Tuesday, October 14, 2008

Banks Will Become the New Engine of Social Engineering

Future generations will not remember that banks once loaned money for profit to be repaid with interest. In the future, banks will loan money for a profit to be repaid with interest and accomplish some attached social goal.

We have become so accustomed to the US Tax Code being used to manipulate our activities that it is now second nature. If you want to encourage the development of more Green Energy, grant energy tax credits. Or, impose taxes on carbon polluters.

Consider the overlay with regard to federal educational assistance granted to States for education. You (the State) may have this money from the federal government, however, it must be spent under the following conditions and within the following parameters.

Title IX was enacted as part of the Education Amendments of 1972 (Cits Omitted). This amendment prohibits sex discrimination in education by programs that receive federal financial assistance. It was patterned after Title VI of the Civil Rights Act of 1964, which prohibits discrimination on the grounds of race, color, or national origin in any program or activity receiving federal financial assistance. American Association of University Women. Hostile Hallways: The AAUW Survey onSexual Harassment in America's Schools. Washington DC: American Association of University Women Educational Foundation, 1993.

What does that have to do with banking, you ask? Well today, nothing; tomorrow, everything.

The US Treasury has stated it will purchase 250bn of preferred stock in certain US Banks.

NEW YORK (CNNMoney.com) -- The federal government on Tuesday announced an extraordinary and historic direct investment in the nation's banks - the biggest bet ever made with taxpayer dollars on the U.S. financial system.
As a start, the Treasury will pump $250 billion into financial institutions. Nine of the nation's largest banks have already agreed to take the capital and in return will give preferred shares to taxpayers and accept limits on
executive pay. Half of the money, or $125 billion, will go to the nine large banks.
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The nine financial institutions that will split that first pool of money include the nation's four largest commercial banks - Bank of America (BAC, Fortune 500), Citigroup (C, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Wells Fargo (WFC, Fortune 500). Also included are the two remaining independent investment banks - Goldman Sachs (GS,
Fortune 500) and Morgan Stanley (MS, Fortune 500) - as well as Merrill Lynch (MER, Fortune 500), which last month agreed to sell itself to Bank of America. Two other major banks that primarily serve Wall Street rather than retail customers, Bank of New York Mellon (BK, Fortune 500) and State Street Corp. (STT, Fortune 500) round out the nine institutions getting help in this first round of investments. U.S. pulls the trigger: Government to pump billions into banks, expand deposit and loan guarantees, Chris Isidore, CNN Money, October 14, 2008.

I understand the Treasury Secretary's desire to thaw the US and world credit markets. Perhaps it is prudent to take emergent and heroic efforts to save the financial system, as we know it.

However, the poison is in the cure. The money injected into these banks will become part of the Tier 1 capital of the banks, which is good; it will provide the greatest leverage for the money invested. We the taxpayers, will be paid if and when the preferred stock pays dividends or is sold. But, it is a unseen “drug” to politicians – once they figure out its hidden usefulness.

Unless the feds are divested of this investment in banks in the near future, this "drug," will become permanent. Give a Congress the opportunity to perform further social engineering via its investment in all major US banks and the drug will become too powerful and too intoxicating to be relinquished.

These investments are, again, unsound in what purports to be a free economy.

Hugh Wood, Atlanta, Georgia


The photo is of the Second Bank of the United States. Pres. Andrew Jackson vetoed it into oblivion in 1832 for its rampant economic cronyism. You would think we would learn.

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See also, Commentary: Why this bailout is as bad as the last one :: By Jeffrey A. Miron Special to CNN Editor's note: Jeffrey A. Miron is senior lecturer in economics at Harvard University. A libertarian, he was one of 166 academic economists who signed a letter to congressional leaders opposing the government bailout plan.

CAMBRIDGE, Massachusetts (CNN) -- Ten days after passage of its $700 billion bailout of the financial sector, the U.S. Treasury has announced that it will implement this program, in part, by giving banks $250 billion in return for shares of their stock.
In other words, the U.S. government will acquire a significant ownership stake in the banking sector.
The goal of this stock purchase is to "inject liquidity." This will, in principle, improve bank solvency and increase bank lending, thereby minimizing the chance of a recession.
This approach appears to be favored by the Treasury over the previously announced strategy of buying "troubled assets" from banks. The Treasury is also planning to guarantee new bank debt and expand insurance of bank deposits.
Alas, the new approach is no better than the first. Here's why.
If banks were fundamentally sound but temporarily in need of cash, they could sell stock on their own to private investors. Few investors now want bank stock, however, because they cannot tell which banks are merely illiquid -- short of cash for new loans because their assets are temporarily sellable only at fire-sale prices -- and which are fundamentally insolvent -- short of cash and holding assets whose fundamental values are less than the bank's liabilities.
This lack of transparency is a crucial impediment to new investment, and therefore to new lending.
Government injection of cash, however, does little to improve transparency. A bank with complicated, depreciated assets is in much the same position after the government gives it cash as it was before, since outside investors will still have limited information about the solvency of any individual bank.
Perhaps the new cash will spur the sale of bad assets, or nudge banks to reveal their balance sheets, but that is far from obvious. Banks, moreover, might remain cautious even with this increased liquidity simply because of uncertainty about the economy. Thus it is hard to know whether cash injections will actually spur bank lending.
In any event, government ownership of banks has frightening long-term implications, whether or not it alleviates the credit crunch.
Government ownership means that political forces will determine who wins and who loses in the banking sector. The government, for example, will push banks to aid borrowers with poor credit histories, to subsidize politically connected industries, and to lend in the districts of powerful members of Congress. All of this is horrible for economic efficiency.
Government pressure will be difficult for banks to resist, since the government can both threaten to withdraw its ownership stake or promise further injections whenever it wants to modify bank behavior. Banks will respond by accommodating government objectives in exchange for continued financial support. This is crony capitalism, pure and simple.
Government ownership of banks will not be a temporary expedient. Politicians can swear they will unwind the government's position once "economic conditions improve," but no one can enforce this promise. The temptation to use banks as a political tool will be permanent, not temporary, so government ownership will continue for decades, or forever.
Worse yet, government ownership of banks sets a precedent for ownership in every industry that suffers economic hardship. Some might argue that banking is "essential," but many industries -- autos, steel, computers or agriculture -- will make similar claims when it is their turn to demand a bailout. Thus banking will be only the first victim in an enormous expansion of the government's role. This again will have disastrous consequences for economic efficiency.
Last but not least, a government "injection of liquidity" is still a bailout in all but name.
The injection means that banks get cash, and they get it now. This benefits current stockholders and bondholders, which is why stocks have jumped on news of the injections.
The government, however, gets stock that might end up being worthless, since some banks will fail anyway. The government gets stock that may never trade in a market or have its value determined by fundamentals. The government gets stock that it cannot sell for years, if ever, without generating turbulence in asset markets as investors interpret the government's decisions or position themselves to profit from them.
Government purchase of bank stock, therefore, is a transfer from taxpayers to people who took huge risks and lost. The United States, and the world, got into the current mess by trying to insure away risk, which everyone should have known was a fool's errand. Thus bailing out risk-taking -- or providing new guarantees for loans and deposits -- will generate even greater problems down the line.
It is time for the government to do the one thing it does well: nothing at all. This might mean serious economic pain in the short term, as more banks fail and the economy suffers through a recession. As for a cancer patient who has a tumor removed, however, the long-term benefit will more than compensate bondholders, which is why stocks have jumped on news of the injections.
The government, however, gets stock that might end up being worthless, since some banks will fail anyway. The government gets stock that may never trade in a market or have its value determined by fundamentals. The government gets stock that it cannot sell for years, if ever, without generating turbulence in asset markets as investors interpret the government's decisions or position themselves to profit from them.
Last but not least, a government "injection of liquidity" is still a bailout in all but name.


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