Optimality of Abolishing Usury and Financial Bondage

November 08, 2008

Sankarshan Acharya
Pro-Prosperity.Com and Citizens for Development

November 08, 2008

Letter to President-elect Barack Obama

Sub: Optimality of Abolishing Modern Usury and Financial Bondage

Dear President-elect Obama,

There is unanimity that falling U.S. home prices caused the financial meltdown.  The falling home price is invariably linked to shipping of American jobs overseas, irresponsible lending practices and lax government regulation. Whatever may be the causes, the financial meltdown has bankrupted many American households.  It has deepened the economic depression with trillions of dollars of savings wiped out, many homes foreclosed and good paying jobs vanished. 

How should the new administration respond to contain and reverse the downfall? 


My research shows that a government, serving the best interest of the vast majority, should urgently adopt the following policies:

A.    Write down debt owed by the vast majority, say 95% of households with net-debt outstanding.  The incentive to work and pay goes down with indebtedness.  Financial theory advocates debt relief through workout of insolvent entities.  This theory justifies the bankruptcy act with a neutral court monitoring the workout procedure.  Barring households from seeking bankruptcy protection is a serious deviation from the fundamental theory on debt and work.  The current household indebtedness may be unsustainable if the vast majority is piled with net debt.    

B.     Lower the interest rates on credit cards and mortgage loans drastically, equal to the Fed funds rate plus about 2% to cover the cost of servicing the loans.

C.     Stop bailouts of financial institutions that transfer taxpayer money to privately-held hedge funds through allied banks and investment banks.  My estimate shows that the government has already transferred or 1.6 trillion dollars from the balance sheet of the Federal Reserve and a part of 700 billion TARP dollars.  These funds have mostly helped privately-held hedge funds convert their risky credits at the tottering financial institutions to government secured assets.  The preferred stakes in nearly bankrupt financial institutions sold to taxpayers are worth little.  In addition, the executives of the decrepit financial institutions with vested interests in allied hedge funds have hogged up unseemly bonuses and pays. 

D.    Your new tax and health insurance plans will profoundly enhance middleclass wealth in the long run. Immediate passage of these plans will boost confidence within households, which is needed urgently to rebuild consumer confidence.

E. Open unfettered immigration of talents from all over the world with no restriction on H1B visa seekers and naturalization of talents.  The housing markets plummeted because of tacit indignity meted to immigrants in workplace as well as government service centers.  When the immigrants left, they handed over their home keys to the lenders.  The crescendo of home foreclosures accelerated as the current administration contemplated to deport illegal immigrants.  Many immigrants became illegal when their applications for permanent residency were arbitrarily denied. But it is only the wealthy CEOs and other supporters of the current administration who had imported many immigrants, often illegally, especially from Mexico to build houses and grow crops in USA. These "illegal" immigrants have proved to be vital for the U.S. economy. But they have been pushed to a situation in which they have no attachments to their homes in USA. Legalising them will improve the home sector tremendously.

F. Pass a stimulus package, but it alone will unlikely stem the downward spiral. Stimulous creates new money for new jobs, which is good to stem the tide of unemployment. But these jobs should produce globally competitive goods and services to enhance American competitiveness and standard of living. Otherwise, the trade balance will further shift to the rest of the world. Then the dollar will decline, inflation will rise and net income will fall. This will worsen the economy further. Debt relief will rather serve as the best stimulous because it will motivate relieved households to work harder to repay their reduced loan balances.    

Let’s delve into the bigger picture:

1.      Total debt of USA is about $40 trillion: 12T is borrowed by households, 18T by corporations and 10T by the government.  The Federal Reserve can tabulate the latest exact figures.  Blaming “irresponsible” households or Fannie-Freddie for the financial meltdown is obviously farfetched.  As argued in earlier memos, it is the usurious lopsided credit creation that is stupid.

2.      American banks, investment banks and hedge funds have borrowed heavily from the Japanese banks and from the NY Federal Reserve Bank.  FRB-NY maintains reserve deposits of most, if not all, central banks of the world.  My estimate of the total U.S. borrowing from abroad is about 5T. 

3.      The wealthy American households and entities have accumulated a net credit of about 35T, which is equal to 40T in total debt minus 5T of credit from abroad.  This does not include the equity holdings of the wealthy.  The wealthy have been selling, of late, risky debt and equity holdings to transfer the proceeds to government secured assets.  That is, they have stopped lending their money to anyone but the federal government in the form of insured deposits and Treasury securities: this inference is based on market price movements and an unnoticed Federal Reserve plan for Congressional decree to force lending.

4.      Simply put, the wealthy hold about 35T of credits in the form of government secured assets.  A large part of this sum is usuriously usurped by paying low to real producers of globally competitive goods and services and through other devious means narrated in my earlier memos.  Let’s see how:  The wealthy individuals and institutions have been in-charge (directly and indirectly) of the Federal Reserve policy to keep the interest rate usuriously high.  They have successfully fooled the Federal Reserve model by rigging up inflation in prices to keep the interest rate high.  They can rig prices by using their amassed credits to set up huge bids, for example, for crude oil.  Rigging can succeed especially with tacit support of rulers benefiting from such schemes. 

My inference is that the rigged-up inflation and incessant media barrage have induced many middleclass American households to divert their savings to purchase commodities at rising prices and to sell stocks at falling prices.   The schemers have thus wangled the savings of the vast majority of American households and simultaneously penalized everyone by enforcing usuriously high interest rates and gouging food and energy prices. 

We have proved the existence of such modern usury, as deflation and lower interest rates emerged after the government goaded insured banks to ask the deeply leveraged hedge funds and investment banks to repay the loans taken from the insured deposit base.   

5.      A few individuals and entities seem to have usuriously amassed most of the credits. They have bankrupted a majority of indebted households who ironically but obliviously prop the usurious credits.  The creditors have bankrupted most financial institutions (including even the Federal Reserve and Government) which have helped in amassing the credits by bankrupting debtors.  The same creditors are now asking the government-which is supposed to represent the best interest of the vast majority of bankrupted households-to grant their institutions more taxpayer funds by scaring that a failure of these institutions will ruin the indebted households further.  The government is already scared to give away a total of about 2.3T: 700 billion in TARP and 1.6T drained from the Federal Reserve balance sheet.  But the doled out federal funds have been basically transferred back to the same creditors–whose hedge funds had lent to and are now collecting from their allied financial institutions–as government secured assets.

6.      The government has basically given a riskless amount of 2.3T dollars to the creditors for a baggage of risky assets transferred to taxpayers.  The government has thus become a hedge fund with nearly 10T of existing debt plus 2.3T new debt and many more trillion in indirect guarantees.  The assets of the government include tacit tax liens on households.  The creditors are thus precariously dependent on the trust of taxpayers.  Since the vast majority of insolvent households cannot repay even by laboring harder, the same creditors have to pay, which amounts to writing off the credit obligations by fiat. This seems to be the only optimal solution that will be imposed by the vast majority if the government does not act in their behalf. 

7.      The surreptitiously generated usurious credits cannot be sustained in a democracy.  The current election shows that a majority would no longer like to remain financially subjugated.  The percent of households with net debt is unknown because the government does not record data on net assets of individual households. My guess is that at least 90% of households have net debt, though all of them did not vote for you.  The government should record such data, vitally needed for remedial policies.  In any case, the percent of households with net debt must have increased dramatically because the modern system of usury continues and the wealthy succeeds in scaring the government to bail out financial institutions to transfer their credits from risky assets held in these institutions to government secured assets. 

8.      Even if your administration could not undo the modern system of usury, the humanity and the true (not tinkered) market forces would eventually undo it after more severe spasms, e.g., due to a recurrence of the Great Depression.  As a prelude to this foresight, the Federal Reserve and other Central Banks around the world have been cutting their interest rates drastically.  The media is now talking about a zero interest rate environment.  But the governments are still supporting usury through banks charging households 6-9% on mortgage loans and 24% on credit cards, when money is supplied at 1% or less.  If governments want to serve the vast majority, they need to decree mortgage and credit card rates as equal to the central bank rate plus a premium of about 2% to cover the cost of servicing the loans.  Since creditors (including taxpayers whose funds are given to banks) are being forced to accept 1% or less, the borrowers should not be usuriously charged.  The punditry that such decree will dissuade banks from lending risky borrowers is specious when reckless lending practices have been blamed for the current meltdown.  The specious punditry is a clever strategy to perpetuate usury surreptitiously.    

9.      A solution for the vast majority is to force their government to do what they themselves will deem to be optimal: (i) void a significant part of the credits in the system by writing off the debts of the vast majority, for example, of 95% of households with net debt, and (ii) drastically cut the rates of interest on mortgages and credit cards by decree.  I have come to this optimal policy solution since 2003 when I foresaw a looming deflation and depression under the veneer of government-hooted pseudo GDP and productivity growths.  The Federal Reserve had invited me to participate in their conferences.  I had genuinely urged the Fed in 2005 to distribute copies of a book[1] to government officials and policymakers.  I had believed that at least in USA, the officials would protect the best interest of the vast majority.  If they had heeded to the policies then, we would have perhaps saved about 12T of wealth lost by the American households including the very rich.  But how could a central bank concocting literature on market discipline–to prove that banks and capital markets would self-regulate in the best interest of taxpayers-heed to optimal regulation?[2]  They would rather trash all research on optimal regulation: maybe the “invitation” was to bury my research publicly.  But they could not succeed.  The humanity has now paid a steep price for their shenanigans and prejudice. 

10.  The vast majority will not optimally bailout financial institutions either by TARP or by equity infusions.  They would have their government take over the critical lending institutions with insured deposits and let other institutions operate independently as universal banks without a government deposit guarantee. This optimal system will induce real market discipline with (i) genuine risk takers investing their savings through universal banks with sufficient capitals, (ii) the panic-prone risk-averse individuals depositing their savings in safe banks that hold only government securities, (iii) a total elimination of thinly capitalized banks because no one will bank with them, and (iv) no government-sponsored systemic moral hazard costing taxpayers trillions of dollars.

China does not sponsor the modern system of usury.  China did not have a central bank until 1994.  The Chinese government takes stern actions against the private perpetrators of usury.  India disbanded organized usury after nationalizing banks, but government elements still perpetuate usury through private agents and tacit collusion with nationalized banks.  Russia does not sponsor usury. The rates of interest in India, China and Russia have remained high due to their fear of capital outflows.  The Japanese and Chinese strategists are now calling the U.S. to borrow in yen or yuan denominated instruments.  The current international monetary and exchange rate system is thus very fragile.  The IMF in its current form could not exist, as I had argued earlier.  Now the market forces have eliminated the existing form of the IMF by seeking a transformation with more funds from Japan, China and Middle-East.   

In conclusion, if governments do not heed to the best interest of humanity, true market forces will eventually correct the system through pain inflicted on all.  The humanity will adopt an optimal system of governance in which usury, even in its current reincarnated form, will cease to exist. 

With profound regards,

Sankarshan Acharya

[1]Acharya, S. (2005): “Prosperity: Optimal Governance, Banking, Capital Markets, Global Trade and Exchange Rate,” Citizens Publishing.

[2]The assertion made in the market discipline literature - that banks and markets will self-regulate in the best interest of taxpayers - is based on biased data.  The data are biased because they are generated by the current system which is suboptimal for taxpayers.  My research on optimal bank regulation published in the Journal of Finance shows that taxpayers will optimally require banks to hold positive capitals.  This was used to establish minimum bank capital thresholds in FDICIA 1991.  But these norms were violated when regulators permitted bank holding companies to form fire-walled subsidiaries with less than the minimum required capital on a consolidated basis.    

The Congress may have taken action on Federal Reserve Disclosure after my memo as per the news below. Sankarshan Acharya

Fed Defies Transparency Aim in Refusal to Disclose (Update1)

By Mark Pittman, Bob Ivry and Alison Fitzgerald

Nov. 10 (Bloomberg) -- The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.

Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.

``The collateral is not being adequately disclosed, and that's a big problem,'' said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. ``In a liquid market, this wouldn't matter, but we're not. The market is very nervous and very thin.''

Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.

The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.

``It's your money; it's not the Fed's money,'' said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. ``Of course there should be transparency.''

Federal Reserve spokeswoman Michelle Smith declined to comment on the loans or the Bloomberg lawsuit. Treasury spokeswoman Michele Davis didn't respond to a phone call and an e-mail seeking comment.

$2 Trillion

The Fed's lending is significant because the central bank has stepped into a rescue role that was also the purpose of the $700 billion Troubled Asset Relief Program, or TARP, bailout plan -- without safeguards put into the TARP legislation by Congress.

Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank's purchase of Fannie Mae and Freddie Mac bonds.

Before Sept. 14, the Fed accepted mostly top-rated government and asset-backed securities as collateral. After that date, the central bank widened standards to accept other kinds of securities, some with lower ratings. The Fed collects interest on all its loans.

`We Need Transparency'

The plan to purchase distressed securities through TARP called for buying at the ``lowest price that the secretary (of the Treasury) determines to be consistent with the purposes of this Act,'' according to the Emergency Economic Stabilization Act of 2008, the law that covers TARP.

The legislation didn't require any specific method for the purchases beyond saying mechanisms such as auctions or reverse auctions should be used ``when appropriate.'' In a reverse auction, bidders offer to sell securities at successively lower prices, helping to ensure that the Fed would pay less. The measure also included a five-member oversight board that includes Paulson and Bernanke.

At a Sept. 23 Senate Banking Committee hearing in Washington, Paulson called for transparency in the purchase of distressed assets under the TARP program.

``We need oversight,'' Paulson told lawmakers. ``We need protection. We need transparency. I want it. We all want it.''

Banks Resist Disclosure

At a joint House-Senate hearing the next day, Bernanke also stressed the importance of openness in the program. ``Transparency is a big issue,'' he said.

The Fed lent cash and government bonds to banks, which gave the Fed collateral in the form of equities and debt, including subprime and structured securities such as collateralized debt obligations, according to the Fed Web site. The borrowers have included the now-bankrupt Lehman Brothers Holdings Inc., Citigroup Inc. and JPMorgan Chase & Co.

Banks oppose any release of information because it might signal weakness and spur short-selling or a run by depositors, said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, a Washington trade group.

Frank Backs Fed

``You have to balance the need for transparency with protecting the public interest,'' Talbott said. ``Taxpayers have a right to know where their tax dollars are going, but one piece of information standing alone could undermine public confidence in the system.''

The nation's biggest banks, Citigroup, Bank of America Corp., JPMorgan Chase, Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley, declined to comment on whether they have borrowed money from the Fed. They received $120 billion in capital from the TARP, which was signed into law Oct. 3.

In an interview Nov. 6, House Financial Services Committee Chairman Barney Frank said the Fed's disclosure is sufficient and that the risk the central bank is taking on is appropriate in the current economic climate. Frank said he has discussed the program with Timothy F. Geithner, president and chief executive officer of the Federal Reserve Bank of New York and a possible candidate to succeed Paulson as Treasury secretary.

``I talk to Geithner and he was pretty sure that they're OK,'' said Frank, a Massachusetts Democrat. ``If the risk is that the Fed takes a little bit of a haircut, well that's regrettable.'' Such losses would be acceptable, he said, if the program helps revive the economy.

`Unclog the Market'

Frank said the Fed shouldn't reveal the assets it holds or how it values them because of ``delicacy with respect to pricing.'' He said such disclosure would ``give people clues to what your pricing is and what they might be able to sell us and what your estimates are.'' He wouldn't say why he thought that information would be problematic.

Revealing how the Fed values collateral could help thaw frozen credit markets, said Ron D'Vari, chief executive officer of NewOak Capital LLC in New York and the former head of structured finance at BlackRock Inc.

``I'd love to hear the methodology, how the Fed priced the assets,'' D'Vari said. ``That would unclog the market very quickly.''

TARP's $700 billion so far is being used to buy preferred shares in banks to shore up their capital. The program was originally intended to hold banks' troubled assets while markets were frozen.

AIG Lending

The Bloomberg lawsuit argues that the collateral lists ``are central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression.''

The Fed has lent at least $81 billion to American International Group Inc., the world's largest insurer, so that it can pay obligations to banks. AIG today said it received an expanded government rescue package valued at more than $150 billion.

The central bank is also responsible for losses on a $26.8 billion portfolio guaranteed after Bear Stearns Cos. was bought by JPMorgan.

``As a taxpayer, it is absolutely important that we know how they're lending money and who they're lending it to,'' said Lucy Dalglish, executive director of the Arlington, Virginia- based Reporters Committee for Freedom of the Press.

Ultimately, the Fed will have to remove some securities held as collateral from some programs because the central bank's rules call for instruments rated below investment grade to be taken back by the borrower and marked down in value. Losses on those assets could then be written off, partly through the capital recently injected into those banks by the Treasury.

Ratings Cuts

Moody's Investors Service alone has cut its ratings on 926 mortgage-backed securities worth $42 billion to junk from investment grade since Sept. 14, making them ineligible for collateral on some Fed loans.

The Fed's collateral ``absolutely should be made public,'' said Mark Cuban, an activist investor, the owner of the Dallas Mavericks professional basketball team and the creator of the Web site BailoutSleuth.com, which focuses on the secrecy shrouding the Fed's moves.

The Bloomberg lawsuit is Bloomberg LP v. Board of Governors of the Federal Reserve System, 08-CV-9595, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporters on this story: Mark Pittman in New York at mpittman@bloomberg.net; Bob Ivry in New York at bivry@bloomberg.net; Alison Fitzgerald in Washington at afitzgerald2@bloomberg.net.

Last Updated: November 10, 2008 10:14 EST

Bailout Price Tag: $3.5T So Far, But 'Real' Cost May Be Much Higher


Posted Nov 12, 2008 10:16am EST by Aaron Task in Newsmakers, Recession, Banking

Related: AIG, FNM, FRE, XLF, ^DJI, ^GSPC, C

While the government is clearly spending a lot of taxpayers' money to bail out financial firms, the tally is even bigger than most Americans (economists and pundits included) are probably aware or willing to admit.

The bailout bonanza has gotten so big and happened so fast it's the true cost often gets lost in the discussion. Maybe Hank Paulson and Ben Bernanke prefer it that way because the tally so far is nearly $3.5 trillion, and that's before a likely handout for the auto industry.

Yes, $3.45 trillion has already been spent, as Bailoutsleuth.com details:

  • $2T Emergency Fed Loans (the ones the Fed won't discuss, as detailed here)
  • $700B TARP (designed to buy bad debt, the fund is rapidly transforming as we'll discuss in an upcoming segment)
  • $300B Hope Now (the government's year-old attempt at mortgage workouts)
  • $200B Fannie/Freddie
  • $140B Tax Breaks for Banks (WaPo has the details)
  • $110B: AIG (with it's new deal this week, the big insurer got $40B of TARP money, plus $110B in other relief)

Tallying up the "true" cost of the bailout is difficult, and won't be known for months if not years. But considering $3.5 trillion is about 25% of the U.S. economy ($13.8 trillion in 2007) and the U.S. deficit may hit $1 trillion in fiscal 2009, hyperinflation and/or sharply higher interest rates seem likely outcomes down the road.

At the very least, the possibility of the U.S. losing its vaunted Aaa credit rating -- which determines the Treasury's borrowing costs -- cannot be discounted.

Moody's has already said it's not in jeopardy of being lowered. But we really can't put much stock in what Moody's -- or S&P or Fitch -- say after the subprime debacle, can we? More importantly, the price of credit default swaps on U.S. government debt has been on the rise since the bailout train got rolling, as Barron's reports.

In other words: Money talks and B.S. walks, to quote Spinal Tap.