By Mike Whitney April 26, 2010 "Information Clearing House" -- Do you understand the root-cause of the financial crisis

? Not many people do, which is why congress' attempt to regulate the system will probably fail and there will be another crisis in couple of years. When the pundits talk about the crisis, they usually point to subprime mortgages or Lehman Bros, both of which played a big role in the downturn, but both of which were merely symptoms of a deeper problem. The source of the crisis is systemic, which is to say that it is the result of a design-flaw in the relatively-new architecture of the modern banking system. (Don't worry; this isn't as complicated as it sounds) You see, credit, which used to be strictly regulated--since it allows banks to create money out of thin air--has become a franchise which is shunted off to hedge funds, insurance companies, pension funds and other so-called shadow banks which are able to take advantage of the loopholes in the system and create gigantic amounts leverage without any regulatory supervision. "Anything goes." At one time, when a bank made a loan, they made sure that the applicant had a job, steady income, collateral, and a good credit history. That's because the banks knew they would be holding the loans to maturity and any loss on the loan would impact their profitability. That's the ONLY way that it's safe to allow private industry (aka--the bank) to create credit. The financial crisis proves that unregulated credit-generation is every bit as lethal as a neutron bomb, which kills everyone in the vicinity, but leaves the buildings still standing. The credit-mechanism cannot be handed over to unregulated speculators without putting the entire economy at risk.

The new system works differently. Now the banks are largely middle-men who originate the mortgages, (or other loans) chop them up into bits and pieces in their off-balance sheet operations, and sell them to investors in the secondary market. The process is called securitization and it magically transforms one man's liability (the loan) into another man's asset. (the security) But don't be fooled. The debt is the same as if it was still sitting on the banks balance sheet instead of some oddball structured-debt instrument, like a mortgage backed security (MBS) or a collateral debt obligation (CDO). What's really changed, is the ability to generate credit has shifted from highly-regulated depository institutions to fly-by-night speculators whose only interest is to maximize leverage, create another bubble, and cash-in before the mighty zeppelin crashes to earth. Keep in mind, that a bank is any institution that takes deposits and agrees to provide ready-access to cash for people who want to withdraw funds. A bank makes its money by "borrowing short" (deposits or repo) to "go long". (putting money in long-term illiquid assets) That means that a bank is required to hold liquid reserves and enough capital to meet its needs even in a crisis. The banks have abdicated their role as credit producers, because the shadow banks can do the job cheaper. And the reason they can do it cheaper is because they are undercapitalized. Take AIG for example, they were selling insurance policies (CDS) but they didn't have the capital reserves to pay off the claims. Think of how easy it would be to make gobs of money if you could sell property that you didn't really own. The only problem, of course, is that if you engaged in such activity, you'd be dragged off to the hoosegow in chains. So how do the shadow banks make so much money by increasing leverage? Here's how it works: There are three houses on the block; all of them are identical and all of them are the same price, $100,000 each. Harry buys the first house and pays cash, $100,000 on the barrelhead. Joe buys the second house and puts 10% down, in other words, he pays $10,000. Frank, who works for a big chiseling hedge fund on Wall Street, buys the third home and puts 0% down; so he has zero equity. 12 months later the value of all three homes has gone up 10%; so now they are all worth $110,000. That means: Harry has made a measly 10% on his investment. Joe has made 100% on his investment.

And chiseling Frank has made $10,000 pure profit. This simple breakdown is intended to help people grasp the real purpose behind securitization and derivatives trading, which is not to make markets more efficient or to "disaggregate" (spread) risk. It is simply to peddle garbage assets which are balanced on minuscule slices of capital. It's a shyster's dream-come-true; capitalism without capital. All Wall Street's profit's derive from some variation of this low-capital, high-risk schema. ZERO-HOUR FOR LEHMAN: The day the shadow system blew up Before to the meltdown, the depository "regulated" banks were mainly funded through repurchase agreements (repo) with institutional investors. (aka---"shadow banks"; investment banks, hedge funds, insurers) The banks would post collateral, in the form of bundled "securitized" bonds, and use the short-term loans to maintain operations. When the banks collateral became suspect -- because no one knew which bundles held the subprime mortgages -- then intermediaries (primary dealers) demanded more collateral for the loans. Suddenly the banks were losing money hand-over-fist as the value of their assets tumbled. Lehman got trapped in this revolving door and couldn't roll-over its debt using its shabby collateral, which, by now, everyone knew was garbage. There was a bank-run on the shadow system; the secondary market collapsed. In other words, the banks were going to the primary dealers the same way that I would go to a pawn shop, and borrow money by posting my lavish, fully-landscaped 4,000 ft colonial home and custom Maserati sports car for a $200,000 loan. That scam might work for a while, but eventually the owner of the pawn shop will wise-up and realize that I don't really own a lavish, fully-landscaped 4,000 ft colonial home and custom Maserati sports car. Rather, I live in a makeshift clapboard shack with a corrugated tin roof by the railroad tracks and drive a rusty Schwinn bicycle to my job collecting aluminum cans for the recycling center. That's what happened to Lehman. When Lehman Bros collapsed, there was NOT a panic. That's a myth. Lehman merely triggered a radical repricing event, which means that the assets that had been trading for artificially-high prices, suddenly fell to reflect what reasonable people thought was there "true" market value. This (collective) judgment was not made out of fear, but rather with the knowledge that the underlying collateral (shabby mortgages) was gravely impaired. Prices in the repo market for some MBS and CDOs fell more than 50 percent. Of course, Bernanke still clings to the idea that these are just "unloved" assets that will eventually bounce back. But what else can he say: "We're going to mark these turkeys down to their real value and shove the banking system off a cliff?" That's not going to happen. So, it's up to congress to grasp the thistle and demand that the shadow banks be strictly regulated from here-on-out so we don't end up in the same pickle two years from now. The state has a compelling interest to make sure that credit-generating financial institutions are strictly regulated. Credit expansion is vital to economic growth and to raising standards of living. But, in the wrong hands, it will increase inequality, divert money away from productive activity, and inflate asset bubbles that end in disaster. The reforms which are now being debated in the congress, (Too big to fail, off-balance sheet operations, derivatives trading, securitization) miss the larger point. Regulators must have the authority to intervene wherever they think it is necessary to ensure that institutions are adequately capitalized, that lending standards are strictly upheld and that credit production is carefully monitored by trained government supervisors.

Comments (14)
Sort by: Date Rating Last Activity carpe meridian · 13 weeks ago



The other piece of this puzzle is the fact that first the banksters rewrote and rigged the bankruptcy laws so that when they were able to lure private individuals into these "neutron bomb" loans, that it made it nearly impossible for them to escape liability for their debts short of becoming penniless. Then, when the borrowers could not afford to continue paying on the overpriced real estate, they were still stuck paying off the loans. The crooked bankers made money at every step along the way. While our government slept. The Fed, the SEC, the FBI. All either asleep at the switch or complicit in the scam. Take your choice. And of course, when the fit hit the shan, the taxpayers were obliged to pay for this. The American Dream... You have to be asleep to believe in it. (George Carlin)


1 reply · active 13 weeks ago 0


Jack Auff · 13 weeks ago

Reforms being debated in Congress? WTF are you smoking, Whitney? Those dog and pony shows are just for us dumbasses to fool into thinking that finally, the theives, liars, con artists and yes, mass murderders that control Wall Street, the Fed and Congress are actually going to be reined in and justice delivered. Nothing could be further from the truth. When the smoke and BS clears, the same bastard Wall Street banks that shoved the economy off the cliff will be bigger and badder than ever, devising up more ways to fleece the taxpayers.


Report -1

Concerned Citizen · 13 weeks ago What Really Triggered the Financial Crisis? THE CREATURE FROM JECKYLL ISLAND...It has once again reared its UGLY HEAD.

THE FEDERAL RESERVE, which is neither federal or a reserve, considering it is based upon FRACTIONAL RESERVE lending, as opposed to the currency being backed by gold or silver as the FOUNDERS INTENDED. A corrupt system that is based on DEBT and ENGINEERED to CREATE booms and busts. An oligarchy of elites that REFUSE to DISCLOSE who the STOCKHOLDERS of the FEDERAL RESERVE are. For more please read: "The Creature From Jeckyll Island" by G.Edward Griffin.


Report +1

Guilliermo de Espero · 13 weeks ago

The founding fathers of the US did NOT intend for the currency to be back by gold or silver. All the gold was in the hands of your enemies (ie. the brits) why would they hand the money power over to them? That would be crazy. Which is why they created the Continental. You've got the problem correctly identified, but your solution is wrong. Instead you need to take the money power out of private hands by moving away from a credit system and into a public controlled money system. 1. Put Fed in Treasury 2. end fractional reserve system 3. spend government money to replace private money For more please read: The Lost Science of Money - by Steven Zarlenga and Look for the American Monetary Institute and their "American Monetary Act" for more info


1 reply · active 12 weeks ago 0


Concened Citizen · 12 weeks ago Coinage Act of 1792 (Scan of Original)


Report +1

Guilliermo de Espero · 12 weeks ago

Yes, there was a split. The continental, the currency that gave you your country, was back by nothing but the sovereign power of a state. It was not back by gold or anything. At the end of the war it did lose its value, not due to government mishandling, but by British counterfeiting (they had boats in NY Harbour printing day and night). Secure that the country was safe, the bankers then retook the money power from the state. The founding fathers were definitely not unanimously agreed on this subject. The experience of the colonies showed how a government money system could not only work but bring untold prosperity in its wake. In fact, according to Franklin the main reason for the war of independence was not taxes but that the King had taken away the colonies power to print paper money, pushing them into deep depression. "The colonies would gladly have borne the little tax on tea and other matters had it not been that England took away from the colonies their money, which created unemployment and dissatisfaction. The inability of colonists to get power to issue their own money permanently out of the hands of George the III and the international bankers was the PRIME reason for the Revolutionary War." - Benjamin Franklin Even with the "Coinage Act of 1792" Jefferson wrote to Washington NOT to sign the bill. Amike, William


Report +1

Guilliermo de Espero · 12 weeks ago

Also, if the coinage act was so successful, why the need for Greenbacks (government issued fiat money, which again saved the country) less than 100 years later? It's funny how only when their own existence is threatened will the bankers allow the government to assume the money power. As long as its used only for war, never on the real economy (so as not to let the people see the prosperity it would bring) and only long enough to secure the banker his future existence, whereupon they reusurp what they but temporarily lent to its rightful owner (the people).


2 replies · active 12 weeks ago 0


Guilliermo de Espero · 12 weeks ago "Money exists not by nature but by law" - Aristotle


Report 0

Guest · 12 weeks ago This was posted by someone over at Calculated Risk I thought it was hilarious:

Lehman Brothers II: This time, it’s Sovereign! Our wacky hero’s are back, this time in the sunny islands of Greece! Join last year’s favorite screw-ups Helicopter Ben, Larry “Summertime” Summers, Tim “Brainiac” Geithner, and Wall Street’s most hilarious sidekick Lloyd “the Gambler” Blankfein as they travel to Europe and take on the sovereign bond markets, European and Asian stock markets, the currency exchanges, and the European Monetary Union, all while simultaneously try to stash all the gold they can carry in secret Swiss accounts without alerting US tax authorities! Their crazy antics will have you rolling in the “Isles” as they match wits with the foxy Angela Merkel, Europe’s own Money Honey ... Will the boys get busted partying at the Hague? Will interest rates rise as the money runs short? And what happens when the guys take "Braniac" Geithner to his very first nude beach? (Look out, Braniac - you haven’t seen “naked swaps” like these before!) Don’t miss the wild premiere weekend, coming soon to a theater near you! (Also, see the new short feature “Panning for Goldman” with everybody’s favorite country comedienne, Claire McCaskill, and a new cartoon by Eric G. Lewis!)


Report +1

Guilliermo de Espero · 12 weeks ago I never said the Coinage Act wasn't passed. I merely stated that the founding fathers were NOT unanimous in there support for it, as YOU stated. And I never stated that it wasn't back by gold. I said that the Continental and the Greenback were NOT back by gold. Do your even read what I write? I'm quite aware that the US went off the gold standard in '72.

Concerning the Continental depreciation again, did you not read what I said? The British counterfeited billions of dollars, this would have wreck ANY paper currency and had nothing to do with what the colonies did themselves. For most of the war the Continental functioned most excellently. Concerning Lincoln, why then did he issue the greenback? He could have borrowed and paid interest to the banks, but he didn't. Also, after the war greenbacks were exchange 1 for 1. One dollar in greenbacks for one dollar gold. But you know what? Almost nobody wanted the gold, 99% of people did not turn them in, they loved them.



Post a new comment
Enter text right here!

Comment as a Guest, or login: Name
Displayed next to your comments.

Not displayed publicly.

Subscribe to

Submit Comment

Comments that include profanity or personal attacks or other inappropriate material will be removed from the site.
Comments by

Social Trackbacks
Retweet this Post

mofetabanu What Really Triggered the Financial Crisis?       : Information Clearing House - ICH: via @addthis View all Social Trackbacks

Click on "comments" below to read or post comments

Top 10 Posts
Audio of incident between Canadian citizen and US immigration officer. (306 comments) America: The Grim Truth: Information Clearing House ICH (298 comments) The Imminent Crash Of The Oil Supply : Information Clearing Hous (218 comments) Rarely Published Pictures Of The BP Disaster : ICH Information Clearing House (191 comments) Israel Kills 20 : Attacks Gaza Aid Fleet : Information Clearing House (159 comments) Noam Chomsky Has ‘Never Seen Anything Like This’ &nb (149 comments) The U.S. Middle Class Is Being Wiped Out : ICH - Information Clearing House (144 comments) : ICH - Information Clearing House (142 comments)

Comments (9) Click here to learn how to post a comment .Comments that include profanity or personal attacks or other inappropriate material will be removed from the site. See our complete Comment Policy.



Sign up for our Daily Email Newsletter

Please help Support Information Clearing House

One-Time Donation

Recurring Monthly Donation $

Gaza Flotilla Drives Israel Into a Sea of stupidity : Information Cle (124 comments) 76 US Senators Sign on to Israel Letter : Information Cle (110 comments) Comments by IntenseDebate

Thank you for your support

In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. Information Clearing House has no affiliation whatsoever with the originator of this article nor is Information ClearingHouse endorsed or sponsored by the originator.) Search Information Clearing House