By the start of the 1960s, banking in America was in a state of flux.
Boundaries were being blurred – especially those separating “commercial banks” and “investment banks” under Depression-era Glass-Steagall parameters. The banking landscape was shifting. In fact, it was about to go volcanic.
The Truman Administration had championed the break-up of bank cartel arrangements, whereby a powerful coterie of commercial-bank bond underwriters controlled how corporations financed debt and who got to distribute bond offerings. Subsequent regulatory changes (requiring bidding for underwriting assignments) broke up the “Gentleman Bankers Code,” which had been code for cartel.
A more competitive landscape drove banks to expand. Branch banking spread through shopping malls and onto prime locations on America’s Main Streets.
The hunt for deposits was on.
And it got ugly fast…
Commercial banks needed more and more deposits to supply funds to rapidly growing corporations. And they wanted to make small business and consumer loans, wherever they could.
Intense banking competition was driving down lending profitability. At the same time, corporations were self-financing themselves through retained earnings and increasingly turning to insurance companies with whom they could directly place their bonds.
Commercial banks were losing their predominant position as providers of capital… while investment banks were growing rapidly.
The investment banks, with insignificant amounts of their own capital, were raising equity capital for corporations and trading blocks of stock accumulating in pension plans, which were mushrooming as a result of 1950s tax law changes and collective bargaining victories by labor unions.
Commercial banks had to grow rapidly to offset declining profit margins in the lending business. And they had to figure out how to compete with more aggressive and more profitable investment banks, as well as their institutional investor clients, who were rapidly becoming suppliers of capital.
So they did.
Under Glass-Steagall, commercial banks were allowed to deal and trade in U.S. Treasury securities, municipal bonds (which were considered safe by virtue of issuers’ taxing authority), and foreign exchange.
Historically, banks didn’t so much trade foreign currencies as they did manage exchanging one currency for another in the spot market and on a “forward” basis. This service, which banks had a monopoly over, facilitated borrowing clients, who were increasingly U.S. multinational corporations, overseas corporations, and foreign governments in need of currency exchange services.
They weren’t supposed to underwrite equity issues, distribute them or trade in them. But they did.
Commercial banks set up trust departments and, in some cases, controlled separate trust banks. The old Bankers Trust, backed by J.P. Morgan’s interests, was a prime example.
Trust departments were “entrusted” with safeguarding client assets. That included equity securities. As securities trading increased, for reasons about to become apparent, banks blatantly circumvented Glass-Steagall prohibitions and actively facilitated trading.
Two seminal events in the 1960s paved a one-way path from traditional banking to casino banking.
First, in 1961, George Moore and Walter Wriston of First National City bank brilliantly sidestepped regulatory prohibitions against banks paying interest to depositors. Their brainchild was the “negotiable certificate of deposit,” simply referred to as CDs.
By structuring a deposit as at least a 30-day “loan” to the bank, interest could be paid to the lender. The word “negotiable” was the magic ticket. Depositors’ CDs and the “liabilities” (deposits) they represented could be traded.
The invention spawned a world-wide hunt for deposits, as banks could raise money virtually anywhere and compete for “hot money” by offering competitive interest rates.
Excess deposits – those that banks couldn’t lend out and those that exceeded regulatory reserve requirements – were traded to other banks in the overnight federal funds (bank to bank) market.
The transition from primarily managing assets (loans) to liabilities (deposits) was almost instantaneous.
Trading floors were built and staffed to speculate on interest rate products. Those instruments, CDs, Treasuries, municipal bonds, and foreign exchange, were all interest rate-based. With the ability to aggressively attract depositor capital – to be used as trading capital – commercial banks embarked upon a hugely profitable new business…
The business of speculation.
Now here’s the second thing that changed.
Commercial banks traditionally offered mergers and acquisition advice, usually as a free service to their bond underwriting clients. But not for long.
Investment banks in the 1960s went on the offensive. To generate mergers and acquisitions fees, they actively put corporations in play. Soliciting takeovers from prospective clients was part of the new mantra of “conglomeratization.”
Putting corporations into play had become easy.
Large blocks of stock were spread among trust banks, held directly by pension plans and in the hands of institutional investors. Investment banks had access to these blocks of securities through their relationships with their institutional clients, as well as having access to stock residing at brokerage affiliates. Commercial banks had access to blocks of stock through their trust departments and brokerage operations they were setting up through the bank holding companies they manufactured to hold commercial bank businesses and separate brokerage businesses that commercial banks, on their own, weren’t allowed to operate.
Because blocks of stock were held for individuals by their pension managers, the institutional managers got to vote the shares in their safekeeping. M&A bankers used their institutional relationships to maneuver voting blocks of stock to their advantage in the new war games.
Seeing their corporate clients under attack and recognizing the pull investment banks were having over fee-paying corporate giants, commercial banks recast their M&A bankers as swashbuckling, fee-generating do-gooders.
Which, of course, they weren’t.
M&A bankers rode roughshod over and corralled thousands of American corporations in the Go-Go 60s – for increasingly larger and larger fees. More than 25,000 businesses were merged, acquired, or “vanished” in the 1960s.
Commercial M&A bankers and investment bankers had forever been transformed into commando-bankers, acting like generals on the ever-widening casino floor.
And this was only the beginning of “transactional banking.”
Events in the 1970s would act like an accelerant, igniting a fire under bankers that would further their power and lead to the implosion of a tiny shopping mall bank in Oklahoma.
That “off the radar” event, in a matter of days, led to the failure of a single money-center bank. Its losses were greater than all the failed banks in the Depression, combined.
Only, it didn’t fail. It was the bank that directly led to the American banking doctrine of too-big-to-fail.
Our last chapter was about how the U.S. Federal Reserve was created and why. But it ended with an extreme example of how the universal central banking model works today.
As another domino threatened the house of cards holding up European banks, more money had to be pumped into Cypriot banks so their doors didn’t close and rapid contagion wouldn’t implode all of Europe, and then the world.
Only this time was different.
The ECB reached straight into Cypriot bank depositors’ pockets and stole about $6 billion from them. The “how” isn’t important. It’s a simple equation, as revealed in Part V. Governments are the backstoppers of central banks; that’s where their authority ultimately comes from.
Why did the ECB steal depositors’ money? So they could turn around and lend that and more to the insolvent banks to keep them alive. It’s the latest twist in the old “extend and pretend” game.
The big question is, how did banks get so big and so dangerous in the first place?
Or, how did stodgy traditional banking morph into “casino banking” on a global scale?
Here’s how it started…
It’s all based on the American model.
With the Federal Reserve set up as the “lender of last resort,” U.S. banks prospered.
The end of World War I provided banks with a huge opportunity to lend money to European countries, both American allies and to defeated Germany. It was a tidy arrangement for them, on account of de facto U.S. government backing of the loans and Germany’s forced reparations payments.
Meanwhile, back home, the Roaring Twenties were in full swing. Money was plentiful in the form of cheap margin. It took only a 10% down payment to dabble in rapidly rising stocks. Speculation and stock manipulation schemes became rampant.
The bubble burst in 1929. Then wrong-headed moves by the new Federal Reserve, who tightened credit in response to former lax conditions, were compounded by unwise government tariffs that strangled global trade.
The result was America’s Depression.
Bank reform was a huge part of President Franklin Roosevelt’s New Deal to get America back on track. It included separating deposit-taking commercial banks from securities trading investment banks and spawned the Federal Deposit Insurance Corporation to safeguard depositors.
Meanwhile in Europe, Germany couldn’t make reparations payments and resorted to printing money to make do. Massive inflation in Germany led to a collapse in standards of living and the rise of the Nazi Party.
At the same time, Japanese militarism was on the rise. So was Japan’s increasingly acute need to access oil reserves, which it didn’t have and needed to power its industries.
America’s entry into the War woke up its animal spirits and transformed the country into an industrial juggernaut.
After the Axis powers, Germany, Japan, and Italy were defeated, U.S. banks were the only banks in the world in a position to lend, and again, with the de facto backing of the U.S. government, they recapitalized industries and countries across the globe.
The 1950s in America were heady growth days. Corporations were mushrooming rapidly, helping to expand the middle class as they prospered together. Europe was rebuilding, and Japan was using U.S. aid to build factories to manufacture cheap export goods.
As we entered the Go-Go ’60s, huge and growing deposit-taking commercial banks would come face to face with their grossly undercapitalized investment banking cousins and find themselves – and their profitability – under direct attack.
What happened next changed banking forever.
Understanding exactly what happened, why, and how will change your understanding of what banks really do and how what they do affects you and your ability to make money in the landscape they dominate.
Thursday’s chapter will lay it out for you. You’ll immediately see the hidden hand you knew was always there. From there I’ll take you upstairs and show you through the cameras watching you how the casino floor is rigged to benefit the house…
And, of course, show you how to beat them at their own game.
I’m not buying any bank stocks here. I don’t own any at present. And if I did, I’d either sell them or at least hedge them.
It’s not that they’re doing poorly. They’re not. Bank stocks have been strong because they’ve been making record profits. It’s been a good ride if you’re a Too Big To Fail bank or a shareholder.
But, being the cautious trader I am, I’m inclined to take profits when I have them in hand. That’s why I’m out of the banks. I’ve banked my gains and turned cautious.
Citigroup is up this morning. They beat analysts’ expectations.
Wells Fargo and JPMorgan Chase didn’t do badly last week, in terms of their earnings and profit numbers, but investors were disappointed.
But here’s why I’m cautious…
I’ve turned cautious on the group because I’m not seeing domestic or global GDP growth at levels that justify a continuing upward trajectory for big bank stocks.
Citigroup made a nice $3.8 billion profit in the first quarter by reducing costs, unloading troubled assets, and from “strong” loan demand. And they reaped nice rewards from their investment banking unit.
Okay, they’re dumping 11,000 people in the months and quarters ahead. That’s good, I guess. But what were they doing with so many excess employees on the heels of the financial crisis and their near-death experience in 2008? Were they expecting to keep them busy when business skyrocketed? Are they letting them go now because they don’t see the growth they were expecting?
I like that Citigroup’s international footprint deposits rose 3% in the quarter, and I like that total loans rose 5%, But I don’t like that revenue from fixed income, equities, “markets” and debt and equity underwriting rose 31%.
Any time a big bank is making big gains in “markets” it worries me. It also worries me that Citi’s revenue growth slackened in the first quarter.
It worries me that Citi got hammered in the fourth quarter on mortgage woes.
Why does that worry me if it’s in the past? Because Wells Fargo, which has been hiring lenders and support staff to bolster its mortgage business, said last week that their re-financing business slowed in the first quarter and origination volume fell 13% in the first quarter from the fourth quarter. So, maybe Citi’s mortgage woes aren’t behind them.
As the housing market has been firming up, Wells, which now originates one out of every four mortgages made, has been a beneficiary. But what if the housing market pauses? What if rates start rising? What if confidence starts eroding?
Can Wells continue its streak of eight consecutive quarters of record net income?
JPMorgan Chase saw a decline in deposits, and total revenues actually fell 3.6% from a year ago.
Still, they posted a record first-quarter profit of $6.5 billion.
But loan demand was weak. The bank saw revenue from consumer and community banking fall 6.1%.
So, how did they book another record?
They had gains from cost cutting and they’re cutting another 17,000 jobs over the next two years. Sound familiar?
Chase got a nice push in net from backing out $1.2 billion from loan loss reserves. That’s a big number to say won’t be needed, because they see strength in mortgages and consumer credit card losses are looking less troublesome.
Another thing that worries me about the big banks was borne out by something Chase’s CFO Marianne Lake said. She’s concerned about “mounting competitive pricing for loans.” Since there isn’t a lot of across-the-board loan growth, and loan pricing could see margins impacted, I just have to wonder where this is all going.
China’s GDP growth came in today with a 7.7% advance. That is well below the 8% plus growth rate that analysts were expecting.
Is global growth slowing?
News flash… it hasn’t exactly been robust lately – as in the past five years.
All these little factors add up to some fluttering of red flags for me. That’s why I’m out of big bank stocks.
If I’m wrong and they all head higher, that’s okay with me.
They’re still facing headwinds, like Dodd-Frank rules and regulations that will eventually get written and implemented. That could have a potentially dramatic impact on certain revenue streams. Can you say the Volcker Rule?
If you still like the big banks, good for you. I’m not always right. But if you want to sleep a bit better, why not buy some puts to protect your exposure to lofty prices and lock in your gains in a what-if world?
It’s a lot of work being on a board of directors. You have responsibilities too.
Actually, it’s more about responsibilities than work. Believe me, I’ve been a director.
Take the big banks, for instance. With all their problems they must have a lot of board meetings. Talk about work and responsibility. Forget the compensation, it’s not worth it.
Well, maybe it is for some directors. After all, these days a few hundred thousand dollars a year for making a bunch of meeting in exotic places – sometimes – and staying at top notch resorts and hotels, and eating all that rich food, is still worth the tip money.
According to compensation data firm Equilar, in 2011, the last year Goldman Sachs’ numbers were available, they paid their 13 directors an average of $488,709, annually.
That’s up 50% from 2008, which was a not such a good year. But it pales in comparison to 2007, which was a very good year, when directors averaged $670,295.
Here is just a sampling of compensation figures.
Equilar reported that, in 2012 Morgan Stanley directors averaged $351,080. Bank of America directors averaged $275,000. J.P.Morgan Chase directors got $278,000. Citigroup directors got $315,000. And Wells Fargo directors earned $299,429.
Now, don’t get me wrong. I would love to make that kind of compensation. Stocks are fine – if I can hedge them. Cash or stock grants or any of the other stuff… Maybe a loan or a special mortgage… Whatever. I’m on the Team, gosh darn it! But it doesn’t matter. As Dire Straits said, it’s good “money for nothing.”
Making meetings is work. Work, to me, is being required to be somewhere at some time to take care of your business. That’s work.
Now, if your work is eating and drinking and talking, or napping while other people are talking – or not talking – then that’s what I call a cushy job. A lot of directors think that is what they’re brought in to do – or not do. But it’s still work. And, like a lot of jobs, if you show up for work, you get paid.
The other part of being a director is the part that matters. It’s the part of the “job” that isn’t talked about.
It’s the responsibility thing.
The truth about the big banks is that their directors are (supposedly) responsible for their corporations. But they don’t take responsibility for doing their jobs at anywhere near the level that they should.
CEOs and everyone on down the line gets blamed – and they should – for their misdeeds. But no one blames the (usually) nameless directors.
They get paid a tiny fraction of what their executives – the ones they pick – get paid, from the compensation packages that they, the directors, grant them.
The executives pay their traders and rainmakers a ton of money to make them look good to the directors. And if they all make a lot of money, the board of directors has the power to give themselves raises and bonuses, too. Sweet!
The top-top dogs, the directors, executive and non-executive directors, are responsible for the mess they allow their companies to sink into.
But, because they’re mostly hand-picked by the cronies and sycophants on boards, they mostly act like traders in the trenches, figuring out how much risk they can take to get paid more at the top.
If they screw up royally, they have elaborate insurance policies that the company pays for to shelter them from the God-awful judgment and flagrantly abandoned responsibilities they were hired to exercise in the first place.
Nothing ever happens to them. They are the ultimate protected class.
There’s nothing wrong, in my playbook, from paying directors gigantic amounts. Even a lot more than what they are being paid now, even for a “part-time” job. If they do their jobs responsibly, then they’re worth it.
The problem is that they don’t do their jobs and they aren’t responsible for what happens.
I’m speaking about banks, in particular, but this applies to all corporations. Let directors earn what they’re worth. But if they fail, claw back all their compensation and make them pay all the insurance premiums shareholders paid out to cover their worthless behinds.
Okay, you directors out there, let’s hear what you have to say about that.
It’s the Willie Sutton bank robber quote in reverse. Willie was asked, “Why do you rob banks?”
He famously answered, while in handcuffs, “Because that’s where the money is.”
But, banks can’t keep robbing the public if they keep shooting themselves in their feet. That’s where central banks come in. They are the real kingpins keeping their robber minions in pinstripes – instead of prison stripes.
Estimates now are that U.S. banks – the too big to fail ones – will end up paying more than $100 billion in fines, settlement costs, to buy back bad mortgages, to right some of the past wrongs related to the mortgage crisis they caused.
It could end up being more. But they’re all still in business. They’re able to digest these “costs of doing business,” and get bigger. And the banks are making enough profits to want to “reward shareholders” by raising their dividend payouts and buying back their stock.
Then there’s the LIBOR mess. Banks colluded to manipulate the London Interbank Offered Rate. LIBOR is referred to by the British Bankers’ Association (an outfit populated by bankers as a kind of trade group that oversees LIBOR dissemination), as “the world’s most important number.”
There have been some settlements already. Three giant European banks – Royal Bank of Scotland, UBS, and Barclays – have ponied up almost $3 billion to settle matters regarding their involvement.
How much will the big American banks have to pay to settle their end of the scheming manipulation?
Nobody knows. But estimates I’ve seen range from $7.8 billion (I have no idea how the analyst came up with that figure… Thin air?) to more than $125 billion.
The point is that no one knows how much it will cost banks because it’s impossible to calculate how so many people, businesses, municipal governments, and anybody who paid interest based on LIBOR, was adversely affected.
The banks will pay whatever they have to in order to get these matters settled. They’ll all still be in business and able to digest these “costs of doing business.” They’ll get bigger, and make enough profits to want to “reward shareholders” by raising their dividend payouts and buying back their stock.
But the hits keep coming folks.
Now the banks are being investigated for collusion, price fixing, restraint of trade, and just flat out being the criminal enterprises that they are. And for all their hard work in keeping credit default swap (CDS) trading off exchanges – where prices would be transparent and honest.
Then again, who cares about that little corner of the market for that little product t? It’s only estimated to be in the tens of trillions of dollars. They are weapons of financial mass destruction in the shaky hands of speculating shysters. Okay, that’s a hyperbole. There is a place for CDS, it’s just not where it is now – which is everywhere.
How much will it cost banks? $1 billion? $10 billion? $100 million billion?
The banks will pay whatever they have to. They’ll all still be in business. They’re able to digest these “costs of doing business.” They’ll get bigger, and make enough profits to want to “reward shareholders” by raising their dividend payouts and buying back their stock.
Starting to get the picture?
Banks have become protected criminal enterprises.
They couldn’t do what they do without two things…
Make that one thing, because the one thing really encompasses the two things. I was going to say with they operate under the auspices of their cronies in government – and the Federal Reserve or central banks everywhere. But forget the government stooges. They are beholden to the Fed and central banks, which they long ago sold their souls to.
Without central banks to bail out the banks they would fail. And they should. But they can’t because they are too big to fail – and too big to jail.
Now that’s a business model!
Oh, and why are governments around the world (case in point: the United States) able to run mega-deficits?
That would be because they’re in bed with their cuddly central banker colluders, so they can print money to buy their never-ending, always-spewing bills, notes, and bonds that finance political pandering to the voters to stay in power.
They couldn’t do it without central banks.
Are central banks criminal enterprises? I ask you.
Chapter Four ended as a cartel of powerful bankers gathered on Jekyll Island to develop a plan for creating a central banking system which would work for their interests.
John Pierpont Morgan was no stranger to how central banks worked. He had witnessed their power firsthand.
Junius S. Morgan, Pierpont’s father, became a partner at George Peabody and Company in 1854 and moved to London – where the American-born Peabody had been bankrolled by Baron Nathan Mayer Rothschild. At the time, the rich and powerful Rothschilds exerted extraordinary control over the Bank of England.
George Peabody and Company rode the mania for railroad shares, whose prices in 1857 were benefiting from the Crimean War’s impact on rising grain prices, which Western railroads transported in huge quantities.
But the good times didn’t last.
As the Crimean War ended, wheat prices began to tumble, sinking railroad share prices and most stocks in the bargain. Another bank run was underway in New York. Banks stopped issuing gold, preventing Peabody’s American correspondents from remitting payments to London. Additionally, British investors were dumping American securities, adding to Peabody’s cash crisis.
George Peabody and Company was on the verge of failure when it was saved by an £800,000 credit line from the Bank of England.
J.P. Morgan was twenty years old at the time and had just begun working for one of his father’s correspondent agents in New York.
He would never forget how the Bank of England saved what would become the House of Morgan…
The meeting on Jekyll Island brought together banking competitors to essentially fashion a cartel to be overseen by a central bank enforcer.
John D. Rockefeller’s Standard Oil of New Jersey had grown so big that it needed its own captive bank. Rockefeller deposited enough money, and did enough business through National City Bank of New York, the country’s largest bank, to effectively control the bank. He also controlled the Chase National Bank through his brother, William.
Rockefeller wanted a lender of last resort, too. His banks were no less prone to depositor runs than any other institution.
All of the men on Jekyll Island wanted the same thing: access to the unlimited liquidity backstop that only a central bank could provide.
The “National Reserve Plan” that they came up with was nothing short of brilliant.
To start with, the group knew that bankers putting forward a plan for a central bank – which they would control – would never get far. Banks had become evil-doers, and the most powerful bankers in the world had been vilified across Europe and the Americas.
Their creation was called the Federal Reserve System. It not only avoided the word bank, it cleverly implied federal, or government, control over the establishment of a pool of reserves that would backstop the new banking “system.”
To address their competitors (especially the rapidly growing Midwestern and Western banks, none of whom were represented at the meetings) they invented a 12-bank system, so regional Federal Reserve Banks could serve more localized commercial banks.
Of course it was a ruse. Competing banks weren’t getting access to their own regional central bank; all of the regional banks would be controlled by a board in Washington.
The Plan called for federal debt to be converted into money, which would be lent to the government, and for the System to be the depository for all federal funds.
They wanted to be the official creators of money, and have their notes be made legal tender for all debts public and private.
The money they designed incorporated official seals and symbols to make it look like it was issued by the United States Treasury.
Unfortunately for the bankers, opposition to the Plan developed immediately upon its unveiling.
Nelson Aldrich, who championed the “bill” which he claimed to have co-authored as a result of being chairman of the National Monetary Commission, was known to be a mouthpiece for the banks. More work needed to be done to dupe the public and Congress before the grand scheme could be made law.
A political solution had to accompany the public relations assault being organized.
The Republicans, traditionally bank and big business backers, lost the House in 1910, making it impossible to even bring the Plan to a vote.
But the bankers didn’t just need a compliant Congress…
They needed a willing President.
William Howard Taft, the popular Republican President, was up for reelection in 1912. However, the bankers were unhappy with Taft, who endorsed their Plan heartily but demanded control of the beast for personal political reasons. The bankers didn’t want a bunch of politicians dictating to them. Something had to be done about Taft.
It just so happened that several wealthy banker associates of Rockefeller’s, J.P Morgan’s and the Kuhn Loeb banking houses, were financial backers of the President of Princeton University, Woodrow Wilson.
Wilson was an academic who attended the College of New Jersey, and changed its name to Princeton University when he became president in 1902.
It wasn’t surprising to the bankers that Wilson came out publically in favor of their Plan.
Here, they thought, was a man they could do business with.
So, with the backing of directors of Rockefeller- and Morgan-controlled banks, Wilson was anointed Governor of New Jersey in 1910. He didn’t realize it, but he was being groomed to enter the presidential race only two years later.
Since the bankers knew where Taft and Wilson, the Democrat, stood, it was only a matter of putting their man into the White House.
The bankers were backing Taft, as they had before, and Wilson, too. They knew the unknown Wilson had no chance against the well-liked Taft.
To swing the election their way, the bankers devised an ingenious plan. They would bankroll the well-liked Teddy Roosevelt, a former Republican and Progressive, and bring him out of retirement to run as the Bull-Moose Party candidate.
The bankers spread their bets, but angled for Wilson.
Just as planned, Teddy Roosevelt’s entry into the race split Republican voters. Wilson was elected with only 42% of the popular vote.
The White House belonged to the bankers.
The old Jekyll Plan was re-christened for its new voyage through Congress. It was the same plan, with some minor modifications. Only this time the bankers came out against it.
They had come to realize that if they were openly against any bill the public and Congress was for, it would appear that it was a bill that would bridle them – and once and for all bust what had been termed the Money Trust.
It worked like a charm in Congress and with the public. The coup de grâce – which had, in reality, been a coup d’état – was that President Wilson was for it.
He signed the Federal Reserve Act into law two days before Christmas in 1913. It gave the bankers the gift of all gifts. The new Federal Reserve Notes would be made obligations of the United States government.
The Federal Reserve System is a central bank. Central banks don’t have any money. They issue money or credit out of thin air. The money or credit they issue is backed by the taxing power of the governments they partner with.
When banks get into trouble, central banks have the authority to provide them with as much money as they need to remain solvent, get out of trouble, and become profitable again. The unlimited liquidity and backstop spigot that central banks control creates a self-perpetuating banking regime. Favored banks will always get bailed out to become profitable another day.
Central banks – of which the Federal Reserve is, by far, the world’s largest and most powerful – serve banks first and foremost. Secondly, they serve their host governments.
They are the ultimate tool of the rich and powerful.
If you don’t realize that, think about what just happened in Cyprus.
The European Central Bank, with the backing of Germany (whose banks have the most at stake in Europe) just reached into private depositors’ accounts in two Cypriot banks to legally take out as much money as they needed.
To do what?
To give the money to the ECB to give to its constituent member banks (that want upfront cash) so the ECB can in turn make another loan – out of thin air – to Cypriot banks to give them the time to get their houses back in order.
This is how the world operates. If you understand how banks play and what central banks are doing, you can play along and make yourself a ton of money in the process.
I’m constantly asked where I think the market is going next. Since the Dow recently reached new highs and since the S&P 500 is near (about half a percent away, as of yesterday’s close) its old October 2007 highs, it’s no wonder that’s the question on everyone’s mind and tongue.
My answer is: I don’t know where it’s going.
But I do know what to do about it.
Here’s the thing…
The market is like the lottery, you’ve got to be in it to win it. And that includes being out of it at times, too.
That’s not contradictory. Here’s why. Being fully invested is taking a big position. Being partially invested is taking a smaller position. Being out altogether is still a position.
That’s how professional traders think. Everything you do puts you in a position. Being in cash is a position every bit as much as being fully invested is having a position.
What’s important – and what all successful traders do – is to watch your position.
If you’re in stocks, what is your exit strategy on the profit side? On the loss side?
How are your stocks performing relative to firm-specific issues or the market’s general trend?
Equally important–as in always, always–is when and where to apply that cash?
With that in mind, here’s what I’m looking at as we hit record after record – and what I recommend doing about it.
First you must ask yourself:
Why have markets risen while domestic economic growth has been stagnant? What is moving markets higher? And what can change?
The Fed has been keeping interest rates for interbank lending and borrowing at essentially zero. That drives down all interest rates. They’re doing that by buying government bonds and agency paper – meaning government guaranteed mortgage-backed securities. They’re buying $85 billion worth per month, and they expect to keep it up.
What the Fed is doing, besides prodding consumers to spend in an attempt to keep access to installment credit cheap, is supporting a recovery in the banks’ balance sheets. The Fed is giving them cheap money to buy the same government bonds they’re buying, so banks’ inventory of bonds will appreciate along with paying them interest. By buying agency paper, they’re supporting the valuation of mortgage-backed securities on the banks’ balance sheets, hopefully long enough to see housing – and those bond prices – bounce back.
The by-product of the Fed’s action has been articulated as its primary intention, which, they say, is to help drive up markets, confidence, and the economy.
It’s been working for the markets, but not so much for the economy. Why?
Because banks are more interested in themselves and repairing their balance sheets (in other words, making safe money) than lending at low rates.
They are not in the lending business, especially loans to small businesses and consumers – unless it’s through revolving credit lines, dispensed with myriad penalties and exorbitant interest rates through credit card issuance. They’re not into allocating capital to borrowers, either, as much as they’re into creating products. There’s a big difference.
Fortunately for corporations, earnings have been great. And with low interest rates they have been able to refinance higher-interest debt and amass large quantities of cash.
Incidentally, that’s not good for banks. When corporations have positive cash flows, when they are flush with earnings and sitting on reserves, they don’t need to borrow from banks.
A lot of corporate earnings are coming from overseas. That’s been good on account of slow domestic growth.
But, those earnings have benefited from a weak dollar. As other countries work to devalue their currencies to make their exports cheaper, and as the dollar continue to strengthen, overseas earnings–when translated into a more expensive dollar–will not be as robust as they have been. On top of that, if global growth falters, earnings will take a bigger hit.
The domestic hope is that housing is bouncing. That’s important because in spite of the $10 trillion in growth from a rising market, fewer and fewer people are actually in the market other than in their pension and retirement funds. Average Americans need a robust housing market; it’s where the bulk of their wealth has traditionally resided.
I worry about banks not lending to potential homebuyers, which can cause housing to stall. I worry about contagion from the ongoing mess in Europe. Cyprus is a real problem. It is another canary in the coalmine, like Greece was. Europe’s problems are not going away.
American growth isn’t likely to be robust if the banks aren’t lending, and if fiscal restraint (à la Europe’s belt-tightening) slows the meek forward momentum that the economy has seen.
That’s what worries me about the market being as high as it is – and its prospects for going higher still.
Then again, there is so much sidelined cash, a lot of which is heading back into equities, and the prospect that low rates will see an exodus out of bonds and into stocks, the Great Rotation, that markets have potentially plenty of firepower to go higher. In fact they could go a lot higher.
So, what am I recommending?
Follow the big trends and trade on the same side, starting with the big macro trends all the way down to the minor trends within bigger trends, if they’re all going the same way.
The markets are going up, so stay in them. Get out as you take profits when your positions slip back and hit the stops you always should be raising as the market rises.
Apply your cash diligently and sparingly to new positions, especially if they are speculative.
Take small losses on new positions when you get in. You’re late to the party, but the punchbowl is still out there and heavily spiked, so join in but do so incrementally.
If you’re putting on defensive positions (hopefully they pay solid dividends), add to them on dips. But think about an exit strategy if the big picture turns negative.
We may not get a significant correction, in which case you want to be riding this bull market higher.
Then again, the markets love to sucker in sidelined cash right before they crash.
Is a crash possible? Yes it is.
There are technical reasons why the markets are shaky. I’m not talking about technical analysis. I’m talking about high-frequency trading trends and the massive growth of ETFs. The interplay between them is a danger zone that could undermine markets in a New York second.
When it comes to the market, I know I don’t know which way it’s going, but I always manage to make money when it goes in either direction. My trick is to follow the trend and follow that nagging feeling I get when the trend shows cracks that not everyone else sees.
Chapter Three ended with the rise of J.P. Morgan and how he used chronic boom and bust cycles to his own great advantage. That brings us to the Panic of 1907.
The Panic of 1907 was a seminal event in the history of banking. It spawned the Federal Reserve System – but not immediately. There would be a long cloak-and-dagger affair before the Federal Reserve Act was signed into law – while Americans were distracted – two days before Christmas, on December 23, 1913.
How Congress was duped by many of its own, and how the public was blindsided into believing their government was creating a safer banking system is a testament to the power of private banks to run and, for their own profit, ruin America.
Here’s how it all happened.
In The House of Morgan, Ron Chernow’s history of the Morgan banking dynasty, he succinctly explains, “In the early 1900s national and most state-chartered banks couldn’t take trust accounts (wills, estates, and so on) but directed customers to trusts. Traditionally, these had been synonymous with safe investment. By 1907, however, they had exploited enough legal loopholes to become highly speculative. To draw money for risky ventures, they paid exorbitant interest rates, and trust executives operated like stock market plungers. They loaned out so much against stocks and bonds that by October 1907 as much as half of the bank loans in New York were backed by securities as collateral.”
Up to now, I’ve given you a removed history of banking. From now on I’ll move you forward at times to show how what happened in the past is still happening today. You’ll learn to see what’s going on from the perspective of history repeating itself – then you’ll be able to protect yourself and make money by seeing into the future through the dark past.
What happened during the Savings & Loan Crisis of the late 1980s and early 1990s resulted in almost 800 banks failing. But it was also a slightly distorted mirror image of trust excesses in the 1900s. The S&Ls raised huge deposits garnered by hawking high-yield CDs, only to speculate in the real estate and other “investments” that would eventually blow them up.
The Knickerbocker Trust was attempting to corner copper and speculate in shares. If they succeeded, copper prices would go through the roof, and they would make hundreds of millions. But then, on October 21, 1907, copper prices began to collapse on word that Morgan and Guggenheim were getting into the copper mining business. The collapse dragged down shares across the board. The Knickerbocker Trust, with its huge position in copper, and the shares it owned, was wrecked.
Another run on banks was underway.
Bankers Trust, which was set up by the House of Morgan and its allies to capture trust business that commercial banks in the Morgan sphere couldn’t profit from, was not spared in the bank run. Bankers Trust was run by Benjamin Strong, who later became the all-powerful President of the New York Federal Reserve Bank.
J. Pierpont Morgan personally led the rescue of the market and banks. But it had become clear that big banks, including his allied institutions, were not too big to fail.
The New York and and other Eastern banks also wanted to tame Western banks. These were growing so quickly that, by 1913, these non-national banks, outside of the Washington-New York sphere of influence, would grow to represent 71% of all the country’s banks and 57% of all deposits.
The Gentleman Banker’s Code, which kept Eastern banks from stealing each other’s clients, needed to be enforced out West. And a lender of last resort had to be created.
As a result of the Panic of 1907, in 1908 Congress passed the Aldrich-Vreeland Act. The law was, more or less, a two-act play.
Act One authorized banks to issue “scrip” – a currency substitute that is not legal tender – instead of cash to depositors if they were facing a run, and instead of using gold or government bonds as reserves, banks could make loans (issue cash or scrip) against any bonds and commercial loans. In other words they could use assets, which carried real liabilities, as reserves.
Act Two created the National Monetary Commission to study and recommend legislation to bolster the banking system.
Of all the nine Senators and nine Representatives on the Commission, only one did anything.
Nelson Aldrich, the rich Republican Senator from Rhode Island, was the chairman of the Commission. Aldrich took two years to study central banking around the world. At home, he was counseled continuously by the “Money Trust” – bankers he was in bed with and represented in Congress.
A plan was coming together, but it needed to be mastered and sanctified.
That’s where G. Edward Griffin’s masterpiece of muckraking, The Creature from Jekyll Island, opens up. In chapter one, Griffin pulls back the cloak on Nelson Aldrich’s plush private rail car to reveal the passengers heading, under the cover of darkness, from New Jersey to a hunting lodge on Jekyll Island, Georgia, both owned by J.P. Morgan.
Griffin writes, “This was the roster of the Aldrich car that night:
Nelson W. Aldrich, Republican Whip [of the] Senate, Chairman of the National Monetary Commission, business associate of J.P. Morgan, father-in-law to John D. Rockefeller, Jr.;
Abraham Piatt Andrew, Assistant Secretary of the U.S. Treasury;
Frank P. Vanderlip, president of the National City Bank of New York, the most powerful bank at the time, representing William Rockefeller and the international investment banking house of Kuhn, Loeb & Company;
Henry P. Davison, senior partner of the J.P. Morgan Company;
Benjamin Strong, head of J.P. Morgan’s Bankers Trust Company;
Paul M. Warburg, a partner in Kuhn, Loeb & Company, a representative of the Rothschild banking dynasty in England and France, and brother to Max Warburg who was head of the Warburg banking consortium in Germany and the Netherlands.”
It was at this meeting on Jekyll Island that the blueprint for the Federal Reserve System was laid out.
But it would take three more years, and the considerable power and money of the conspirators, to buy the Presidency of the United States in order to get his signature. He would sign the legislation that Congress was duped into passing in order to create the greatest money-making machine the world has ever known.
How did they do it? You’ll get that in the next installment.
And one last thing: This isn’t some conspiracy theory or maybe-it’s-true-who-really-knows kind of thing.
This is American history.
No one disputes it. Everyone just forgot how we got here.
Some people will do anything to make money in the market.
Believe it or not, folks have even resorted to manipulating stocks to fatten their wallets.
And, crazy as this sounds, there are more people doing it than anyone imagined.
Now, I know you’d never do that. But the SEC isn’t so sure. Neither is the FBI.
According to yesterday’s Financial Times (the pink paper that some financial types read), the FBI is joining forces with the SEC in order to “tackle the potential threat of market manipulation… that [has] taken markets beyond the scope of traditional policing.”
What’s hilarious to me is that, before the FBI goes looking for market manipulators (like you) along with the SEC, it should be looking at the SEC!
But I digress…
The Feds (that’s the FBI) are throwing their lot in with the other Feds, the SEC’s (who aren’t Fed enough) Quantitative Analytics Unit that looks at abuses of certain market data and information.
Apparently, some abuses result in manipulators keeping an excessively large amount of money – over above what they pay their lobbyists and what they donate to keep the SEC in Dunkin Donuts and internet sleaze while they do their manipulating thing.
But I digress…
The good news is that this “crack” team isn’t just smoking the stuff. They’re following the smoke trails of crack-the-market, manipulator types like hedge funds and – crazy as this sounds – you.
That is if you happen to do something that you probably do, and have been doing. Only, you didn’t know it was “abusive manipulation.” Well it is now.
I don’t know where the SEC got this notion, that high frequency trading (HFT) shops and trading desks – located in hedge funds, brokerages, and banks – have been manipulating stocks. They only flood the markets with quotes (quote stuffing) to set up suckers. They only place millions of orders – and cancelling them quickly (layering) – to set up suckers. HFTs are able to construct the National Best Bid and Offer quote for any stock before the exchanges consolidate quotes to disseminate any NBBO to the world, so they can trade before and against any incoming quotes and sock it to the suckers. Just harmless, innocent stuff like that…
I just don’t know where they got that notion.
I hope they the SEC doesn’t read this, but I hope the FBI does:
Hey, Feds! The SEC are the gangsters giving the HFT lads and lassies preferential access to all their servers to read all of the data they can get their hands on before the exchanges even get it. Hint: start there you idiots!
But I digress…
This is about warning you that you’re on their Watch List.
What’s frightened me is that I, too, am a market manipulator – and I didn’t realize it.
The Financial Times article reported that, among all the other front-running and other abusive manipulation that’s going on, “Also on their radar is artificial intelligence trading, an algorithm that predicts market reactions based on history.”
My God, they’re targeting technical analysis! We’re all manipulators. It’s not those high frequency traders…
Predicting market reaction based on history. Lord help me, I’ve been doing that for years.
Who knew that a head and shoulders pattern was blatant manipulation?
Who knew that our recognition of rising wedges was giving other innocent market players a wedgie?
Who knew that looking at lines on a graph was the real reason we’ve all been so successful lining our pockets… at the expense of all those other innocent market suckers?
Oh the humanity! I am so sorry that I ever bought that graph paper to make my X’s and O’s on all those point and figure charts. I swear I wasn’t trying to manipulate anything!
Wait a minute. What am I worried about? History is always prelude to the future. That means nothing will come of any of this new do-si-do dance of the Flailing Feds.
The HFT shops, desks, banks, and the manipulators – like you and me – are free to trade.
Someone ring that bell. There’s money to be made today.