Banking

Modern banking is an interesting business. Banks are in the business of turning assets into money. The common misconception about banking is that banks turn deposits into loans. This is actually backwards and here is why that is.

A home builder wants to build a speculative house to sell to an unknown customer. He proposes a business plan to a commercial bank that lays out the cost to construct and sales prices of comparable homes. At this point, the house is an idea. There is no money yet, but the concept of money is there.

The bank assesses the credit risk of the borrower and the potential for loss. After doing some modeling, the bank decides that it is willing to provide financing for up to 80% of the value of the house. This leaves a margin of 20% for the price to fall in case of a default or for economic conditions. At this point, the house is still an idea and no money exists.

The home builder builds in a gross profit margin of about 18% into the cost of the house, so he basically puts no capital into the loan. Finally, the bank advances funds to begin construction. But where did it come from? Did it come from deposits? Maybe a little bit. Most likely, the bank simply created an electronic transaction that created new liquid deposits and created a debit balance on its books for the loan. The liquidity is now in the "system" with a few keystrokes.

With this credit, the home builder may now go to its suppliers who get basic materials that are purchased and manufactured using this new liquidity. On top of this manufacturers and basic materials suppliers can provide credit on the promises to pay aka receivables. This is essentially credit on credit and is technically unsecured.

So the sequence is idea --> credit --> asset monetization. The bank turned the entrepreneurial home builder's idea into newly created money. The money is added to the pile of current deposits in the system. The Federal Reserve can withdraw some of this money at any time through open market purchases of Treasury obligations (bills, notes, and bonds), which I will go over in a bit.

Ideally, if the world were all good, the Federal Reserve would withdraw any excess money that increased the per capita amount of money and credit in the system. Doing this would maintain the value of dollar holdings, i.e. price stability or no inflation. Unfortunately, what has happened is the banks have been allowed to loan unsecured money (like credit cards), which technically inflates the money supply and is backed by nothing. If these loans were backed by something like lendable equity in a home, this wouldn't be a problem. However, there is nothing, and capital requirements for credit cards are fairly low because banks use statistical methods to determine likely loss rates. In good times credit companies are able to make boat loads of money. However, in bad times, like now, credit card companies are writing off 10% of their unsecured loans. When they are backed by small amounts of capital, this causes bankruptcies and debt destruction. If you ever wondered how "wealth" can disappear, this is it. Unsecured credit blowing up. This is why stocks can fall significantly. Stock margin accounts are essentially secured by nothing but the perceived value of equity claims on corporations. If you look at the amount of outstanding margin versus the total market cap of the stock market you will see that much of the perceived value in stocks is borrowed... on the margin of the stock that is being borrowed. See ponzi scheme.

Now let's look at sovereign credit. Sovereign credit is backed implicitly by tax revenues and the productive ability of the taxpayers. While it is only implicit, I would contend that it is for the most part backed with the threat of force and improsonment on its own people. Regardless, sovereign credit is unsecured, meaning there is no collateral backing the credit.

In a country where there are legal tender laws, which is basically all of them, the government and the central bank monopolize the supply of money. If the government has a central bank, the government initially HAS to borrow from the central bank to put money in circulation. If the government does not have a central bank, then the government will mint or print whatever it proclaims as legal tender. In our case, we have fiat money, which is quite literally, money by decree and is backed only by the credit of the US taxpayer.

When the government does not deficit spend, the value of the money in circulation stays relatively constant or increases with productivity and technological advances. The government does not have to go to the central bank to put more money into circulation. Instead, it pays back its obligation through tax receipts. In this case, the central bank simply collects interest on money lent in overnight lending to underfunded banks (banks with less deposits than loan assets).

Let's look at our current situation. Today, many banks would be considered insolvent. They are only open through government and therefore taxpayer guarantees. In order to fulfill its guaranty and also its deficit financing, the government has to create money. It does this by going to the central bank, asking them to purchase some government bonds, and therefore provides the government with currency which is direct monetization. Other times, the central bank conducts open market operations in government bonds where it will buy from individuals and financial institutions. In this case, the central bank turns assets into currency, monetizing obligations of the taxpayer.

So the crucial difference is, banks monetize hard assets, while central banks monetize future tax receipts. One can be collected on in the event of default, while the other comes back with a big fat zero recovery. Every time the central bank monetizes future tax receipts, it inflates the supply of money and credit. This in turn leads to the common idea of price or purchasing power inflation over time due to the supply of money and credit increasing.

The central bank sees the contraction of private credit with great unease because without private credit, public credit has to expand to maintain asset prices. But the pace of private credit contraction is continuing due to the taxpayers' distrust of bankers. My guess is that this is a secular shift towards less debt in people's lives. My premise during the entire crisis has been that instead of the central bank accepting private credit contraction, it will monetize taxpayer backed credit to match any private credit contraction. This will support asset prices, but will not create significant private sector jobs because the government will have to spend the money, and it does so in a rather inefficient way because the process is politicized.

Much of this crisis would not have been created or lengthened if we had no central bank or if the government did not have control over money. Money, chosen by the free market, can be anything and the most common forms are gold and silver for simple reasons; they are difficult to counterfeit and are divisible. Gold and silver can be used as collateral for credit. In fact, banks used to be run as storage facilities and clearing houses for gold credit. Banks would issue depository receipts against which individuals and businesses would transact. It's a very simple system and it could be replicated very easily electronically.

Ron Paul has some great ideas on controlling fiat money's expansion. The first idea is to end legal tender laws that basically force people to transact in Federal Reserve notes. If there were no legal tender laws, the market would decide with what type of money to transact its business. My guess is that companies would settle transactions in gold and silver because they would not have to maintain a huge treasury department to transact in money markets, treasury bills, and other short term funding mechanisms because all of the gold and silver could be kept in bank vaults for a relatively small fee. If the first idea wouldn't pass congressional approval, another idea is to allow gold and silver to be used as legal tender in payment of taxes. Very similar concept to the first idea.

If you really start to delve into the financial system, it is relatively easy to see that it was designed by investment bankers looking to scrape a fee off of everything. Limits on FDIC insurance force medium and large businesses to create a treasury function that transact in money and treasury markets where banks get a fee. The monopoly on money by governments allows international investment banks to collect a foreign exchange fee, whereas gold and silver settlement between corporations would be a very straightforward transaction. 401(k)s are fee generating machines for the mutual fund racket. Tax deductibility of interest on housing encourages people to go into housing debt and raises the price of housing. Credit card servicers like VISA and Mastercard take a 3% fee right off the top of any card transaction. War is an extremely profitable venture for banks because usually the government has to borrow money to pay for it. It issues treasuries which it then sells to dealers (at a discount) who then distribute them to their clients (for a fee). What's not to love if you're a banker? Bankers are extremely creative in finding ways to scrape off the top of every transaction. Cap and Trade is the next new banker revenue source and eventually they will come up with bigger and better sources to suck free capital through their vacuum.

Overall, I would say that most bankers are decent people. They just want to make money like the rest of us and they don't really see from a global view what they are doing. In fact, if you go to a commercial bank, I would venture a guess that 99% of the people that work there have no idea how a bank really works. The evil people are those that legislate fees into your life and force you to pay banking fees. This is corporatism at its worst and the focus of my ire is toward these people who turn an entity that was initially supposed to protect liberty into an entity that forces people into bank and debt slavery. Welcome to the United Banks of America. That'll be a 1% fee.

Ron Paul: Person of the Year

The Southern Avenger's retort to Ben Bernanke's selection for Time's Person of the Year.

Double Whammy

Looks like the tax payers are about to get screwed for Christmas.

The Senate and its feckless leader, Harry Reid is planning on forcing votes for the Communist Healthcare Package and Investment Banker Bonus fattener aka Cap and Trade in the coming week. Passage of these two bills should enrage the people. They are both complete garbage that will raise the cost of healthcare and raise the cost of everything else respectively.

It's getting close to time to completely opt out of this craziness. The Federal Government is completely out of control. The only way to stop them is through the States. Remember, the Constitution is a contract between the States and the Federal Government that strictly lays out what the Federal government is allowed to do by the states and their people, not the other way around. States need to assert their 10th amendment rights and nullify any unconstitutional actions by the Federal Government.

So the message from the imperial federal government is clear: Merry F'n Christmas!

De ja vu

I've been on a blogging hiatus, but things are getting really interesting now. It appears that the equity markets are tapped out following TARP repayments by Citi, BofA, & Wells Fargo. To me this marks the second phase of Great Depression II. The big banks are now sufficiently capitalized to begin their assault on the smaller regional and local commercial banks. This is what happened in the first Great Depression. The fist leg down, like October 2008-March 2009, occured in the final months of 1929 through the middle of 1930. A six month bear market rally ensued which allowed big banks to recapitalize for the next leg down. During the next leg down JP Morgan gobbled up many of the thousands of small banks that went belly up.

My fear is that the next shoe to drop will be longer and much more brutal to individual wealth and freedom than even the first Great Depression. Many of my commodity positions have been knocked down quite significantly and I wouldn't be surprised to see massive unrelenting deflation for the next few years. The government helped kick the can down the road by trying to offset the contraction in private credit, but it looks like things are about to really pick up and the people who did have substantial reserves to ride out a 6-12 month downturn are starting to run dry. I still see too many people think that things will return to the days of 2004-2006. It ain't going to happen and people need to protect their wealth from those who try to take it, legally or illegaly.

Phase II, here we come.

Bernanke's Confirmation Hearings

... didn't go so well. Senators DeMint and Bunning grilled the Quasi-Federal Counterfeiting operation chairman and called him and his organization out for what it is, a taxpayer looting operation.

Bunning


DeMint

The Southern Avenger Strikes Again

Swiss, Guns, & Crime Rate

November Returns

SigmaStock

SigmaStock ended the month up 10.85% driven by strong emerging market returns. This brings the return since I started trading this system in March to 49.35%.



SigmaSeek Futures

SigmaSeek ended the month up 72.74% driven by higher precious metals, the falling US dollar, strengthening Mexican Peso, and falling Natural Gas. Soybeans also added to the returns, although Corn and Wheat underperformed. This brings the 5 month return of SigmaSeek to 57.95% since the SigmaSeek system began trading.



Overall, this system has emerged out of a nearly 11 month equity base to hit new equity highs. This is typical for a trend following system; long periods of drawdown followed by short periods of very fast returns. For a 10 year look at simulated performance see below:

The Cost of War

Interactive Unemployment

Watch the unemployment virus spread:

Cash for... Weatherization

David Leonhart of the NY Times is a classic theiving liberal. This is evidenced by an article in the NY Times titled: A stimulus that could save money. What he did not mention in the title is that he could save money personally by stealing it from you and putting it in his own property. Please read the bilge excerpt below.

This year, my wife and I had an energy audit done on our home. We were interested in finding out if we could save money and, given the attention that weatherizing was starting to get, I figured it could also make for good column fodder. For $400, an auditor spent hours scouring our house, with the help of a big fan he set up in our front door and an infrared camera. He produced a full-color, 13-page detailed report, informing us of the leaks in our house, and he was also willing to tell us which changes were usually a waste of money (new windows).

Even so, we are still trying to figure out which weatherization projects we should do. The whole package would probably cost $4,500 and save us something like $400 a year. We may not stay in the house nearly long enough to justify the investment.

Such concerns are typical. How do you find an auditor? How do you know whether you should seal a few ducts or pay $2,000 for new insulation? Which of the existing subsidies -- state and federal -- might you qualify for?

Mr. Doerr and Mr. Clinton are well aware of these problems. Mr. Clinton has sent the White House a memorandum written by his foundation staff that lays out the reasons people don't weatherize their homes. Mr. Doerr, who sits on a board of outside economic advisers to Mr. Obama that is working on a formal cash-for-caulkers proposal, told me that his goal was to "keep it really simple so we can do it really fast."

The Doerr plan would cost $23 billion over two years. Most of the money would go for incentive payments, generally $2,000 to $4,000, for weatherization projects. The homeowner would always have to pay at least 50 percent of the project's total cost. About $3 billion would be set aside for retailers and contractors in the hope that they would promote the program, much as car dealerships promoted cash for clunkers. (Mr. Doerr says he owns no stake in any weatherization companies.)

So what Mr. Leonhart is saying is that the payback period for weatherization is about 10 years (~$4000 with annual savings of $400). But by stealing from you through a government tax and redistribute plan, he can cut HIS weatherization return on investment to 1-5 years depending on how much the government says it is ok to steal from you. This kind of logic permeates the liberal media. What he is saying indirectly is "It is ok to steal from you to pay for improvements to my property." Anyone who believes this deserves to read the NY Times and have his money stolen from him.