Sunday, 12 July 2009

Who pumped up the housing bubble? [updated]

Did you know that in December of 1994, the US monetary base was $427.3 billion. In December of 1999, it was $608 billion. In December of 2007, it was $836.4 billion.

This monetary base was backed by a decreasing supply of actual “standard money” held by banks. In December of 1994 such reserves were $61.36 billion; in 1999, they $41.7 billion; in December of 2007, they were $42.7 billion.

On the back of these reserves, however, as of December 2007 the total money supply of the United States, i.e., currency plus bank deposits of all kinds that are subject to the writing of checks, including the making of payments by debit card, was $6901.9 billion.

Just to say that again: In December of 2007, there were $6901.9 billion of checking deposits backed by a mere $42.7 billion of standard money reserves. 

Between December of 1999 and December of 2005, almost $1.7 trillion of new and additional fiduciary media were created by banks, and lent out. By December of 2005, under conditions created by US Federal Reserve chairman Alan Greenspan this ratio of actual standard-money reserves to checking deposits exceeded 126 times. By December 2007 checking deposits came to stand in a multiple of more than 160 times the standard money reserves of the banks. [1]

Where did all that money come from?  Overwhelmingly it was created out of thin air in a process described by George Reisman as the creation of counterfeit capital.  It was created as credit, and it was lent out.   And where do you think it went?  This graph from the New York Times shows where, if you haven’t already guessed:


That’s quite some “hockey stick,” don’t you think?  Well, all that money had to go somewhere, right. 

As George Reisman says, “Credit expansion was the source of the funds that fueled both the stock market and the real estate bubbles.”  And the source of that credit expansion – the organisation that aided, abetted and actively encouraged the leveraging of credit on the back of dwindling real reserves – was the Federal Reserve.  Compared to the Federal Reserve’s chairmen, Bernie Madoff was a piker.

    Since its establishment in 1913 and certainly since the expansion of its powers in World War I, responsibility for credit expansion itself has rested with the Federal Reserve System. The Fed is the source of new and additional reserves for the banking system and determines how much in checking deposits the reserves can support. It has the power to inaugurate and sustain booms and to cut them short. It launched and sustained the stock market and real estate bubbles. It had the power to avoid both of these bubbles and then to stop them at any time. It chose to launch and sustain them rather than to avoid or stop them.
To be responsible for a bubble and its aftermath is to be responsible for a mass illusion of wealth, accompanied by the misdirection of investment, overconsumption, and loss of capital, and the poverty and suffering of millions that follows. This is what can be traced to the doorstep of the Federal Reserve System and those in charge of it. It is destruction on a scale many times greater than that wrought by Bernard Madoff, the swindler who first made his clients believe they were growing rich, only to cause them ultimately a loss of more than $50 billion. Madoff is one of the most justly hated individuals in the United States.
In contrast to the $50 billion of losses caused by Madoff, the losses caused by the Federal Reserve System and those in charge of it amount to trillions of dollars, probably to more than $10 trillion if the stock and real estate bubbles are taken together. Instead of affecting thousands of people as in the case of Madoff, tens of millions have been made to suffer hardship. Indeed, practically everyone has been harmed to some extent by what the Federal Reserve has done: the owners of stocks that have plunged, pensioners, the unemployed and their families, towns and cities suffering the consequences of business failures and plant closings.
It is difficult to imagine living with the knowledge that one is personally responsible for such massive destruction. Such knowledge might easily drive someone to suicide or at least to some means, such as drink or drugs, of not having to allow it into consciousness.
Alan Greenspan, who was Chairman of the Federal Reserve's Board of Governors from 1987 to 2006, the period encompassing both bubbles, is clearly the single individual most responsible for the bubbles. The present Chairman, Ben Bernanke, also bears substantial responsibility, though not to the same extent as Greenspan. While Chairman only since January of 2006, Bernanke has been a member of the Federal Reserve Board since 2002. Thus he was present in a major policy making position during most of the housing bubble and crucial years leading up to it.
Neither Greenspan nor Bernanke have resorted to drink or drugs to conceal their responsibility from themselves. Instead they have resorted to specious claims about the cause of the bubbles, the housing bubble in particular.

Reisman’s dismantling of Bernanke’s and Greenspan’s wriggling is a virtual J’Accuse for the whole modern fractional-reserve banking system, and the economic destruction is has caused.  Why not print it out and read it over brunch: Credit Expansion, Crisis, and the Myth of the Saving Glut.

You owe it to yourself to read and digest it, if you do want to understand just what  the hell is going on in the world.

UPDATE:  “Can the monetary system regulate itself? Our current system, no,” says Lawrence White,  “but a free banking system on a gold standard, yes.” So he argues in this 51-minute talk, taped at Rhodes College in March.  [Hat tip Anti Dismal]


  1. The July 2009 Investigate magazine has an article “Barbarians At The Gates” by Alan Gallagher. He responds to Peter Hensley’s article which blamed bankers for the crises.

    I agree with Gallagher but one bit that puzzles:

    “Hensley’s Assertion Two: “It was like printing money, which they did. They became modern day alchemists. They created money from nothing.”

    Also not so. Money can only be created by governments, and more particularly these days, by central banks. This incorrect assertion stands shoulder to shoulder with the old chestnut that banks create credit – also untrue.

    Let me give a simple explanation. Bank A has $1000 in the kitty. It lends $100 to debtor B. In due course it sells a derivative to investor C for $100 backed with an assignment of the debt owed to it by B. The situation now stands that the bank has its $100 back and the kitty is restored to $1000, B no longer owes $100 to A but owes it to C. No new money or credit.

    This simple demonstration shows the impossibility of “creating new money.” If it were possible the world economies would have collapsed many decades ago, inflation of proportions of post war Germany, and world financial markets in tatters.”

    Don’t banks create money by their leveraging?

  2. Sorry Greg, I have no idea who Alan Gallagher is -- or who Peter Hensley is, or what his arguments are -- but that paragraph you quote is just garbage from beginning to end.

    I can only suggest you look again at the figures above showing the true measure by which the US money supply has been inflated in reality, and place that fact against Mr Gallagher's "simple demonstration [showing] the impossibility of 'creating new money'," and contemplate the fact that expecting to get an education out of the garbage you find in 'Inwhistigate' magazine is like expecting to find flowers growing out of the sewage ponds.

  3. George Reisman is always worth a read, I make sure I check his blog at least every fortnight.

    Regarding the creation of counterfeit capital, I also found the below article by Rothbard brilliant in concisely enumerating the sleigh of hand involved in our fractional reserve central banking systems. For those having difficulty grasping some of the basic concepts, this article is a great - easy to read - introduction.

    Rothbard's essay on fractional reserve banking.

  4. Just wondering if Alan Gallagher understands derivatives? The valuation of derivative assets & other structured financial products are quite complex (very complex) and often, some financial analysts frequently use or refer to the term (ie, derivative) without understanding them how they work. There are many types of derivatives available today in the financial markets, but mostly their evaluations are done via software which have been specifically designed to do those tasks, because the user is shielded from having to know complex algorithms that the software uses in its calculations. Some evaluation can run for a few minutes (monte-carlo-type asset pricing).

    All the user has to do is to throw some numbers in and the system spews out the evaluation (ie, an approximation only, since the algorithms are not psychic to foresee the future fluctuations of interest-rates if the specific derivative is interest-rate based). There is no room for guess work in the evaluations of derivatives, since these products are traded in the millions of dollars and if the evaluator is off-target by even a small, error of say 0.0001, this number can be multiplied by the millions (principal) and the result will be the potential loss or gain. I just simplified it here but my point is that evaluation is very difficult and this is the main reason that some financial institutions are hiring quantitative dudes (math, engineering, physics) rather than economic dudes to develop evaluation models for them.

    I guess that Gallagher refers to widely traded derivatives by financial institutions as caplet/floorlet, swaption, floating-rate-notes/fixed-rate-notes, mortgage-backed-securities, etc...

    BTW, Gregster, I am not a banker but my interest is solely on writing software for financial derivative evaluations (including equity, fixed-income-security, forex and may be commodities at some stage in the future). I am guessing that you're a banker, am I correct?

    I am looking to sell this solution to the local banks & other financial institutions, but the few I have made contact so far said they don't do such stuff. I have tried the NZ Reserve Bank (twice) and the first contact they replied that they don't do complex stuff like that but this person wasn't a financial analyst in my opinion she seemed to be someone from the IT department. I have emailed the NZRB's deputy governor with an overview of the solution but no reply yet. I was recommended to try NZRB by an Auckland bank, since the bank said that the solution overview that I sent them , are not the stuff that they do. I know that my market is overseas, but I need to start here (locally), ie, I must crawl (establish locally) before I walk or even run (look to offshore).

    So, please let me know Greg, if you're banker because I am interested to chat.

  5. ..and contemplate the fact that expecting to get an education out of the garbage you find in 'Inwhistigate' magazine is like expecting to find flowers growing out of the sewage ponds.

    Sure, I know. The article was by a contributor. Loudon is in the same issue.

  6. I am guessing that you're a banker, am I correct?


    No I'm not in banking. I am in the food industry as a Quality Assurance Manager. Ex microbiology & chemistry.

    I view politics/economics from the perspective of what I've learned of pure Capitalism and Objectivism, if that's any help to you. And I'm still learning.

    Best of luck with getting it off the ground.

  7. I used to enjoy reading Rolling Stone magazine, right up until they gave the Jonas brothers a top 20 album of the year rating or somesuch. They have, if you have been looking, developed a stronger and stronger political mouthpiece over the years. There is a new piece today laying the blame for repeated bubbles at the feet of Goldman Sachs.


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