by M. Nahum Daniels
If you’ve been wondering about the book I wrote, RETIRE RESET!, we are publishing some excerpts right here on our blog so that you can learn more. Along the way, you will learn why our firm, Integrated Retirement Advisors, was founded: we’re on a mission to help people with retirement!
Here are some excerpts from Chapter 5.
Chapter 5: THE MONEY MAKERS
In the aftermath of the Global Financial Crisis (GFC), governments and regulators have recognized that banking practices were not incidental to the global crisis that almost crashed the world into an economic depression; the failings of a fragile global banking system were at its heart. Indeed, a more accurate account of events might depict a “Global Banking Crisis.” So, after 2008, managing “systemic” banking risk became the focus, containing it became the goal, and internal compliance departments burgeoned, while equity, fixed income and commodities trading desks shrank. Banking processes and culture came under the spotlight and the picture that emerged wasn’t pretty. Many observers were shocked to learn that high-powered bankers were rigging global financial markets.
Protected and Privileged
Criticized for brazen self-dealing, elitist privilege and even criminal misconduct, banking culture has come under increasing scrutiny since the Great Financial Crisis. For malfeasance ranging from manipulating the London Interbank Offered Rate (LIBOR) at which banks lend to each other and to which $800 trillion in global assets are pegged, to price-fixing Credit Default Swaps (CDS), to precious metals and energy trading, dozens of the biggest American and European banks have been fined for restraining competition via secret meetings held by traders to benefit themselves and their institutions.
Years of scandal and allegations of misconduct have taken a serious toll. Battered by an unending barrage of revelations, Americans’ confidence in banks stood at 27% in a June 2016 Gallup Poll, well below the 40% historical average. Whether liberal or conservative, only one in four Americans were willing to say they had “a great deal or quite a lot” of confidence in banks, a level that is unchanged since 2013.
Nevertheless, it’s no exaggeration to say that big banking remains a protected industry and high-powered bankers comprise a privileged elite. Why are we, the people, so forgiving? What exactly do banks contribute to our economy that renders them so essential?
Banks Make Money
Large banks serve as the repository for the money that greases the wheels of commerce—the wellspring of our prosperity and standard of living—while they manage the global payment system that enables willing buyers and sellers around the world to transact business.
At its core, modern banking is the business of lending. Banks fill the role of financial intermediary between borrowers and savers. From its inception in the Middle Ages to serve the gold trade— storing, lending and issuing banknotes representing deposits held of the precious metal—bank lending was ingeniously built around other people’s money (OPM).
Sound banking practices would have dictated that a banker kept a 100% reserve against demand deposits, holding an ounce of gold in the vault for every one-ounce banknote issued. But bankers realized that they could lend a multiple of all the gold money deposited by their lenders by creating a multiple of banknotes against the same reserves, then keeping 100% of the interest charged on the overage.
US financial history is littered with banks that failed due to a mismatch of fractional reserves to depositor claims when poor judgment and/or bad business conditions caused losses from nonperforming loans. This is what happened during the great banking panics of 1893, 1899 and 1907. And it’s exactly what happened during the Great Depression. The stock bubble collapse in 1929 and ensuing margin calls led to the liquidation of $20 billion of bad bank loans extended during the previous debt bubble, about half of which ($9 billion) was stock market margin loans. This liquidation was followed from 1931 to 1933 by four waves of bank runs.
The Federal Reserve System: America’s Central Bank
The Federal Reserve System had a far more modest purpose than it does today when it was first launched in 1913. It was originally designed to serve the public interest and maintain financial stability by heading off the recurrent financial panics that a less unified banking system had suffered previously.
Starting in the 1980s, the Fed began to grow into its much larger, current role as accommodating buyer of government debt and comanager of the nation’s economy. It was at this time that deficit spending took off. The Federal Reserve System has since become a principal agent of government; by buying federal debt, it has enabled politicians to spend without taxing. Unlike all other central banks, however, and despite appearances, the Fed is not an agency of government. It is privately owned and operated by its member banks.
The complex product the central banking system offers is credit. Credit is first a measure of worthiness. It is also a byproduct of leverage because it is derived as a multiple of other people’s savings. Above all, credit can be monetized; like currency, it is a form of money that has its own financial reality. Banks turn credit into money by issuing debt. The reality is that banking does not “print” money into being, it “lends” money into being. In an ingenious feat of financial engineering, banks create money when they lend wealth that they themselves have borrowed!
For lenders, sound debt is good and the more of it that is outstanding, the better. The good news for lenders is that these are boom times for debt.
Dr. Ben Bernanke was Fed chairman in 2008. His response to the Great Financial Crisis / Great Recession of 2008-09 was three rounds of Quantitative Easing (QE), creating money to buy government and federal housing agency securities for the Fed’s balance sheet, while releasing reserves to member banks at little to no cost. Bernanke admitted that while Quantitative Easing was consistent with Monetarist theory, it was still only “an experiment,” but central banks around the world still followed headlong and did the same.
“Central banks launched the huge social experiment of quantitative easing (QE) with carelessly little thought about the side effects.”
~William White, PhD Ex-Chief Economist,
Bank for International Settlements
Integral to loosening the money supply and making loans cheap, Bernanke initiated ZIRP, the Zero Interest Rate Policy. ZIRP set the interest rates over which the Federal Reserve had control at close to zero.
Unfortunately, these rates also set benchmarks for interest paid on customer deposits, driving rates down to a pittance and crushing your savings’ earning power. The financial fortunes of risk-averse retirees would have to be sacrificed—and their tolerance for risk challenged—for the good of big-time economic actors who could continue to borrow and spend.
The Unintended Consequences for Retirees
It’s critically important to understand how bank policies and actions can adversely affect retirees. Under an economic system fueled by credit, the US and its citizens are indebted like never before. As of 2016, total government and personal debt stood at $33 trillion, most of which was accumulated over the last forty years. In 1980 the debt aggregate was about $3 trillion, of which government debt stood at less than $1 trillion. Today, the US national debt stands at [$22 trillion at the time of this posting] after almost doubling over the last eight years alone. According to the US Department of the Treasury, at the current rate, federal debt could double to $40 trillion by 2030—assuming that trillions in private and government pensions don’t implode and need to be bailed out by the federal government, thereby taking on even more debt in the process.
According to MarketWatch, by the end of 2016 Americans carried more debt (including consumer debt, mortgages, auto loans and student loans) than before the financial crisis. As US incomes have remained stagnant for decades, we’ve substituted debt for earnings in what some have come to call “debt-serfdom.”
How might all this debt affect you? First, you may carry mortgage or educational debt (your children’s or grandchildren’s) and/or consumer obligations into retirement. Second, you may have to contend with a significant rise in the real cost of living during your retirement years, an inevitable byproduct of the Federal Reserve’s tireless money creation. Third, as a saver, the Fed’s zero-rate policy will challenge you to earn a safe return on your cash. Finally, as an investor, you may face decades of low returns—nominal and real— driven by slow growth in the underlying economy and exacerbated by a little-understood process known as “financial repression.”
The bottom line? Investors need to recognize the potential risks imposed by a banking culture that serves its own purposes, but that is not particularly focused on the needs or future wellbeing of America’s retirees.
Chapter 5 Takeaways
- In today’s financial world, bankers serve government borrowers, with both borrower and lender believing that national economic wellbeing depends on their collaborative market interventions.
- As credit-issuers, the banks serve as intermediaries that leverage fractional reserves to stimulate economic activity by literally creating money through the lending process itself.
- The Federal Reserve System, our “central bank,” was established in 1913 to mitigate liquidity pressure on banks. After 10,000 banks still failed during the early phase of the Great Depression, the Federal Deposit Insurance Corporation (FDIC) was introduced to serve as an additional layer of depositor protection to tamp down the public’s tendency to panic.
- Some of the unintended consequences of modern banking practices include wealth inequality, monetary inflation, excessive debt burdens on households and governments and manipulated rates that favor borrowers at the expense of savers.
- While the Fed sees its mandate today as protecting the international strength of the US dollar and interacting with our economy to help it achieve full employment and broad-based prosperity, our banking system does not shoulder a specific mandate to provide financial security to America’s retirees and, in fact, some of its actions may actually prove inimical.
If you would like to discuss your personal retirement situation with author Nahum Daniels, please don’t hesitate to call our firm, Integrated Retirement Advisors, at (203) 322-9122.
If you would like to read RETIRE RESET!, it is available on Amazon at this link: https://amzn.to/2FtIxuM