Late last week, the financial markets were rocked with the announcement that the biggest, and heretofore assumed most stable US bank, J.P. Morgan, lost $2 billion in recent months. The $2 billion was especially of concern, since it was the outcome of what is euphemistically called ‘trading’ by the industry – a term which more accurately should be called by its true nomenclature: speculation in high risk financial securities. In other words, the kind of investing that set off the previous global financial crisis in 2007. The $2 billion losses were apparently attributed to derivatives trading, specifically ‘credit default swaps’, a particularly volatile form of derivatives.
But what is more serious than just the $2 billion in losses by J.P. Morgan is that the loss is likely just a tip of the iceberg. More news of losses is undoubtedly yet to come. And it probably won’t be limited just to J.P. Morgan. Other investment banks (Morgan Stanley, Goldman-Sachs, as well as various Euro investment bank counterparts) are also likely in a similar position. Hardly noticed last week when the J.P. Morgan news broke, for example, was the almost simultaneous announcement that one of the big three French banks, Credit Agricole, had a 75% drop in revenues.
What has also been conspicuously missing in most public commentary thus far concerning the J.P. Morgan losses is what is the source of the $2 billion derivatives-credit default swap losses? What specific speculative CDS trades lay behind the $2 billion? Was it speculation in global commodities – which have recently gone bust? Was it gold futures speculation? Oil futures insurance contracts? Or perhaps European periphery states’ (Greece, Spain, Portugal, Italy, Ireland, Latvian, etc.) sovereign debt CDSs? Or was it CDS ‘bets’ placed in US markets or Brazilian or other currencies? European securities speculation is the most likely source, given that J.P. Morgan’s big trader – sometimes called the ‘London Whale’ appears responsible for much of the $2 billion in losses.
It has been generally under-reported by the US press, but banks all across Europe are contracting their lending sharply. Is that because of Greece? Spain? Or does that story have something similar to do with the J.P. Morgan losses? Whatever, the contraction in bank lending now accelerating in Europe all but guarantees that the Euro recession now underway will be more deep and protracted than official forecasts. The Euro banks are in serious trouble. Continuing austerity policies and deepening recessions across Europe – and bona fide depressions now emerging in the southern European periphery – will result in bank problems even more severe than at present over the next twelve months.
The Euro banking problem began to emerge late last year, 2011. However, it was temporarily postponed by the European Central Bank, the ECB, pumping trillions of Euros (worth roughly $1.30 each) into the Euro banks. This has served to buy the Euro banks some time, measured in months not years, so that the major European governments, led by Germany and France, together with their bankers can come up with a more generous and longer term bank bailout program. Europe is not in a sovereign debt crisis. The real crisis lies more fundamentally in the Euro banking and monetary systems. The southern tier states—and soon others in the north—have a sovereign debt crisis only because the banks, the northern banks especially, pumped vast sums into the southern tier economies over the past decade.
The north did so not for altruistic reasons, but to make money off of booming southern real estate speculation. As the southern tier economies’ GDP surged due to a false, speculative driven real estate boom, the northern banks lent even more to governments to help build out those economies’ infrastructure to accommodate the real estate boom. Some of that secondary lending was distributed by their governments to the rest of their society in the form of social spending. So the ‘sovereign debt crisis’ created is really secondary to the real-estate driven speculative investment boom ‘gone bad’. Sound familiar to all you US folks? Real estate speculation driving banking crises and government deficits and debt?
What happened with J.P. Morgan last week—and is still yet to happen further with J.P. as well as with other US banks—also shows how deeply the US banking system is integrated with the European. J.P’s losses are Euro-centered, speculation driven, and CDS and other derivatives based.
That means what’s been happening in Europe and its banking system is not isolated from the U.S. banks. Today’s emerging European bank crisis—the second globally since the first in 2007-09 centered in the U.S.—will have a significant impact on the U.S. And it follows that if a second banking crisis emerges on both sides of the Atlantic, a second general recession will follow on both sides as well. The European side has already begun. European economies are already well down the road of that recession. And there’s no way the U.S. economy, despite all the false hype about another recovery now occurring in the U.S. (the third such since 2009), cannot avoid a further downturn as well.
The Euro bank crisis has begun to spread its contagion to the U.S. banking system, as last week’s J.P. Morgan losses—centered in Europe and in the latter’s speculative markets—now clearly shows. Watch for more bad news to come on both sides of the Atlantic.
The roots of the two banking crises are similar. In the U.S. in 2007 it was speculative excesses that brought down the ‘shadow banks’ first, in particular the investment banks and insurance ‘banks’, like AIG, Bear Stearns, Lehman Brothers. But the big commercial banks were linked by derivatives speculation with their ‘shadow’ cousins. They too were dragged down, as was the almost entire financial system in the U.S. Lending to non-banks and consumers collapsed, as then did the rest of the economy.
The solutions introduced to the 2007-09 banking crisis by the U.S. Federal Reserve, the central bank of the U.S., and the Obama administration in 2009, did not resolve the fundamental problem of US bank instability. Massive amounts of bank ‘bad assets’ still remain on U.S. banks’ balance sheets. The Obama-Fed solution in 2009 was not the outcome of the then official programs introduced by the Obama administration to bail out the banks in 2009—i.e. the PIPP, TALF, and HAMP programs. Those programs were dead on arrival within a few months. The solution in 2009 was the Federal Reserve’s pumping of $9 trillion in liquidity injections into the banks, to offset the banks’ massive balance sheet losses. But the bad assets were not removed thereby. The black hole of losses was merely temporarily filled up by the Fed’s injection of trillions. That was supposed to result in the banks’ lending to non-bank businesses once again. But they didn’t. And they still aren’t, except for only the very largest and stable companies. Small and medium enterprises are still starving for funds. Investment and hiring is still a dribble and much less than the anticipated traditional ‘trickle down’.
The real program to bail out the banks in 2009 by the Obama administration also included a series of phony ‘stress tests’ to convince the public the banks were now ok. That was designed to get the public to buy bank stocks and restore badly needed bank capitalization. Congress and the administration then further allowed the banks to falsely report their balance sheet results, by suspending ‘mark-to-market’ accounting (true market value of assets) and by letting the banks falsely report their real financial situation. Not least, the administration and the Fed then allowed the banks to turn to speculative investing once again, in particular derivatives and other risky financial instruments—all at the same time they were promoting financial “regulatory reform.”
Last week’s J.P. Morgan loss is the inevitable consequence of the phony 2009 bailout of the US banks by the Fed and the Obama administration (and the even phonier Dodd-Frank financial regulation Act that followed). J.P. Morgan clearly illustrates the consequences of the Fed’s $9 trillion injection of free money into the banks, the phony stress tests that covered up the real situation, and the giving of free rein to the banks to engage in high risk speculative investment in CDSs and other financial instruments.
Initially derided by the Europeans back in 2009-10, the same U.S. bailout approach has been followed in Europe since 2010. After having initially described the U.S. Federal Reserve’s ‘bank stress tests’ of 2009 as “a joke”, Europeans have followed suit with similar cover-ups of the true conditions of their banks in 2011. The European Central Bank, ECB, subsequently followed in the footsteps of the U.S. Fed last year and started pumping trillions in liquidity injections, free money well below market rates, into their banks in order to try to buy time until a larger collective Euro bailout plan was developed. That plan, however, is being rolled out piecemeal and is still not fully defined or implemented.
The Federal Reserve’s policy of injecting trillions of dollars of ‘free money’ into the banking system in the U.S. is called ‘quantitative easing’(QE). It has had two and a half iterations thus far, with a third on the horizon as the US economy weakens. However, the Fed’s QE policy has not resulted in a sustained recovery of the U.S. economy. All that the Fed’s QE programs have accomplished has been to provide free money to the banks (at 0.1% borrowing rates). The banks borrowed the free money, or were paid full purchase price by the Fed on their market devalued bonds. Banks then took the free money and mostly lent it to speculators like Hedge Funds, or speculated themselves directly, in credit default swaps and other derivatives, in foreign currency markets, in commodities markets, etc. In other words, the massive free money bailouts by the US central bank only resulted in even more speculation by the banks. Is anyone surprised finally by J.P. Morgan’s credit default swaps and other speculative losses now emerging?
The ECB has recently gone down the same path as the Fed with its own version of QE to keep the Euro banks from collapsing. But the result will be no different in Europe than it has been in the U.S.: the euro banks may be temporarily ‘bailed out’, but no permanent solution has been undertaken. No real banks’ bad assets have been removed, bank lending to all but speculators and well-heeled big corporations will continue to decline longer term, household consumption in Europe will continue to decline, and all the rest.
Like austerity solutions on the fiscal side, quantitative easing on the monetary side produces no basic long run results and recovery—but to the contrary only makes the economy worse.
Europe is now repeating the errors of US central bank policies since 2008, just as the US after the November elections will, this writer predicts, repeat the European fiscal errors of austerity—that is, deep deficit cutting. The two economies will in turn likely exacerbate each other’s weakening economic condition in 2013.
The real solutions to the parallel failures of fiscal and monetary policies in both the U.S. and in Europe today require basic restructuring of the banking systems in both economies. The solution to the banking crisis—whether in Europe or the U.S.—is not further free money, massive liquidity injections by central banks. The solution is to create a broad ‘utility banking system’ for consumer households and small businesses. The solution is a thorough restructuring of the mission and monetary tools of the central banks and their complete democratization. The solution is not to abolish the Federal Reserve, as simplistic conservative ideology now proposes, but to fully democratize the Fed in order to make it responsive to the needs of Main St. and not an appendage of Wall St.
On the fiscal side, massive fiscal spending is required—financed not from deficits but from a fundamental restructuring of the tax system. But unlike proposals from liberal mainstream economists, it is not sufficient simply to spend more on fiscal stimulus. It is not just a question of magnitude of spending. It is a question of the composition and timing of that spending, as well as measures to remove household debt and regenerate household real incomes once again.