Shadow Banking, Shadow Academy and Shadow Governance: Economic Collapse

This is revised and incorporated in Section 2 of Triumph of Ancient Philosophy

Dr. Sankarshan Acharya
Founder, Pro-Prosperity.Com and Citizens for Development

October 18, 2015. Revised October 19, 2015

To:        Honorable President Barack Obama
Cc:        Everyone affected (please feel free to circulate)

Date:     October 18, 2015

Dear President Obama,

In the Democratic debate on October 13, 2015, Mrs. Hillary Clinton asserted that the financial crisis of 2008 was caused by shadow banking (which she did not define) as per advise of experts. This is a dangerous obfuscation of the factual finding of the Financial Crisis Inquiry Commission, published in 2011, that the financial crisis was caused by a failure of experts, financial honchos, and government regulators including the Federal Reserve. 

To see dispassionately why introducing the jargon of "shadow banking" as the cause of 2008 financial crisis is dangerous for the future of the US economy, let's focus on the failed expertise/wisdom that caused the crisis.  This failed expertise has guided the post-crisis US policies to revive the economy.  What has the failed expertise produced in the 7 years following 2008? Unprecedentedly and alarmingly rising inequality, shrinking middle-class, 94 million people still searching for jobs, $13.5 trillion of new Fed money and new government borrowing. 

Introduction of the jargon of "shadow banking" is obviously motivated by the following:

  • To obfuscate, if not erase, the factual findings of FCIC that the 2008 crisis was caused by a failure of the established expertise which is concocted and promoted by the elite academy and followed religiously by industry honchos and government regulators.
  • To hoodwink enterprising American households that their political leaders have not embraced the established expertise before the crisis as well as afterwards.         
  • To spiel shadow banking as another form of invisible hand (god).  "Invisible hand" was concocted by the founder of modern economics Adam Smith in year 1776 when the US became independent. Smith presents a gospel that invisible hands emerge periodically to cause economic crises and take away accumulated assets of a vast majority of enterprising households.  This gospel was revived by the current established expertise in a book published by the Oxford University Press, authored by a Yale finance professor and endorsed by established academics in the elite academy including Dr. Ben Bernanke, ex-Chairman of the Federal Reserve.[1]   
  • The gospel of shadow banking is being peddled by the failed experts to circumvent criticism that god (invisible hand) caused the 2008 crisis.[2]   
  • To propagate shadow banking as a more reasonable academic gospel - new avatar of "god" and "invisible hand" - that causes periodic illiquidity (spontaneously triggered by sunspot!) resulting in enormous decimation of wealth of the enterprising households to justify Federal Reserve's printing of oodles of new money and the government's reckless borrowing.  This gospel of failed expertise obviously presumes that enterprising households are too naive, if not too stupid, to understand expert-proffered notions of "god," "invisible hand," "shadow banking," and "illiquidity." Indeed, an academic paper promoted by established academic experts presumes spontaneous (sunspot triggered) illiquidity in the financial markets to 'justify' Federal deposit insurance.  This academic presumption/gospel is thus promoted as a public policy prescription! This paper was reprinted by in a Federal Reserve publication perhaps to rationalize the 2008 crisis.[3]
  • After I warned about eroding American competitiveness and about recurrence of the Great Depression in a memo in January 2005 sent to President Bush[4] with copies to many important members of Congress including you, when you were my senator from Illinois, Dr. Ben Bernanke was chosen to head the Federal Reserve despite the opposition from a glorified maestro of wealth creation in USA, Dr. Alan Greenspan.  The most crucial factor for choosing Dr. Bernanke as the head the Fed was that he was the only economist who had a doctoral dissertation on the Great Depression.  The crucial conclusion of this dissertation was that the GD could have been avoided if the Federal Reserve created sufficient credit to redress illiquidity.  Most experts have praised Dr. Bernanke for practicing as Fed-chief what he had researched.  This research had the philosophical backing of eminent experts like Maynard Keynes, Milton Friedman and others known as Keynesians.[5]
  • That the US can print oodles of money to revive the economy from every depression is the basis of hubris of established academic expertise underlying the proclamation that the American system of banking and finance is invincible.  In fact, the President of American Economic Association has openly talked about invincibility of US banking and finance in the wake of my submission to the US Congress in 2003 of a published paper that details how a looming economic crisis would unfold unless my safe banking policies were adopted.  I had then warned that vested interests would not allow adoption of such policies until taxpayers lost trillions of dollars.[6]
  • Academic hubris has led the established experts to suppress competing selfless research that proves unconstitutionality, inefficiency and instability of the system of governance. This system is prone to severe economic depression from which revival is impossible until it is completely replaced with a constitutional-efficient-stable system.[7] These research findings obtain in the most comprehensive general equilibrium model of micro-economic game theory (ever written in the literature) in which the optimal behavior of households, firms, government regulators and markets lead to equilibrium macro-economic policy.  This research led me to warn about the onset of GD, the fallacy of the Keynesian philosophy and potential instability in society in more clear terms in my 2005 memo to President Bush and in several memos to him and Congressional leaders thereafter. 
  • The failure to revive the US economy after printing oodles of money (to redress "illiquidity") proves once again that the moral-hazard prone unconstitutional-inefficient-unstable system of governance is the root cause of the ongoing modern form of Great Depression.

Ultimately, though, vested interests (the failed experts, industry honchos, government regulators and their political patrons) have failed to suppress research on constitutional-efficient-stable system of governance, despite their high decibel spiel of gospels of "illiquidity," "invisible hand," and "shadow banking." But their denial in accepting the reality and continued sway over governance has resulted in massive inefficiency in the economy:

  • Rising debt and inequality. 
  • Stagnant, if not declining, productivity is just a small indication of massive inefficiency.  For example, say, 10000 economic experts suppressed the selfless research findings of paramount importance to the economy through the blind academic referring system controlled by shadow invisible hands.  Each of these experts continues to earn at least five times of the pay of this researcher.  Multiply the average annual income of a failed expert by 10000 and at least 30 years of their hubris-ridden punditry to see the gargantuan direct loss to the economy.  Their talents could have been productively used in other endeavor.  This is just a direct loss to the economy.  A silver lining of super efficiency in this example is the fact that a negligible amount of funds were needed to discover truths of immense significance to economy.  My research was not driven by any pecuniary incentive or reward or publicity.  It was driven by curiosity to find rules of governance of banks and financial markets that could avert the frequent banking failures and economic recessions.  My ulterior motive obviously was and continues to be serving the enterprising individuals that prop society and my existence.   
  • The indirect loss due to suppression of selfless research challenging the established system of governance is trillions of dollars, as stated in my memo to Congress in 2003 and vetted by news reports after the 2008 crisis emerged. 
  • Trillions of dollars waged on energy, food and emerging markets have been wiped out because depressed households with shrinking incomes, severe underemployment and fear of the future are consuming less, eating less and wasting less.  The economy is naturally reaching the point of affordable prices through deflation and efficiency by defying the diktat of shadow banking, invisible hands, shadow academy and shadow governance.  
  • Universities have laden their graduates with massive debt after emptying the students' parental savings by propagating a mythical hope of good jobs and economic prosperity with university degrees. 
  • Banks and trading houses as well as universities have piled up sumptuous facilities with the hope of continued backing by the unconstitutional system of robbery.  

Endless jargons coined to obfuscate the root cause of the ongoing economic Depression shows that the "shadow academy" is confounded about the excesses it has engineered in the economies around the world.  Perhaps to present the academy as pro-poor, this year's Nobel Memorial Prize was awarded to someone for measuring poverty, although the winner has candidly expressed to a premier Indian television channel, NDTV, on October 16, 2016 that he did not know whether there exists a unanimous agreeable norm for measuring the degree of poverty!  Why is the sudden obsession of the academy for poverty? Is it a gimmick to camouflage the reality that the prevailing academic wisdom is solely responsible for driving the vast majority of enterprising households to poverty as defined by a unanimously agreeable norm that I have presented in numerous memos and papers and a book[8] published in 2005 and scripted since 2002?

  • I have presented unique, unanimously agreeable norms for measuring economic prosperity, poverty and richness: the level and rate of growth of household net-worth. 
  • A negative and declining net-worth indicates growing poorer and a positive, rising net-worth indicates turning richer. 
  • A vast majority of households with negative and declining net-worth harbingers economic Depression. 
  • I have pleaded for institution of such net-worth measures in memos submitted to top political leaders.  I have also presented these measures in a paper, entitled "Constitutional System of Money and Finance," which is published in 2013 in the Journal of Financial Transformation, which claims to have 18 Nobel Laureates as authors. 
  • Is there any political leader, industry honcho, regulator or academic expert who considers any other measure other than net-worth for gauging his/her own economic prosperity?  No!  Even my 'non-expert' students and poor village friends unanimously agree that net-worth is the only measure of their own well-being as well as of their true financial freedom.  Negative net-worth is financial bondage.
  • Why are the academic experts and political leaders then not instituting these unanimously agreeable norms for prosperity, poverty or richness?  This is bewildering, especially, in democracies. 
  • It is mind-boggling to note how the academy awards a Nobel Memorial Prize in Economics for measurement of poverty to someone who publicly admits, correctly, that he has not developed any unanimously agreeable norm to measure poverty!  The academy is obviously confounded.   

Shadow Banking Defined

Incidentally, "shadow banking" can be precisely defined as short-selling or fictitious, unconstitutional creation of assets and their derivatives for selling to investors, mutual funds and pension plans to rob private wealth surreptitiously, as narrated in a paper on short-selling by privileged mega banks with power of market making and clearing.[10] Here is my synopsis of some of what happened around the 2008 crisis:

  • Short-sellers had short-sold fictitiously created mortgage backed securities (backed by no loan) to MBS holders like Lehman Brothers and Bear Stearns.
  • Short-sellers used their proxy in the Treasury and Federal Reserve to shut down many MBS holders to erase any trace for such robbery while booking profits by closing their short-positions without covering. 
  • The short-sellers have planned the same game with respect to Fannie Mae and Freddie Mac, but are finding it hard to consummate their robbery executed through the same strategy of short-selling (shadow banking) because these victims are the lenders to the vast majority of enterprising households who comprise the core of American economy.[11] 
  • Painting Lehman Brothers, Washington Mutual, Bear Stearns, Fannie Mae and Freddie Mac as shadow banks to blame these victims of shadow banking (played by robber barons) is the game of unconstitutional robbery followed by government intervention to erase all traces of such robbery by the perpetrators of shadow banking. 
  • Dr. Ben Bernanke has stated that the toxic asset-riddled Lehman Brothers lacked the necessary collateral. His assertion precludes all those assets that LB had purchased from mega short-sellers like GS and JPM.  The mega short-sellers fictitiously created such assets with liar loans backing them and got them rated high by public rating agencies to attract buyers like LH, BS, WaMu, mutual funds and pension plans.  The buyers of toxic assets trusted the mega short-sellers because they seemed trustworthy and backed by regulators. 
  • The Fed and Treasury primarily rescued the short-sellers (the true underlying shadow banks) and let them go scot free with the Dodd-Frank Act of 2010 making the short-sellers systemically important too-big-to fail institutions to be run by too-big-to-be-jailed bankers and with the SEC protected from lawsuits against its permission of short-selling.  
  • Here are some pertinent rhetorical questions:
    1. Why did the Fed pump tens of billions of dollars to Goldman Sachs and many more billions via AIG and made GS a bank holding company overnight to let it draw cheap Fed funds from the Fed? 
    2. Why did the Fed and Treasury not force GS and JPM to cover their short positions? 
    3. Why did the Fed not extend the same credit facility to the victims of shadow banking? 
    4. Wouldn't a fair treatment of all financial institutions have saved the 'shadow banks' like Lehman Brothers, Washington Mutual, Bear Stearns, etc. and restored trust in US banking, finance and governance?  A fair policy-driven treatment could have perhaps hurt the robber barons and their allies in the government. 
    5. If shadow banking (short-selling) is the culprit behind the 2008 crisis, why did Dodd-Frank Act of 2010 have a new rule by which no one could sue SEC for its permission for short-selling?
  • The robber barons armed with shadow banking laws and with de facto control over government have basically been eliminating those they rob while blaming the robbed for causing the crisis.

Shadow Academic Punditry Defined

Shadow academy can be defined as sophisticated suppression[12] of research discoveries that (a) can be adopted as law to avert surreptitious robbing, and (b) are, therefore, paramount to the vast majority of enterprising households: 

  • Elimination of rules that facilitate robbery even surreptitiously is necessary for restoration of constitutional fairness, economic efficiency and stability because the enterprising households are not too naive to know how they are being robbed. 
  • Robbery of their hard-earned wealth of the enterprising households is economically inefficient and unsustainable because these households prop everyone including (a) the robbers, (b) the rulers that create the shield (rules of law) to facilitate such robbery, (c) the poor who depend on enterprises for employment and (d) even the failed academic experts, industry honchos and government regulators.

A vivid example of shadow academic punditry surfacing right now is to argue that a Recap-Release-Privatization of Fannie Mae and Freddie Mac to end their conservatorship (Bloomberg News October, 19, 2015) should not be done because doing so would raise the cost of mortgage borrowing, hurt affordable housing and burden taxpayers. This punditry thus advocates continuance of government conservatorship of Fannie and Freddie:

  • This is shadow academic punditry.
  • This punditry compares an infeasible sub-optimal (disequilibrium) Recap-Release-Privatize strategy of ending conservatorship with continuance of status quo of the currently unsustainable and enormously risky government conservatorship while omitting the equilibrium, efficient, fundamentally fair and feasible alternative of Recap-Release-Privatize-Regulate-and-Ban-Shadow-Banking policy for home mortgage financing for enterprising households who truly prop the nation.
  • The current government conservatorship is unsustainable/unstable with the ongoing 100% sweep of Fannie-Freddie profits to the Treasury because the lenders of enterprising households have been thus effectively incarcerated after their equities have been confiscated in 2008 with an agenda of their elimination dictated by those that caused the 2008 crisis (the TBTF banks run by TBTJ bankers).
  • The de facto government (TBTF-TBTJ) takeover of home mortgage financing since 2008 is fraught with enormous risk (to taxpayers, enterprising households and everyone they prop in the economy) due to encouraging of risky mortgage borrowing for votes under Democratic control and large GSE fees (for eventual elimination of Fannie and Freddie) and subsequent high interest rates under Republican control.
  • Continuance of government conservatorship thus entails enormous risk to economy, mortgage borrowers and taxpayers due to politics. This political risk has been omitted in Bloomberg News punditry. Why does this punditry not state that Democrats in control had pushed (for their constituents) risky affordable housing to relatively less creditworthy borrowers and the Republicans created FHFA to raise GSE fees to eventually eliminate Fannie-Freddie by transferring their mortgage business profitably (i.e., at enormous risk to enterprising households) to TBTF banks run by TBTJ bankers for privatization of profits and socialization of losses. Genuine punditry does not omit the political reality that bedevils the nation.
  • The plain Recap-Release-Privatize strategy is infeasible because, without government guarantee, privatized Fannie and Freddie will be land in a fiasco from day one after such release. Even the private banks with government guarantees like deposit insurance, TBTF and TBTF protections are unable to increase the scope of their mortgage lending..
  • The plain Recap-Release-Privatize strategy is unstable because privatization of Fannie and Freddie profits with a tacit risk of their future rescue imposed on taxpayers will lead to eventual bailout (socialization of losses) like that done for TBTF and TBTJ private banks.
  • This Bloomberg News punditry is shadow because it omits the most significant strategy available to taxpayers, mortgage borrowers and lenders, namely, Recap-Release-Privatize-Regulate-Ban-Shadow Banking (RRPRBSB) alternative obtained in general economic equilibrium within a model of coalitions of borrowers and coalitions of lenders. The elite academy has published several papers based on models involving coalitions of lenders by significantly omitting coalitions of borrowers to conclude that lenders are thus ordained by the elite academic invisible/shadow hand to set interest rates for borrowers to pay. Perhaps to maintain the supreme status as a powerful invisible-shadow hand, the elite academy does not want to even review my paper based on suppliers (lenders) and demanders (borrowers) of credit to determine interest rate (price of credit) in economic equilibrium.
  • The only rational inference about the motive of such shadow academic punditry as published in Bloomberg News on October 19, 2015 is to continue to obfuscate the shadow banking shenanigans of TBTF banks run by TBTJ bankers on elimination of Fannie and Freddie in order to erase all the traces of unconstitutional robbery, without worrying about enormous inefficiency and potential instability engendered by such shadow punditry and shadow banking practices.

Shadow Governance Defined

Shadow governance can likewise be defined as the prevalent unconstitutional system of robbery which is economically inefficient and unstable. 

Conclusion

Thus, "shadow banking," "shadow academy" and "shadow governance" have imperiled the US economy.  Unanimously agreeable principles for governance[13] and academic recognition of research discoveries[14] which, enacted as law, can obviate all the shadows are vital for revival of the economy. 

With profound regards, 

SankarshanAcharya        
Founder, Citizens for Development & Pro-Prosperity.Com
Director, Research Center on Finance and Governance

[1] As per a book authored by a Yale professor published by the Oxford University Press.  For complete citation see Acharya, S. (2013), "Arbitrage Pricing of Total Risk of Assets and First-best Governance of Financial Markets," http://pro-prosperity.com/Research/moralhazardliberty.pdf  For a rational definition of god, see Acharya, S. (2012), "A Unifying Philosophy of Governance [Universal Religion and God]," Journal of Governance and Regulation, http://pro-prosperity.com/A-Unifying-Philosophy-of-Governance.html
[2] Acharya, S. (2015), "Diktat of Unanimously Agreeable Governance and Unified Philosophy Necessary for Individual Freedom," http://pro-prosperity.com/Diktat%20of%20Unanimously%20Agreeable%20Governance%20and%20Philosophy%20for%20Freedom.html
[3] Acharya, S. (2013), "Constitutional Capitalism for First-best Efficient Governance, Obtained in general equilibrium based on rational microeconomic analysis, devoid of parochial dogmas, politics or prejudice," http://pro-prosperity.com/Constitutional%20Capitalism.html
[4] Acharya, S. (2005), "Enhancing American Competitiveness," http://pro-prosperity.com/USPresident013105.html
[5] Acharya, S. (2014), "Fallacy of Keynesian Economic Philosophy," http://pro-prosperity.com/Fallacy-of-Keyensian-Economic-Philosophy.html
[6] Acharya, S. (2007), "Warning to US Congress in 2003 on Current Home Mortgage Debt Debacle," http://pro-prosperity.com/Global%20Economy%20Chatterbox/Warning-USCongress-In-2003-On-Home-Mortgage-Debacle.html
[7] Acharya, S. (2013), "Constitutional System of Money and Finance," http://pro-prosperity.com/Research/Constitutional-Monetary-Finance-System.pdf and Acharya, S. (2015), "Unconstitutional Robbing by Government and Citizenship Rights," http://pro-prosperity.com/Research/Constitutional-Monetary-Finance-System.pdf
[8] Acharya, S. (2005), "Prosperity: Optimal Governance, Banking, Capital Markets, Global Trade and Exchange Rate," Citizens Publishing, http://pro-prosperity.com/Citizens%20Publishing/TableOfContents.pdf
[9] Acharya, S. (2012), "Economic Inefficiency and Unconstitutionality of Short-selling and Privileged Private Market Clearing," http://pro-prosperity.com/Research/Sub-Optimality%20of%20Short%20Selling.pdf
[10] Acharya, S. (2010), "Blind Review of Academic Papers Unconstitutional, Detrimental to National Competitiveness," http://pro-prosperity.com/Blind-Review-Academic-Papers-Unconstitutional-Uncompetitive.html
[11] Acharya, S. (2015), "Losing Financial War on Enterprising American Households," http://pro-prosperity.com/Losing%20Financial%20War%20on%20Enterprising%20American%20Households.html

[12] Acharya, S. (2015), "Absolute Knowledge on Governance," http://pro-prosperity.com/Absolute%20Knowledge%20on%20Governance.html

[13] Acharya, S. (2013), "Universities Need to Award Research on Stability, Economic Efficiency and Constitutional Fairness," http://pro-prosperity.com/University%20Award%20Research%20on%20Stability,%20Efficiency%20and%20Constitutional%20Fairness.html