The Result of Government Interference in the Financial Markets

Back before the Bush/Obama recession of 2008-09, Rep. Barney Frank (D-MA) became chairman of the House Financial Services Committee, joining Sen. Chris Dodd (D-CT) who became chairman of the Senate Banking Committee. These two morons believed that the banking system unfairly deprived many Americans of the opportunity to own their own homes. (At that time mortgage lenders required required borrowers to present proof of income sufficient to pay the monthly mortgage payments and to invest twenty percent equity when purchasing a home.) They used their offices to force lenders into providing what became known as “sub-prime” mortgages – no verification of income and no equity. The result was a rapid rise in the price of housing – the free mortgage money created a demand in excess of supply. It also fueled a rapid escalation in the construction of new homes – again free mortgage money caused demand to exceed supply. (For those of you who were forced to endure a teachers union led education in the Portland Public Schools, when demand exceeds supply prices go – the bigger the gap, the higher the increase.) It didn’t take long for many of those sub-prime loans to go into default because the borrowers either could not or would not pay the installment payments. That translated into massive defaults on existing homes and suspended construction of new homes – the housing market crashed. Along with that came a widespread financial crises as investors began to understand that financial institutions were hiding their risk from subprime loans by bundling them with good loans and selling them at discounts to would be investors. The whole thing collapsed and banks began to fail. That was the direct and proximate cause of the Bush/Obama recession of 2008-09 which took us nearly a decade to overcome.

Does any of this sound familiar? Congress and the president interfering in the financial markets to effect a social objective then ultimately succumbing to the reality that the market cannot absorb unfunded social experiments.? But politicians never learn. Primarily because many of those politicians are people who you wouldn’t hire to make change at Starbucks for your grande, half and half, one-pump vanilla chai iced latte – but now they are in charge of telling our financial institutions what to do.

So where are these two morons today? Well, Mr. Franks is on the board of directors for Signature Bank which was seized over the weekend because of probable insolvency and Mr. Dodd is a high priced lobbyist for – guess what – the banking industry. Proving once again that the financial industry is more than willing to trade incompetency for political influence.

But back to the present.

The big financial news last week was that the massive Silicon Valley Bank (SVB) has failed and that the Federal Deposit Insurance Corporation FDIC has seized the assets and operation of the bank. According to Forbes, SVB recently reported an asset value of $212 Billion and was the major banking organization for much of the Silicon Valley tech firms – particularly the start ups that populate Silicon Valley. Because these start-ups do not produce any net income they rely heavily on banks and private investment for money with which to pay their current bills (salaries, rent, utilities, supplies, etc.). The demise of SVB will result in the closing of a hefty number of start-ups, layoffs, and bad debt for their suppliers.

So what happened? Well, there is “what happened” and then there is “what caused it”. What happened is that there was a “run” on the bank. Businesses began to withdraw their deposits from the bank. The accumulation of demands exceeded the bank’s current available funds. That in turn required SVB to liquidate its “reserve” funds – primarily federal government bonds. And that is when things turned to guano instantly. And here is why.

The Federal Reserve Board requires federally chartered banks to maintain a particular level of “reserves” and further imposes restrictions on the quality of those reserve funds – in other words funds that are relatively liquid with a low degree of risk. Let’s remember who and what the Federal Reserve Bank is. It is a federal agency appointed by the President of the United States and confirmed by the United States Senate – they are drawn primarily from academia, federal regulatory agencies and those banks that engage in revolving door policies with the federal government. They are in essence federal bureaucrats beholden to the politicians for their appointments and their funding.

It is currently chaired by Jerome Powell. He was initially appointed to the Federal Reserve Board by President Barack Obama. He was appointed chairman by President Donald Trump and reappointed by President Joe Biden.

The two biggest roles of the Federal Reserve Board is that it creates “new money” with which to buy the federal bonds that are required as succeeding administrations and Congress spend in excess of available revenue; i.e deficit spending. In order for the federal government to create cash to pay for expenses in excess of income, the Treasury Department issues federal bonds which are supposedly secured by the “full faith and credit” of the United States government – a grossly suspect assurance given that the federal government is borrowing money to fund its current and recurring expenses. The Federal Reserve then purchases those bonds by printing new money.

The second role is, as noted above, that it requires federally chartered banks and other financial institutions to maintain a particular level of “qualified” reserves. Not surprisingly the financial institutions subject to that Federal Reserve are encouraged – directly and indirectly – to purchase federal treasury bonds because they are “deemed” to be secure AND you can purchase them from the Federal Reserve which just printed new money to purchase them from the Treasury Department. And you thought that Bernie Madoff and Sam Bankman-Fried were the only snake oil salesmen in the financial world.

So these financial institutions were sitting on a ton of federal treasury bonds purchased back in the days before Mr. Biden assumed office when inflation was running below two percent and treasury bonds were yielding was between 0.9 and 1.9 percent. Today treasury bond yields are about 6.9 percent – a best case scenario of a five percentage points difference. That means that it would take $3,630 invested at 1.9 percent to equal the return of $1000 invested at 6.9 percent. Which in turn means that your 1.9 percent $1000 bond is currently worth only $275 – so much for a “secure reserve.” Multiply that by the millions held by banks and investors and you have a real problem. It is dire unless you can hold the bond until maturity when you will, in fact, get your $1000 back. But its current worth is only $275 which is all that matters when these financial institutions are called up to pay up on requested withdrawals. (Side hint: If you don’t need access to your money for a period of time for the bonds to mature, they would be a heck of investment.)

So who is to blame here? First and foremost Mr. Obama, Mr. Trump and Mr. Biden along with members of Congress for approving $24.6 Trillion in deficit spending since the beginning of Mr. Obama’s terms until today which leaves us at in excess of $31 Trillion in debt. Second it is the Federal Reserve System that printed the money to purchase those deficit bonds and then imposed their repurchase on the financial institutions in the name of “quality reserves. And finally, it is the financial institutions who failed to manage their reserves as they watched interest rates climb from 1.9 per cent to 6.9 percent knowing full well that every point of increase reduced the current value of their reserves and their underlying capital worth.

For those of you who believe that everything the federal government touches in pursuit of social restructure turns to bat guano, these are proof positive. And the worst part of it is that this is just the tip of the iceberg. We are a nation ruled by an idiocracy.