the process, their countries supported unequivocally. Stillman’s number-two man—midwestern-born Frank Vanderlip, who harbored a grudge against the eastern banking establishment and Wilson for cold-shouldering him during his presidential campaign—didn’t share the same loyalties. He was less concerned than his upper-crust boss and the Morgan partners about the war’s outcome and openly opposed American intervention until 1916, by which point German-American relations were more obviously battered. Nor did he support British demands that National City Bank terminate dealings with German banks, to which Stillman had responded that in victory the British would remember the banks that helped them.

Thus, at the end of 1914, it was National City Bank that opened a $5 million credit line for Russia in return for the designation of Russian purchasing agent for war supplies in the United States. The Morgan Bank remained true to its pro-Allies position and chose not to be involved in such dealings, while Vanderlip was more detached and sought to strengthen National City’s position for whatever the postwar world would bring.

Stillman was less interested in war-related financing than Vanderlip, who believed it would augment the bank’s position as well as America’s global status. To him, it was important to forge ahead in Latin America and other underdeveloped countries while the European financial powers were busy with their war. That Stillman took some of this advice to heart enabled National City Bank to cover much ground postwar, not just relative to the European banks but also to the Morgan Bank. As Vanderlip wrote Stillman in December 1915, “We are really becoming a world bank in a very broad sense, and I am perfectly confident that the way is open to us to become the most powerful, the most far-reaching world financial institution that there has ever been.” Vanderlip’s views ruffled Stillman’s feathers because of Stillman’s past collaboration agreements with the Morgan Bank. But they also ruffled the feathers of Morgan and Lamont in a way that would have huge repercussion for postwar peace.