Yesterday we promised a final blowout for the final posting in the "Halloween Horror Special" series. Well . . . the subject matter certainly fits, but the treatment may not be up to our usual incredibly high standards. The fact is that we have to get to work on another posting we hope to make today and try to get some people and organizations moving on the Just Third Way. So, here goes for our final episode of our version of the Tree House of Horrors.
It's not a coincidence that the typical American idea of the haunted house is a late Victorian mansion. As a result of the home mortgage crisis caused by the Panic of 1893 and the ensuing Great Depression (Part I), many people abandoned the over-priced homes they had purchased or built. Their mortgages exceeded the market value of the home, and it was much easier in those days simply to walk away from an unpayable debt, disappearing into another state without leaving any clues to your whereabouts. Consequently, banks and mortgage companies foreclosed on properties that they couldn't sell, and which were left to fall into ruin. This provided generations of children and village idiots with dares to spend the night in the house from which the owners had mysteriously disappeared without leaving a trace, and the stories made up to explain it . . .
It took, however, the Panic of 1907, to which the Panic of 1893 inevitably led, to wake people up to the need for genuine reform in the financial system. The president of the Knickerbocker Bank and Trust, the third largest bank in New York, used the bank's resources (reserves) to try and "corner" copper. It almost worked, but "almost" doesn't count when you're up against J. P. Morgan. The Knickerbocker went bust, and runs ensued on the banks in New York, a panic that quickly spread across the U.S. and Europe.
The demand for reform was immediate and overwhelming. One of the most critical reforms, finally embodied in Glass-Steagall a generation later, was to separate commercial and investment banking. Separating commercial from investment banking effectively prohibited commercial banks from using their assets to invest (or speculate) in corporate shares or securities of other companies. All that, of course, changed with the repeal of Glass-Stegall.
Who said that those who fail to learn from history are doomed to repeat it? It doesn't matter, because the truth of the aphorism is evident. The home mortgage crisis that accompanied the Panic of 1893 was repeated with the sub-prime mortgage crisis of 2007 — ironically an even 100 years following the Panic of 1907 that finally provided the incentive for genuine reform of the financial system . . . carefully dismantled beginning in the 1980s.
And what followed the home mortgage crisis? Genuine reform to institute proper internal controls of the financial system? Hardly. The financial and political powers-that-be immediately went to work replacing even more internal controls with questionable external regulation with no bite — bulldogs with rubber teeth, and blind in both eyes.
They also, welche wonne!, insisted on subsidizing not the poor homeowner losing his or her house, or the worker thrown out of a job as Keynesian economics demands, but the gamblers and speculators in commercial and investment banking who caused the problem in the first place by taking advantage of the lack of proper internal control, as well as massive money creation for non-productive spending. (Well . . . that last is in accordance with the Keynesian prescriptions.)
The nail in the coffin (appropriately enough for our Horror Special) is that the financial services industry is getting a double benefit from the government bailout and subsidization of the gamblers on Wall Street. Not only are they making tremendous fees from transactions involving speculation without financing any appreciable amount of new capital, they are now, according to yesterday's Wall Street Journal, making huge profits by "investing" "excess reserves" in the stock market. ("Banks Turn Their Reserves to Profit," Wall Street Journal, 10/27/10, C1.) "J. P. Morgan Chase & Co. earned $4.4 billion in the third quarter, in part because it released $1.7 billion from the bank's loan-loss reserves." Once again, it evidently doesn't pay to go up against J. P. Morgan.
In plain English, the commercial banks are not lending to businesses to finance new or replacement capital, which is the purpose of a commercial bank. Instead, they are putting the money into the stock market . . . something not even an investment bank is supposed to be doing. This has dried up the ephemeral "supply of loanable funds," so that businesses are starved for credit.
The "supply of loanable funds" may be a meaningless concept within the Just Third Way understanding of banking and finance, which uses classic banking theory, but it is a virtual god within a financial and economic system locked into the assumptions of Keynesian economics. The bottom line is that by using bank assets to invest in something other than new or replacement capital in the agricultural, commercial, or industrial sectors, the financial services industry has completely abandoned its proper role in the economy, even by Keynesian standards. There could not be a better argument for the reforms embodied in Capital Homesteading.
Correction: the best argument is yet to come, although we hope it doesn't — the coming collapse when the house of cards being built by the weird union of politics, economics, and finance on a foundation of disproved Keynesian assumptions improperly implemented not only comes crashing down, but erupts in a financial inferno that few people in the United States can even imagine.