How the Bankers Have Protected their Huge Paychecks

“ Americans should lose faith in their government. They should deplore the captured politicians and regulators who distributed tax dollars to the banks without insisting that they be accountable… Only with this appropriate and justified rage can we hope for the type of reform that will one day break our system free from the corrupting grasp of the megabanks”.

• Neil M. Barofsky, the former Special Inspector General in charge of oversight of the Troubled Asset Relief Program (TARP)

Commercial bankers don’t make their outrageously high paychecks from making loans as may be believed. They make them by using depositor money to speculate in investments, called proprietary trading (prop trading).

• They were stopped from doing this by the reforms initiated by FDR

• They were allowed to do it again by the reforms initiated by Bill Clinton

• They have been allowed to continue doing it by the reforms under Barack Obama

As long ago as 1914, Louis Brandeis, when a lawyer, warned of this problem in the title of his book, Other Peoples’ Money and How Bankers Use It.

• “Other peoples’ money” -refers to customer money on deposit

• “How bankers use it” -refers to bankers using the money to speculate for personal banker bonuses.

To understand the reason for Brandeis’ concern, understand that bankers do not hold customer deposit money in trust. There are no controls whatsoever on how bankers use that money. They can use it in the banking business as they wish including in the most speculative of investments.

Before the Great Depression of the 1930s, bankers were investing in businesses such as the new railroads, then when the businesses began to fail, the bankers tried to prop them up with loans. When these businesses failed and the loans were not repaid, there was no cash to meet customer withdrawal demands.

To solve this problem FDR initiated two reforms in legislation called Glass-Steagall (only 38 pages):

• Banks had to decide whether they would be commercial banks taking deposits and making loans, or investment banks that did not take deposits.

• Commercial banks were then severely restricted so they could not invest deposit money for bank profit (prop trading)

Bill Clinton removed both of those restrictions allowing banks to become financial supermarkets with no restrictions on how bankers would use deposit money. (Gramm Leach Bliley)

Bankers once again invested depositor money. They bet billions with the hedge funds that the housing market would continue to rise. When it did not, the hedge funds were able to seize all of the banks’ assets including deposit money to satisfy what the banks owed them. The savings of America were at risk. The whole financial system would become frozen. So, the government stepped in with a multi-billion dollar bailout.

Obama’s reform was the 800 page Dodd Frank. The voluminous number of sections did not separate the banks into commercial and investment banks, nor did it restrict commercial banks from using the depositor money in prop trading.

The bankers remained free to use depositor money to speculate for bigger banker bonuses in derivatives. They now have no concerns because they have tested the system. They know that as long as their bets are big enough to bankrupt their banks and that they’re all doing it, the government will have to bail them out- and will not make a banker relinquish a penny of the income made from this reckless activity.

The Banking System Remains Vulnerable

While the mainstream economists and analysts were praising the stability of the financial system leading up to 2008, there were some who cried warnings but were ignored. They are again saying that the financial system remains as fragile and vulnerable to a severe meltdown today as it was in 2008.

They were right then, most likely they are right again.

• Warren Buffett warned about the danger of derivatives in his 2002 letter to shareholders.

• After the reforms of 2008, in his 2016 letter, Buffett again warned that the danger of derivatives continues.

Beginning in 2003, Janet Tavakoli, the founder of Tavakoli Structured Finance, a former banker who was involved in derivative creation at major banks is worth listening to. As Think Advisor notes: she predicted the thrift industry blow-up and the demise of Enron. Then she foresaw that excessive leverage and structured products’ (derivatives) misratings would lead to a global financial crisis in 2008.

She echoes Buffett’s warning about their continuing danger. She says the story of what actually happened leading to the 2008 financial crisis has been covered up:

● “ It’s a story that needs to be told because nothing has changed.”

● “ There’s been a lot of lying, and the lying has been so good that many people in the business aren’t fully aware of the big picture of what happened.”

Tavakoli says the reforms of 2008, including Dodd Frank, have made the system more vulnerable: “And now we’ve made it worse. It’s like handing a drunk driver who got into a crash the keys to a bigger, faster car together with a bottle of vodka.”

In my Section on banking, I give the details of how this all came about that Tavakoli mentions; uncomplicate the banking system and demystify ‘high finance’ terms. Once the system is explained, the solution becomes obvious.

Note to online readers. The above is an overview of the banking section in my book. The draft section can be found beginning here : The Mysterious Creation Of Moneyand goes for 15 posts.

Acknowledgement: Image by olia danilevich on pexels.

Originally published at https://jandweir.substack.com.