2003 Prognosis Becomes True in 2008
Bailout of Banks is not a Solution

Solving the Real Problems

Sankarshan Acharya
February 23, 2008

2003 Prognosis Comes True in 2008


The following email was sent to all U.S. Senators in 2003. It is about my prognosis in 2003 of the current mortgage debt crisis, brewing since then under the veneer of economic growth and safety and soundness of the banking system. This prognosis has come true, as the crisis has unfolded in 2007 and engulfed the global financial markets since then.

If my Safe Market-Based Banking policy - proposed to the U.S. Congress in 2003 - were implemented, the current crises could be easily averted.  The U.S. Congress actually took note of this market-based safe banking policy proposal, judging from the testimony it sought from the then Chairman of the Federal Reserve Board on the safety and soundness of banking system, after receipt of that paper.   The FRB had then followed up to devote its annual conference in 2003 exclusively to this topic.  But, amazingly, the FRB found that the banking system was safe and sound! 

The goal of FRB has to be synchronized with the national goals.[1]



[1] http://www.pro-prosperity.com/Research/UtilityWelfareDemocracy.pdf

From: Dr. Sankarshan Acharya [mailto:sacharya@uic.edu]
Sent: Monday, March 31, 2003 7:20 AM
To:  
'senator@akaka.senate.gov'; 'senator@biden.senate.gov'; 'senator_bingaman@bingaman.senate.gov'; 'kit_bond@bond.senate.gov'; 'senator@breaux.senate.gov'; 'jim_bunning@bunning.senate.gov'; 'senator_byrd@byrd.senate.gov'; 'senator@cochran.senate.gov'; 'senator@collins.senate.gov'; 'senator@conrad.senate.gov'; 'senator@enzi.senate.gov'; 'russell_feingold@feingold.senate.gov'; 'bob_graham@graham.senate.gov'; 'senator@warner.senate.gov'; 'senator_voinovich@voinovich.senate.gov'; 'senator_talent@talent.senate.gov'; 'mailbox@sununu.senate.gov'; 'senator@stabenow.senate.gov'; 'arlen_specter@specter.senate.gov'; 'olympia@snowe.senate.gov'; 'senator@shelby.senate.gov'; 'senator@sessions.senate.gov'; 'senator@mcconnell.senate.gov'; 'john_mccain@mccain.senate.gov'; 'senator_lugar@lugar.senate.gov'; 'senatorlott@lott.senate.gov'; 'senator@levin.senate.gov'; 'senator_leahy@leahy.senate.gov'; 'senator_kohl@kohl.senate.gov'; 'john_kerry@kerry.senate.gov'; 'senator@kennedy.senate.gov'; 'tim@johnson.senate.gov'; 'vermont@jeffords.senate.gov'; 'tom_harkin@harkin.senate.gov'; 'tom_harkin@harkin.senate.gov'; 'chuck_hagel@hagel.senate.gov'; 'bob_graham@graham.senate.gov'; 'russell_feingold@feingold.senate.gov'; 'senator@enzi.senate.gov'; 'dick@durbin.senate.gov'; 'senator@dorgan.senate.gov'; 'senator_domenici@domenici.senate.gov'; 'senator_dewine@dewine.senate.gov'; 'senator@conrad.senate.gov'

Cc: 'sacharya@uic.edu'
Subject: Safe Banking
Importance: High

Dear Senator,

The U.S. banks have accumulated $55 trillion in derivatives.  The global banking system has about $217 trillion of such ticking financial bombs waiting to explode.  New credit in U.S. during last year alone was about $2.5 trillion.  Obviously the U.S. assets could not have risen in value by more than $2.5 trillion after September 2001.  It cost the U.S. taxpayers $300 billion to bail out failing banks in late 1980's.  How much will it cost this time?  A trillion plus?

Regulators have argued for continuing bank regulation because deposits need to be guaranteed by the government to preclude a rare catastrophe of banking panics and simultaneous withdrawals of deposits.  They remind taxpayers about banking panics causing huge systemic losses to the economy.  But, can't the government create enough "safe banks" that invest only in government securities to let panic-prone depositors save their live savings and leave the rest of  the banks as unregulated universal investment banks?  

Safe banking will not only obviate government guarantee of bank deposits, but also eliminate the elaborate and costly bank regulation.  It will also eliminate the banking moral hazard that may potentially cost taxpayers a trillion dollars when the current financial jugglery unravels.  [Please see the following paper "Safe Banking" forthcoming in a journal.]

Is the current bank regulatory regime continuing due to vested interests of government regulators?  We have to wait for the next catastrophe in bank failures to get an answer. 

With best regards,

Professor Sankar Acharya
Departments of Finance, M/C 168
University of Illinois at Chicago
601 South Morgan Street, 2412UH
Chicago, IL 60607
(312) 413 9204
sacharya@uic.edu

In a policy proposal on Safe Banking, I had written to the U.S. Congress in 2003:

"Another potentially devastating transfer of risks by banks to taxpayers is taking place under the veneer of a relatively healthy banking industry.  This is the very ubiquitous credit derivative scheme which banks use to sell off creams of their loans for immediate profits, while the risk piles up for later days.  By this scheme, loans are not sold by a bank. Only derivates based on loans are written (shorted) by the bank. Short selling of credit derivatives for lucrative premiums enhances current profits, boosting managerial bonus and incentives tied to bank stocks.  For example, suppose that a bank uses $8 in equity and $92 in insured deposits to fund mortgage loans of $100 at 6%.  Suppose that there is an estimated 5% rate of default in mortgage loans.  Then, the bank is expected to receive $5.7 per year.  The bank can sell a credit derivative which guarantees that the first 95% of all mortgage proceeds will be paid to the buyer of the derivative.  The buyer can be some mutual fund that expects, say 3%, guaranteed return.  The mutual fund can pay (invest) $190 to buy this credit derivative if sold by a major bank like Citibank.  Since the mutual fund investors are assured of $5.7 per year, they will generate a guaranteed 3% on their purchase (investment) of the credit derivative for $190.  This sale boosts the bank’s immediate profits by $90.  If the bank efficiently uses its profits, it may be fine because it can face the future residual defaults on its mortgage loans.  But, managements tend pay themselves excessive perquisites and bonuses, which means the load of residual risks invariably piles up for taxpayers.  Taxpayers will bear all the residual risk on a latter date if the bank disburses $90 towards managerial perquisites, dividends and current operations. "   

"The above safe banking proposal can be easily implemented, given political will of the U.S. Congress.  The Congress will be forced to act after any fresh catastrophic failure of banks.  The U.S. witnessed an expansion of $2.5 trillion in new credit during the last one year, primarily in the home mortgage market.  There is no reason to assume that the U.S. assets somehow rose in value more than this colossal new credit even after the terrorist attack of September 2001.  It seems that the U.S. home mortgage market is ballooning without much real support and will likely burst sometime.  This can make many major banks default massively.  Unless the U.S. Congress acts preemptively, it will be forced to react afterwards after uncontrollable bank failures.  Safe banking is the only optimal alternative available for taxpayers. "


Bailout of Banks Robs the Vast Majority


Banks are now secretly trying to influence the government for bailing them out. The plan published by NYT today asks the federal government to buy the underperforming mortgage loans held by banks for prices equal to the current market values of mortgaged homes. By this plan, banks will off-load to taxpayers the bad mortgage loans made recklessly to generate windfall fees and profits, most of which was usurped by the executives as hefty bonuses and perquisites.

Lawmakers sharing parts of usurped windfalls of executives as political contributions have generally passed on bank bailouts in the past. If they do so this time, it will prove unambiguously that they are consistent in fulfilling bank executives' wishes for mutual enrichment at huge losses to the vast majority of taxpayers. Talks about averting threats to the economy basically camouflage the ulterior shenanigans for self-enrichment and entrenchment by robbing the vast majority.


The vast majority of households have always lost on two accounts: lower income or job loss as the executives eliminate positions to enhance their pays, and the brunt of inflation as new money is created by government bailouts.


The only threat stemming now from the reckless mortgage lending of the past is the one faced by the banks and their executives who have pocketed the artificially created profits from usurious fees and interest rates levied on borrowing households. The threat is that they will lose their privileges and perquisites of robbing the vast majority of taxpayers if no bailout is granted.


The unseemly high interest rates and fees could not be supported by an outsourced economy. If the US Congress goes along with the banks' plans, more money will be created to fund the luxury of the robbers in the past and in the future. Creation of more money through bailout will accentuate the robbery of the vast majority of households as their declining incomes will be further decimated due to rising inflation as the new money floods the system.


The new money has gravitated by design to the fringe of schemers who indolently share the fruits of labor of the vast majority of workers that effectively produce globally competitive merchandise, services and ideas. Only the effective workers enhance net exports and raise the value of currency. They thus contribute towards national competitiveness. The ineffective fringe of schemers does not contribute towards national competitiveness. But it usurps massive credits by lobbying and enacting various lopsided laws to propagate and enhance self-aggrandizement. The fringe lends such credits as debt to the vast majority at rates and fees set in lopsided laws they enact through lobbying. The fringe also bids up the prices of necessary commodities to squeeze the vast majority further. It is ironical that the vast majority has failed to use the democratic power to correct the lopsided laws to enhance national competitiveness, prosperity and stability.

Real Solutions


The only way to thwart such robbery of the vast majority (who ironically have the power in a democracy) is to set the optimal CEO compensation in best national interests, to adopt safe banking policies and to ban short-selling of financial securities.


It may seem as if the real problem facing the vast majority of Americans is a lack of universal healthcare or unneeded tax-breaks to the rich. 

 

Analysis can show, however, that the real problem facing the vast majority is short selling of either wages or retirement savings stored in financial securities.  Short-selling of wages of workers is outsourcing or cannibalizing, i.e., firing the highly paid productive workers to rehire them as consultants on lower pay.  Short-selling is a systemic malaise that ultimately enslaves Americans, notwithstanding the short-term steps like economic stimulus.

 

If universal healthcare is introduced with national pricing of insurance premiums, they (the fringe) will short-sell the healthcare workers and company stocks.  So, universal healthcare will likely beget a greater loss to the American households than the savings accruing to them from lower healthcare premiums.  This will leave the vast majority of Americans poorer than they are now.  Besides, the current lack of universal healthcare is not adversely affecting longevity of Americans.  It is just that some families without health insurance face bankruptcy.  But the  degree of household bankruptcy will likely rise, on average, as healthcare jobs and stocks are sold short.

 

If more tax is levied on high earners, they will short-sell the whole market to transfer wealth from pension plans of the vast majority.  It can thus make the middleclass poorer than they are now.  Their immense credits permit them to short-sell the dollar by buying commodities to inflict inflation in prices of food and energy on the vast majority.

 

Let’s recognize that money and credit are nothing but labor (mental and physical).  Even commodities have to be mined or cultivated by labor.  When the king and his monetary associates create money (through, for example, unneeded war or fear mongering) to usurp the same disproportionately, the degree of financial enslaving imposed on the vast majority rises.  The new money so created does not produce globally competitive goods, services or ideas and so it results in higher inflation in prices of necessities.  Such inflation erodes the stagnant incomes of the vast majority. 

 

Creation of new money by a king and his associates, thus, robs the vast majority.   

 

Financial enslaving is a euphemism for actual slaving under the veneer of economic growth which is a false measure of prosperity.[1] 

 

The fringe can lavish a president with luxury to make him ineffective like it did to former president Bill Clinton.  An ineffective president stops thinking.  The fringe blocks missives like this one reaching an ineffective president. 

 

The real problem of financial enslaving of the vast majority by a fringe has thus reached a dead-end. 

 

Only a leader who does not succumb to the clutches or lures of the fringe can uplift a society from such rut. 

 

Prophet Mohammad wanted to stop financial enslaving by scripting Islam that has been embraced by one-fifth of humanity.  He has advocated a riba-free (zero interest rate) financial system to undo usurious lending by the fringe.  He was not alone.  Saint Vashistha has advocated for a zero interest rate society in 1500 BC.  Aristotle and Pluto too have come to the same conclusion before Prophet Mohammad.  Even the Church has accepted zero interest rate in 1700 AD. 

 

Despite the prevailing wisdom, the fringe succeeds in propagating a system of creating new money to expropriate the same usuriously or to short-sell the savings of the vast majority and to lend the usurped credits to the latter for substantially higher repayments in the form of increased labor.  Creation of new money is equivalent to short-selling of the current holdings (monetary and labor) of the vast majority. 

 

Short-selling has, thus, led to a perpetual bondage of the vast majority by the fringe. 

 

Those who run the government system of money-credit-banking-finance-economics have no incentive to inform the perils of short-selling to the vast majority because that is how they can perpetuate indolent usurpation of the fruits of labor of the effective workers who produce globally competitive goods, services and ideas. 

 

The majority may not have comprehended yet the system of being short-sold to be enslaved by the fringe.[2]  It behooves a benevolent leader, therefore, to articulate the underlying common problem facing the vast majority to solve the same.  If the malaise is unresolved, the majority will likely outburst into anger and violence (“terrorism”), as we have seen in the history of mankind. Such outburst may appear incoherent and unreasonable to the fringe because the problem has not been articulated thus far for common understanding.       

 

It is necessary to articulate and present the real problem to the vast majority to garner their support for its resolution. Non-violent policies can resolve an apparently insurmountable problem facing humanity and earth:

 

  1. Zero interest rate.
  2. Ban on short-selling of financial securities[3].
  3. Optimal CEO compensation[4].
  4. Market-based safe banking policy[5]. 

 

Policy (iii) will minimize unwarranted short-selling of jobs, i.e., contain cannibalization and outsourcing.  Such policies or optimal rules of governance[6] can be amended by any new wisdom gained from discoveries of currently unknown elements of nature in future.  Humans have universally formed beliefs about the unknown elements.  But such universal beliefs cannot rationally interfere with optimal governance which is based on truths already discovered.[7] 

 

This optimal system of governance prevents fringes from indolent, usurious usurpation of the fruits of labor of the effective Individuals who produce globally competitive goods, services and ideas.  The fringes here include both the scheming elite as well as others who cannot or will not work effectively.

 

The fittest will and should survive. This is necessary as humans are depleting the limited renewable resources of a beautiful planet.  But scheming for indolent usurpation of fruits of effective labor does not enhance the quality of earth, as it has led to global warming, nuclear proliferation, depletion of nonrenewable resources, and obesity.  So the schemers (elite and non-elite) will have to survive the efforts of self-less non-schemers committed to enhance the quality of earth. 

 

Smart, self-less and non-scheming leaders must emerge to detect and thwart the schemers’ adverse shenanigans on humanity and earth.  Only then can humans enhance the quality of earth for mutual prosperity based on own perseverance and equal opportunity.

May God bless America and humanity.

Sankarshan Acharya



[1]See the example in the paper, “Optimal CEO Compensation in Best National Interest,” http://www.pro-prosperity.com/American%20Prosperity%20through%20Limiting%20CEO%20Compensation.html

[2]It is tempting, however, to hope that the majority has understood the problem, judging from the educated and the relatively better off democrats supporting your candidacy overwhelmingly.  They have rejected the establishment.  Their disillusionment with the establishment has manifested in repudiation of a second-term President’s party members in the Congress.

[3] http://www.pro-prosperity.com/Research/Sub-Optimality%20of%20Short%20Selling.pdf

[4] http://www.pro-prosperity.com/American%20Prosperity%20through%20Limiting%20CEO%20Compensation.html

[5] http://www.pro-prosperity.com/Research/moralhazard.pdf

[6] http://www.pro-prosperity.com/What%20Constitute%20Optimal%20Rules%20of%20Governance.html

[7] http://www.pro-prosperity.com/Universal%20Religion%20and%20God.html

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