TBTF Meets TBTK
by Gary North: Confessions
of a Washington Reject
know what TBTF stands for: too big to fail. We need a comparable
acronym: TBTK. It stands for too big to kick, as in "kick the can."
"Too big to
fail" is such a common phrase these days that HBO chose it as the
title for a
movie on the big bank bailout of 2008. The context of TBTF is
correct: the largest banks, all over the world.
phrase, "follow the money," became famous because of All the
President's Men, the movie about the investigation of Watergate.
No one knows where it came from. The book's two authors don't recall.
The screenwriter is not sure. But it has become part of the American
When you want
to discover who is making the decisions, follow the money. This
applies in two ways to banking, which is the source of money, but
in a banking crisis, becomes the recipient of money. No other industry
enjoys the privilege of being at both ends of the flow of money
in good times and bad.
So, let us
follow the money.
More than any
other industry, large banking has the guarantee of high profitability
and success. The bankers know that the government will not allow
their banks to fail. So, they can take enormous risks based on the
discrepancy between short-term rates (at which they borrow) and
long-term rates (at which they lend).
When the spread
reverses, which it always does at some point, driving up short-term
rates and driving down long-term rates, the result is a recession.
If a very large bank faces bankruptcy, the central bank intervenes
and lends to it at low rates until the old yield curve (spread)
returns: low short rates and high long rates. If central bank intervention
is not sufficient, then the government intervenes and uses tax revenues
to offer more bailout money to the biggest banks.
has created a class of super-rich people. The arrangement is ideal
for them. When they win, they win big. They do not lose, except
when their bank is judged not quite too big to fail. Then the bank
gets bought up at a discount by a TBTF bank. The government arranges
the terms of sale.
has been known by economists and few others for two
centuries. There is a phrase for it: "moral hazard." It is just
about the only phrase in the field of economics that is designated
by the adjective "moral." Economics is said to be value-free science,
and therefore economists are not supposed to invoke morality in
their economic analysis. But "moral hazard" is an exception. We
are never told why the hazard involved is a moral hazard rather
than (say) a government-subsidized speculative hazard.
is correctly described as a moral hazard. It puts morality at risk.
It is a moral hazard because corporate beneficiaries are able to
use money stolen by the government from voters, plus counterfeit
money inflicted on the public by the central bank, to stay in the
business of counterfeiting money. It is a misuse of the public trust.
But economists never speak this way, for all but the Austrian School
economists are in favor of counterfeit money and tax revenues to
save large banks. This is why there was silence from all schools
of economics, except the Austrians, in 2008 when the Federal Reserve
of national government is so totally controlled by the large banks
that the knowledge of how the arrangement works never leads politicians
to stop bailing out the biggest banks in times of crisis.
in 2008 overwhelmingly opposed the TARP bailout. Their opposition
delayed the House of Representatives for a few days, but a falling
stock market, coupled with high-pressure appeals by Treasury Secretary
Hank Paulson, the former Goldman Sachs CEO, and Ben Bernanke persuaded
the House's leadership to join in a bipartisan thumbing of their
collective nose at the voters. "Fork it over, voters. It's good
for you!" The big banks were bailed out, so that they could pay
huge bonuses the next year. The huge insurance company AIG got to
participate in the free ride as if were a bank. It therefore did
not default on its debts to the big banks. It used the bailout money
to meet its obligations.
big losers. Bear Stearns was gobbled up. So was Wachovia. Lehman
Brothers went bust. But the winners got fire-sale discounts on these
assets and lots of new customers. How sweet it is to be on top of
the food chain!
exists in every nation. In 2008, the equivalent scenario was played
out in Great Britain and Western Europe.
The big banks
remain in charge. We know that, because we can follow the money.
More than any
scholar, Murray Rothbard followed the money in America. As an economist,
he wrote the best textbook on money and banking. It is so accurate
that no college or university dares to assign it or even mention
it. Rothbard did what no other economist had ever had done before
when writing an economic textbook. He described the process of fractional
reserve banking as immoral: a form of counterfeiting. The book is
Mystery of Banking. You can download
it for free here.
He was also
a master historian. He wrote several books on the relationship between
fractional reserve banking and American politics, which have been
intertwined from the very beginning of the nation. A posthumous
collection of his articles is A
History of Money and Banking in the United States. You can
for free here.
"kick the can" refers to a specific form of procrastination: to
delay making a decision regarding a problem that can be deferred
but cannot be avoided indefinitely. With each kick of the can, the
problem grows worse. The problem compounds. The resources required
to solve it do not compound at an equally high rate. The can-to-foot
ratio grows larger.
example of this problem in the West is the combined programs of
old age retirement and old age medical care, especially the latter.
These two programs in every Western democracy are underfunded. The
unfunded liability of the combined programs in the United States
is so large that experts do not agree on just how large. A low-ball
figure is $60 trillion. I have seen estimates as high as $100 trillion,
but only in the last two years.
received almost no attention as recently as 1999, when Peter G.
Peterson's book appeared, Gray
Dawn. The book was ignored by the media. He has put a substantial
percentage of his fortune into publicizing this. He is gaining some
hearing among a few people in the American intelligentsia, but he
is gaining no traction politically.
Dawn, he said that he had spoken with senior political figures
around the West. As the Chairman of the Council on Foreign Relations
from 1985 to 2007, he was in a position to meet these people. Without
exception, he reported, they all knew of the statistical reality
of the problem. Without exception, they all chose to ignore it,
since it would not become impossible to deal with until after they
had retired from office. It was not a high priority, because it
was not an immediate political priority. In the meantime, the retirement
tax funds flowing into the governments' treasuries provided funds
for immediate expenditures.
are the mirror image of the fractional reserve banks. The banks
are borrowed short (from depositors) and lend long (bonds and mortgages).
In contrast, the governments spend short (voters) and borrow long
are in the business of buying votes. The currency of the realm of
politics is votes. In the United States, the Congress faces an election
every two years. So, the time frame of a Congressman in an insecure
district is rarely longer than two years. The money that flows in
is immediately spent, for the flow of funds out (follow the subsidies/payoffs)
must come close to match the flow of votes (follow the political
money). There is a fairly tight matching temporally of the flow
So, if Congress
taxes directly and spends rapidly, it faces a problem. The voters'
benefits are offset by costs (taxes). A balanced budget leaves little
room to maneuver. The votes obtained by the beneficiaries of the
subsidies are threatened by the votes lost because of the taxes.
therefore search for a way to pay short and borrow long. If they
find a way to do this, they can buy more votes than they lose. Like
the banks, they make it on the spread. The spread is based on differences
beginning in Germany in the 1880s and universally by the 1930s discovered
a way to cash in on the spread. They promised voters that the government
would offer them retirement programs. Taxes would be low. The voters
In the United
States, 1965 brought the next phase: Medicare. It was the same great
deal: buy votes now with an old age payoff later. In short, buy
votes with promises. Collect taxes now, which can be spent on anything
Congress wants before the next election.
To make the
deal work, there had to be a way to avoid present costs of funding
the old age programs. If the programs had been private, they would
have had to be funded, as with any insurance contract. That would
have created political resistance. So, the politicians offered something
for nothing: large benefits in old age, but low, low monthly payments
in the present payments that had to be lower than what funding
required statistically. What would have been illegal for any private
firm to offer became the universal solution for politicians to cash
in on the "spend short, borrow long" opportunity.
In other words,
politicians imitated the banks. They found a way to make it on the
spread: a spread made possible by differences in time.
CAN HAS GROWN LARGE
The day of
reckoning was built into the arrangement. At some point, the funds
collected from Medicare and Social Security (FICA) taxes would be
less than the payments to beneficiaries. That day arrived several
years ago for Medicare. It arrived in 2010 for Social Security.
Here is the
political problem, which is the only problem that Congress always
cares about. The time constraints have shrunk. The government is
still borrowed long, but the payments to beneficiaries are now rising
rapidly. They now exceed the revenues from taxes. The payoffs to
voters are now in excess of the revenues from voters. To balance
the budgets of Medicare and Social Security, there must either be
tax hikes (politically risky) or reductions in payoffs (politically
What's a politician
size of the on-budget deficit, at $1.6 trillion, dwarfs the size
of the immediate deficits for Medicare and Social Security, which
are off-budget with respect to long-term liabilities. But the preliminary
day of reckoning has arrived: the on-budget effects of the twin
off-budget programs. The trustees of the so-called trust funds are
cashing in the nonmarketable IOUs issued by the Treasury years ago,
demanding enough money to make the pay-outs. The Treasury must write
checks to the trustees. This money comes out of the General Fund,
which is on-budget and immediate.
is concealing the fact that the two old age programs are now in
operational deficit condition. The size of these deficits are small
relative to the overall Federal deficit. Hardly anyone follows the
details of the trust funds, which are declining. The decline in
these funds is paralleled by an increase in the on-budget deficit,
but no one notices.
has seen its spread shrink, namely, the time frame between the money
spent to buy votes immediately and the tax collections needed to
keep the subsidies flowing. The average maturity of the Federal
debt to those lenders other than the trust funds fell to 50 months
in 2009, although recent purchases by the Federal Reserve under
QE2 has lengthened this. We
read on Wikipedia,
addition to the debt increase required to fund government spending
in excess of tax revenues during a given year, some Treasury securities
issued in prior years mature and must be "rolled-over" or replaced
with new security issuance. During the financial crisis, the Treasury
issued a sizable amount of relatively shorter-term debt, which caused
the average maturity on total Treasury debt to reach a 25-year low
of just more than 50 months in 2009. As of late 2009, roughly 43%
of U.S. public debt needed to be rolled over within 12 months, the
highest proportion since the mid-1980s. The relatively short maturity
of outstanding Treasury debt, coupled with the increased reliance
on foreign creditors, puts the U.S. at greater risk of sharply higher
borrowing costs should risk perceptions change abruptly in credit
We are told
by the Federal Reserve that its purchases of Treasury debt will
end this month. So, investors must be found to replace the demand
for Treasurys by the FED. It is not clear who these investors will
be or at what rate of interest.
We are in the
midst of the first public debate over the debt ceiling since 1995.
The Republican House and the Democrat Senate are at odds over how
to raise the ceiling. Any talk about actually freezing the ceiling
is merely for show. To freeze the debt ceiling is to cease kicking
the can. That would be the day of reckoning.
The can is
growing very large. Kicking it is what the voters really want Congress
to do. They do not want the subsidies to cease. But, as always,
they do not want to pay for all of the subsidies. Not since World
War II has the percentage of GDP actually collected in taxes from
the public exceeded 20%.
the can today involves adding to the Federal debt. No matter what
Congress does, it will not balance the budget by tax increases.
Even in World War II, the ratio of tax revenues to GDP did not exceed
23%, and that only for a year. Usually, the post-War ratio has been
around 17% to 18%, as
you can see.
has no ability to balance the budget by anything other than cutting
spending dramatically, but the voters do not want that. This is
why the debt ceiling will be raised by Congress. The public may
say it does not want this, but voters will extract vengeance on
Congressmen whose votes really do lead to spending cuts sufficient
to balance the budget. This is not going to happen. Congress will
not make the attempt.
some point, too big to fail banks will find that the government
can no longer kick the can. There will not be lenders to the government
at interest rates that the government can afford to pay. Even the
Federal Reserve System will stop lending, unless the FED's managers
decide to go to hyperinflation. When the government cannot continue
to meet its obligations, it will default in some form to some beneficiaries.
This is the dilemma facing all Western democracies.
If the big
banks are too big to fail, then they need the government to bail
them out in a crisis. But if the government can no longer afford
to bail them out, then what?
That will be
the day of reckoning for the West: when TBTF meets TBTK.
It is going
Don't get caught
in between. Don't be dependent on either the Federal government
or the TBTF banks.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
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