Taxpayer [public exchequer] is on the hook due to
short-selling
of Treasury Securities by Banks

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

April 14, 2015

To:       Honorable President Barack Obama

Sub:     Taxpayer is on a gigantic hook due to short-selling of Treasury Securities by banks.

Date:   April 14, 2015

Dear President Obama,

It is well-known that banks face survival risk (panics and runs) due to shorter duration of their liabilities (like deposits and short-term debts) than their longer-term assets like 30-year mortgage loans.  The ways to mitigate this risk include the following:

  • Federal Reserve stands ready to lend banks to preemptively avert panics and runs.
  • Banks short-sell Treasuries to generate cash, which reduces duration of their assets.  Short-selling makes them independent of the Federal Reserve.  The short-sold Treasuries are not issued and not backed by the US Treasury; they are artificially created by the short-seller with tacit permission of regulators. Such independence must have prompted the Goldman Sachs CEO-turned Treasury Secretary to propose closing down the Federal Reserve in 2008.  His proposal was eerily consistent with another prominent Goldman Sachs executive, Fischer Black (now deceased former professor of University of Chicago), suggesting inside the Federal Reserve board room to shut down the Fed.  
  • Banks cut down their portfolio of long-term lending, again to remain independent of the Federal Reserve.

The issue is: Who lends the banks so much of the Treasury securities for short-selling?  Obviously, the banks must be creating the Treasury securities out of thin air or getting them from the US Treasury Department.  In order to remain independent, banks would not like to borrow Treasury securities from private holders.

Whether the banks create the Treasury securities on their own or the U.S. Treasury Department lends such securities by artificially creating them amount to the same: The public exchequer (taxpayer) is on a gigantic hook.  It is because highly levered banks operate as shells to privatize profits and socialize losses.  High leverage means little capital.  The reported accounting capital does not consider banks’ massive short-selling obligations (or shadow banking).     

For example:

  • The current low Federal Reserve rate has elevated the price of Treasury securities. 
  • Banks must have sold billions of Treasury securities short either by creating them out of thin air (like they short-sold Mortgage Backed Securities with fictitious loans backing these securities) or by borrowing the securities from the U.S. Treasury. 
  • The Treasury Department has thus authorized banks to create cash out of thin air. 
  • The banks need (and hence are clamoring for) the Federal Reserve to raise its interest rate to depress the price of Treasury securities for the banks to cover their short positions to book windfall profits. 
  • But the Federal Reserve is unable to raise its interest rate due to the wide-spread depression caused precisely by such shenanigans authorized by the U.S. Treasury Department to help the banks by penalizing the public exchequer (taxpayer) and decimating employability in the economy. 
  • As dollars return from closure of investments abroad-where the economies are slowing, thanks again to such shenanigans everywhere-and dollar value rises with the Treasury security value rising and yield slumping beyond the control of US Federal Reserve and banks, as an exasperated CEO of a major bank conceded recently. 
  • Rising Treasury security prices is a specter for banks as their market-to-market capitals fall due to their short positions in these securities. 
  • In the mean time, bank executives have ran away with millions in their bonus and salaries and paid out all the dividends they could by virtually emptying the banks. 
  • Banks have thus become wards of the public exchequer once again, needing more printed money to stay on.

I thought of writing this to you after students in my fixed income securities course at UIC expressed dismay over how the U.S. government is effectively short-selling every hard-working American. 

Why shouldn’t banks be forced to get rid of their shadow banking, which essentially comprises of short positions that are dangerously not considered by regulators as liabilities in calculating bank capital?

With profound regards, 

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