The Game Is Up: The Fed Is Bankrupt

On Feb. 26, Bloomberg News announced that they had hired the firm used by the US Federal Reserve to do "stress tests" on the largest banks, to do a stress test on the Fed itself. The result was what Lyndon LaRouche and EIR have warned for nearly 6 years --- the Fed is drastically bankrupt in fact. This demonstrates once again that nothing but a full Glass Steagall reform and the return to a national banking creditary system can reverse the current global collapse into hell.

    The PDF version has powerful graphics on the financial collapse and the economic destruction of Europe and the U.S.. (see:

http://www.larouchepub.com/eiw/public/2013/2012_10-19/2013-10/pdf/19-25_4010.pdf )

 

The article below appears in the March 8, 2013 issue of Executive Intelligence Review.

 

             Mike Billington

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The Game Is Up: The Fed Is Bankrupt

by Dennis Small

[PDF version of this article]

March 5—In late February, the cat was let out of the bag: The Federal Reserve System of the United States is bankrupt. When the Fed's epitaph is written, it may well cite the cause of death as "the undue diversion of funds into speculative operations." The same applies to the thoroughly bankrupt U.S. banking system, guided by the Fed, and to the British Empire's entire trans-Atlantic financial system as well. As we will show below, the policy of endless hyperinflationary bailouts has finally come to the end of the line.

The public announcement of defunction came on Feb. 26. On that date, Bloomberg News reported that the New York-based risk analysis company MSCI had just completed a stress test on the U.S. Federal Reserve System, which found that, under the "adverse" scenario of a Fed "exit" from quantitative easing (QE)—i.e., selling off the $3 trillion in assets that the Fed has accumulated as part of QE—the mark-to-market loss on the Fed's asset book would be some $547 billion over three years. That is many times the value of the Fed's capital, and it means that the Fed is in fact bankrupt, by any honest accounting measure.

MSCI is the same high-roller company which the Fed itself uses to perform stress tests on the 19 largest U.S. banks. The current study, commissioned by Bloomberg News, applied the same criteria it uses on the banks, to study the Fed's own solvency. "The potential losses are unprecedented in the Fed's 100-year history," Bloomberg wrote in its wire.

The release of the MSCI study was impeccably timed to coincide, almost to the hour, with Fed Chairman Ben Bernanke's annual appearance before the Senate Banking Committee and the House Financial Services Committee, Feb. 26 and Feb. 27, respectively. None of the Congressmen or Senators on the committees were sufficiently emboldened to raise the issue of returning to Franklin Roosevelt's 1933 Glass-Steagall Act as the obvious solution to the looming catastrophe.

A few did take note, however, of the huge losses that would be suffered as the Fed unwinds its QE purchases, and Sen. Bob Corker (R-Tenn.) went so far as to shoot off an open letter to Bernanke the same day he testified before the Senate, demanding to know:

"If interest rates were to rise and your securities portfolio were marked to market, is it not possible that you could be rendered insolvent, at least on a balance-sheet basis? And if so, what kind of risk would that present?"

When a ranking Senator of the United States publicly asks the chairman of the Fed if the Federal Reserve Bank is not "insolvent," you know that things have gone very far.

Members of the Congressional committees may have shied away from talking openly about what many admit in private, is the only workable solution to the system's bankruptcy: Glass-Steagall. But not so organizers for LaRouchePAC, who were all over Capitol Hill, even as Bernanke was testifying—urging adoption of HR 129, which calls for a return to FDR's Glass-Steagall, and distributing the first 500 copies of Lyndon LaRouche PAC's "Draft Legislation To Restore the Bank of the United States," the necessary companion-piece of a return to the Glass-Steagall standard (see p. 4).

The report of the Fed's bankruptcy comes as a shock only to those who have not followed Lyndon LaRouche's writings over the years (see box). But that reality now finally appears to be dawning on large numbers of major players within the trans-Atlantic financial community—including the Fed itself, the Wall Street banking crowd, and their British senior partners—namely, that the Fed itself is flat-out bankrupt.

Easing Your Way into Bankruptcy

The Fed is now reaping what it itself has sowed, at London's insistence, with its policy of hyperinflationary quantitative easing, in response to the 2008 blowout of the world financial bubble. From 2008, through the end of 2012, the Fed issued over $2.5 trillion in new funds simply pumped into the banking system. In 2013, the Fed is on course to pump in an additional $1 trillion, through QE. (The total bailout of the banks is much larger than that, by an order of magnitude; the QE is simply the new cash that the Fed has pumped in directly).

The argument put forth by the Obama Administration for public consumption to justify these bailouts, has been along the lines of: "Hey, we have to help out the banks, so that they can in turn resume lending to businesses and consumers." But that was neither the result, nor the real intention. Over the same period in which U.S. QE totaled over $2.5 trillion, bank deposits did in fact rise by nearly $1.7 trillion. But was this money then lent out by the banks? Of course not: It went to feed the speculative cancer. As a result, total bank lending contracted by nearly $1 trillion between 2008 and 2012, at the same time that QE rose by $2.5 trillion.

But the real problem is even worse than that, because a quick rule of thumb is that perhaps half, at most, of bank lending in any given year is actually productive. The other half is speculative by it nature, consisting of interbank lending, placing bets on mortgages, and so on.

Nor is this policy limited to the United States. The British Empire's entire trans-Atlantic financial system has been hollowed out by this same speculative lunacy.

In the United Kingdom, over the same period, the Bank of England has likewise issued some $590 billion in QE, and bank deposits have also risen—by a dramatic $1.1 trillion, a 42% jump. Bank lending predictably fell in the U.K. during this period, just as it did in the U.S., in this case, by some £80 billion (or $125 billion, at the current exchange rate), a 5% drop.

The same holds true for the policy of the European Central Bank (ECB) for continental Europe. Over this same period, the European equivalent of QE—quaintly known as LTRO, or Long-Term Refinancing Operations—has weighed in with over $1.3 trillion in new funny money, to try to bail out the bankrupt European banking giants, while bank lending continues to stagnate across Europe.

The combined picture for the entire trans-Atlantic financial system is summarized in (Figure 1). Cumulative QE hyperinflated the financial system to the tune of $4.4 trillion by the end of 2012, and is soaring towards $5.5-$6 trillion in 2013. And all the while, bank lending has declined by about $1 trillion.

As LaRouche has repeatedly warned:

"The entire world system is in a crisis. It's a general breakdown crisis which is centered in the trans-Atlantic community.... [This is] a systemic rupture in the entire trans-Atlantic financial and monetary facade."

Derivatives: Double-or-Nothing Gambling

The last five years of QE hyperinflation, comes on top of the unleashing of the derivatives bubble with the 1999 repeal of Glass-Steagall, and that in turn was the follow-up to the 1971 demise of the Bretton Woods system and the systematic takedown of the productive economy in the wake of the Kennedy assassination.

The derivatives aspect of the problem deserves a moment's attention, since the most common question that comes up when angry citizens try to grapple with what is happening, is: "So what the hell are derivatives, anyway?"

That is a very good question.

Financial derivatives are, by far, the largest component of all financial aggregates in the world. Figure 2 shows the growth of these aggregates from 1980 to 2005, which, at that point, totaled just shy of $1 quadrillion (a thousand trillion), according to EIR's best estimate. Today the total is probably closer to $1.5 quadrillion—although the number is essentially meaningless, as are the derivatives themselves.

The point is, that the total financial aggregates are not made up principally of all of the stock markets in the world (overvalued as they are), nor of all the government, corporate, and personal debt in the world (as overvalued as that is). The lion's share—more than 80% of the total—is financial derivatives.

So, again: What the hell are derivatives, anyway?

Derivatives have been described, accurately, as essentially a way to lie and cover up a loss that has already occurred. Rather than facing up to the loss, and recognizing, "I guess I have to pay up or declare bankruptcy if I can't pay the debt," the speculator instead borrows more money in order to place a bet (a derivative) to cover up the loss by speculating on some hypothetical future gain. When that second loss comes due, he again covers the loss by a further bet, in the hopes that eventually he won't have to pay the increased loss.

Another way of describing derivatives, is the case of the gambling addict who is always losing at the roulette table, and rather than pay up and call it a day (and face the wrath of his wife, or his boss), instead says: "No, let's play double-or-nothing!" And when he loses again, he again insists frenetically: "Double-or-nothing! Double-or-nothing!"

In short, derivatives are double-or-nothing speculative bets designed to cover up massive losses, de facto bankruptcy, that are being suffered throughout the economy.

But at a certain point, the game is up, and reality asserts itself. That point is now.

Reality Strikes Wall Street and London

That realization is behind the public barroom brawl over financial policy that has broken out in world banking centers, from Great Britain, to the United States, to Japan and China, over how to address the hyperinflation "meteorite" that is about to strike Planet Earth.

In the U.K., Moody's, on Feb. 22, downgraded the government's debt rating from AAA to AA1, in the wake of a stronger-than-usual vote in the Ban