The Tower of Basel – Do We Want the Bank For International Settlements Issuing Our Global Currency?

In an April 7 article in The London Telegraph titled “The G20 Moves the World a Step Closer to a Global Currency,” Ambrose Evans-Pritchard wrote:

“A single clause in Point 19 of the communiqué issued by the G20 leaders amounts to revolution in the global financial order.

“‘We have agreed to support a general SDR allocation which will inject $250bn (£170bn) into the world economy and increase global liquidity,’ it said. SDRs are Special Drawing Rights, a synthetic paper currency issued by the International Monetary Fund that has lain dormant for half a century.

“In effect, the G20 leaders have activated the IMF’s power to create money and begin global ‘quantitative easing’. In doing so, they are putting a de facto world currency into play. It is outside the control of any sovereign body. Conspiracy theorists will love it.”

Indeed they will. The article is subtitled, “The world is a step closer to a global currency, backed by a global central bank, running monetary policy for all humanity.” Which naturally raises the question, who or what will serve as this global central bank, cloaked with the power to issue the global currency and police monetary policy for all humanity? When the world’s central bankers met in Washington last September, they discussed what body might be in a position to serve in that awesome and fearful role. A former governor of the Bank of England stated:

“[T]he answer might already be staring us in the face, in the form of the Bank for International Settlements (BIS). . . . The IMF tends to couch its warnings about economic problems in very diplomatic language, but the BIS is more independent and much better placed to deal with this if it is given the power to do so.”1

And if the vision of a global currency outside government control does not set off conspiracy theorists, putting the BIS in charge of it surely will. The BIS has been scandal-ridden ever since it was branded with pro-Nazi leanings in the 1930s. Founded in Basel, Switzerland, in 1930, the BIS has been called “the most exclusive, secretive, and powerful supranational club in the world.” Charles Higham wrote in his book Trading with the Enemy that by the late 1930s, the BIS had assumed an openly pro-Nazi bias, a theme that was expanded on in a BBC Timewatch film titled “Banking with Hitler” broadcast in 1998.2 In 1944, the American government backed a resolution at the Bretton-Woods Conference calling for the liquidation of the BIS, following Czech accusations that it was laundering gold stolen by the Nazis from occupied Europe; but the central bankers succeeded in quietly snuffing out the American resolution.3

In Tragedy and Hope: A History of the World in Our Time (1966), Dr. Carroll Quigley revealed the key role played in global finance by the BIS behind the scenes. Dr. Quigley was Professor of History at Georgetown University, where he was President Bill Clinton’s mentor. He was also an insider, groomed by the powerful clique he called “the international bankers.” His credibility is heightened by the fact that he actually espoused their goals. He wrote:

“I know of the operations of this network because I have studied it for twenty years and was permitted for two years, in the early 1960’s, to examine its papers and secret records. I have no aversion to it or to most of its aims and have, for much of my life, been close to it and to many of its instruments. . . . [I]n general my chief difference of opinion is that it wishes to remain unknown, and I believe its role in history is significant enough to be known.”

Quigley wrote of this international banking network:

“[T]he powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences. The apex of the system was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world’s central banks which were themselves private corporations.”

The key to their success, said Quigley, was that the international bankers would control and manipulate the money system of a nation while letting it appear to be controlled by the government. The statement echoed one made in the eighteenth century by the patriarch of what would become the most powerful banking dynasty in the world. Mayer Amschel Bauer Rothschild famously said in 1791:

“Allow me to issue and control a nation’s currency, and I care not who makes its laws.”

Mayer’s five sons were sent to the major capitals of Europe – London, Paris, Vienna, Berlin and Naples – with the mission of establishing a banking system that would be outside government control. The economic and political systems of nations would be controlled not by citizens but by bankers, for the benefit of bankers. Eventually, a privately-owned “central bank” was established in nearly every country; and this central banking system has now gained control over the economies of the world. Central banks have the authority to print money in their respective countries, and it is from these banks that governments must borrow money to pay their debts and fund their operations. The result is a global economy in which not only industry but government itself runs on “credit” (or debt) created by a banking monopoly headed by a network of private central banks; and at the top of this network is the BIS, the “central bank of central banks” in Basel.

BEHIND THE CURTAIN

For many years the BIS kept a very low profile, operating behind the scenes in an abandoned hotel. It was here that decisions were reached to devalue or defend currencies, fix the price of gold, regulate offshore banking, and raise or lower short-term interest rates. In 1977, however, the BIS gave up its anonymity in exchange for more efficient headquarters. The new building has been described as “an eighteen story-high circular skyscraper that rises above the medieval city like some misplaced nuclear reactor.” It quickly became known as the “Tower of Basel.” Today the BIS has governmental immunity, pays no taxes, and has its own private police force.4 It is, as Mayer Rothschild envisioned, above the law.

The BIS is now composed of 55 member nations, but the club that meets regularly in Basel is a much smaller group; and even within it, there is a hierarchy. In a 1983 article in Harper’s Magazine called “Ruling the World of Money,” Edward Jay Epstein wrote that where the real business gets done is in “a sort of inner club made up of the half dozen or so powerful central bankers who find themselves more or less in the same monetary boat” – those from Germany, the United States, Switzerland, Italy, Japan and England. Epstein said:

“The prime value, which also seems to demarcate the inner club from the rest of the BIS members, is the firm belief that central banks should act independently of their home governments. . . . A second and closely related belief of the inner club is that politicians should not be trusted to decide the fate of the international monetary system.”

In 1974, the Basel Committee on Banking Supervision was created by the central bank Governors of the Group of Ten nations (now expanded to twenty). The BIS provides the twelve-member Secretariat for the Committee. The Committee, in turn, sets the rules for banking globally, including capital requirements and reserve controls. In a 2003 article titled “The Bank for International Settlements Calls for Global Currency,” Joan Veon wrote:

“The BIS is where all of the world’s central banks meet to analyze the global economy and determine what course of action they will take next to put more money in their pockets, since they control the amount of money in circulation and how much interest they are going to charge governments and banks for borrowing from them. . . .

“When you understand that the BIS pulls the strings of the world’s monetary system, you then understand that they have the ability to create a financial boom or bust in a country. If that country is not doing what the money lenders want, then all they have to do is sell its currency.”5

THE CONTROVERSIAL BASEL ACCORDS

The power of the BIS to make or break economies was demonstrated in 1988, when it issued a Basel Accord raising bank capital requirements from 6% to 8%. By then, Japan had emerged as the world’s largest creditor; but Japan’s banks were less well capitalized than other major international banks. Raising the capital requirement forced them to cut back on lending, creating a recession in Japan like that suffered in the U.S. today. Property prices fell and loans went into default as the security for them shriveled up. A downward spiral followed, ending with the total bankruptcy of the banks. The banks had to be nationalized, although that word was not used in order to avoid criticism.6

Among other collateral damage produced by the Basel Accords was a spate of suicides among Indian farmers unable to get loans. The BIS capital adequacy standards required loans to private borrowers to be “risk-weighted,” with the degree of risk determined by private rating agencies; and farmers and small business owners could not afford the agencies’ fees. Banks therefore assigned 100 percent risk to the loans, and then resisted extending credit to these “high-risk” borrowers because more capital was required to cover the loans. When the conscience of the nation was aroused by the Indian suicides, the government, lamenting the neglect of farmers by commercial banks, established a policy of ending the “financial exclusion” of the weak; but this step had little real effect on lending practices, due largely to the strictures imposed by the BIS from abroad.7

Similar complaints have come from Korea. An article in the December 12, 2008 Korea Times titled “BIS Calls Trigger Vicious Cycle” described how Korean entrepreneurs with good collateral cannot get operational loans from Korean banks, at a time when the economic downturn requires increased investment and easier credit:

“‘The Bank of Korea has provided more than 35 trillion won to banks since September when the global financial crisis went full throttle,’ said a Seoul analyst, who declined to be named. ‘But the effect is not seen at all with the banks keeping the liquidity in their safes. They simply don’t lend and one of the biggest reasons is to keep the BIS ratio high enough to survive,’ he said. . . .

“Chang Ha-joon, an economics professor at Cambridge University, concurs with the analyst. ‘What banks do for their own interests, or to improve the BIS ratio, is against the interests of the whole society. This is a bad idea,’ Chang said in a recent telephone interview with Korea Times.”

In a May 2002 article in The Asia Times titled “Global Economy: The BIS vs. National Banks,” economist Henry C K Liu observed that the Basel Accords have forced national banking systems “to march to the same tune, designed to serve the needs of highly sophisticated global financial markets, regardless of the developmental needs of their national economies.” He wrote:

“[N]ational banking systems are suddenly thrown into the rigid arms of the Basel Capital Accord sponsored by the Bank of International Settlement (BIS), or to face the penalty of usurious risk premium in securing international interbank loans. . . . National policies suddenly are subjected to profit incentives of private financial institutions, all members of a hierarchical system controlled and directed from the money center banks in New York. The result is to force national banking systems to privatize . . . .

“BIS regulations serve only the single purpose of strengthening the international private banking system, even at the peril of national economies. . . . The IMF and the international banks regulated by the BIS are a team: the international banks lend recklessly to borrowers in emerging economies to create a foreign currency debt crisis, the IMF arrives as a carrier of monetary virus in the name of sound monetary policy, then the international banks come as vulture investors in the name of financial rescue to acquire national banks deemed capital inadequate and insolvent by the BIS.”

Ironically, noted Liu, developing countries with their own natural resources did not actually need the foreign investment that trapped them in debt to outsiders:

“Applying the State Theory of Money [which assumes that a sovereign nation has the power to issue its own money], any government can fund with its own currency all its domestic developmental needs to maintain full employment without inflation.”

When governments fall into the trap of accepting loans in foreign currencies, however, they become “debtor nations” subject to IMF and BIS regulation. They are forced to divert their production to exports, just to earn the foreign currency necessary to pay the interest on their loans. National banks deemed “capital inadequate” have to deal with strictures comparable to the “conditionalities” imposed by the IMF on debtor nations: “escalating capital requirement, loan writeoffs and liquidation, and restructuring through selloffs, layoffs, downsizing, cost-cutting and freeze on capital spending.” Liu wrote:

“Reversing the logic that a sound banking system should lead to full employment and developmental growth, BIS regulations demand high unemployment and developmental degradation in national economies as the fair price for a sound global private banking system.”

THE LAST DOMINO TO FALL?

While banks in developing nations were being penalized for falling short of the BIS capital requirements, large international banks managed to escape the rules, although they actually carried enormous risk because of their derivative exposure. The mega-banks succeeded in avoiding the Basel rules by separating the “risk” of default out from the loans and selling it off to investors, using a form of derivative known as “credit default swaps.”

However, it was not in the game plan that U.S. banks should escape the BIS net. When they managed to sidestep the first Basel Accord, a second set of rules was imposed known as Basel II. The new rules were established in 2004, but they were not levied on U.S. banks until November 2007, the month after the Dow passed 14,000 to reach its all-time high. It has been all downhill from there. Basel II had the same effect on U.S. banks that Basel I had on Japanese banks: they have been struggling ever since to survive.8

Basel II requires banks to adjust the value of their marketable securities to the “market price” of the security, a rule called “mark to market.”9 The rule has theoretical merit, but the problem is timing: it was imposed ex post facto, after the banks already had the hard-to-market assets on their books. Lenders that had been considered sufficiently well capitalized to make new loans suddenly found they were insolvent. At least, they would have been insolvent if they had tried to sell their assets, an assumption required by the new rule. Financial analyst John Berlau complained:

“The crisis is often called a ‘market failure,’ and the term ‘mark-to-market’ seems to reinforce that. But the mark-to-market rules are profoundly anti-market and hinder the free-market function of price discovery. . . . In this case, the accounting rules fail to allow the market players to hold on to an asset if they don’t like what the market is currently fetching, an important market action that affects price discovery in areas from agriculture to antiques.”10

Imposing the mark-to-market rule on U.S. banks caused an instant credit freeze, which proceeded to take down the economies not only of the U.S. but of countries worldwide. In early April 2009, the mark-to-market rule was finally softened by the U.S. Financial Accounting Standards Board (FASB); but critics said the modification did not go far enough, and it was done in response to pressure from politicians and bankers, not out of any fundamental change of heart or policies by the BIS.

And that is where the conspiracy theorists come in. Why did the BIS not retract or at least modify Basel II after seeing the devastation it had caused? Why did it sit idly by as the global economy came crashing down? Was the goal to create so much economic havoc that the world would rush with relief into the waiting arms of the BIS with its privately-created global currency? The plot thickens . . . .

Originally posted on Global Research on April 18, 2009.

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1. Andrew Marshall, “The Financial New World Order: Towards a Global Currency and World Government,” Global Research (April 6, 2009).

2. Alfred Mendez, “The Network,” in “The World Central Bank: The Bank for International Settlements.”

3. “BIS – Bank of International Settlement: The Mother of All Central Banks,” Hubpages (2009).

4. Ibid.

5. Joan Veon, “The Bank for International Settlements Calls for Global Currency,” News with Views (August 26, 2003).

6. Peter Myers, “The 1988 Basle Accord – Destroyer of Japan’s Finance System” (updated September 9, 2008).

7. Nirmal Chandra, “Is Inclusive Growth Feasible in Neoliberal India?”, Network Ideas (September 2008).

8. Bruce Wiseman, “The Financial Crisis: A look Behind the Wizard’s Curtain,” Canada Free Press (March 19, 2009).

9. See Ellen Brown, “Credit Where Credit Is Due,” webofdebt.com/articles/creditcrunch.php (January 11, 2009).

10. John Berlau, “The International Mark-to-market Contagion,” Open Market (October 10, 2008).

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Eastern European Banking Model

A traditional banking model in a CEEC (Central and Eastern European Country) consisted of a central bank and several purpose banks, one dealing with individuals’ savings and other banking needs, and another focusing on foreign financial activities, etc. The central bank provided most of the commercial banking needs of enterprises in addition to other functions. During the late 1980s, the CEECs modified this earlier structure by taking all the commercial banking activities of the central bank and transferring them to new commercial banks. In most countries the new banks were set up along industry lines, although in Poland a regional approach has been adopted.

On the whole, these new stale-owned commercial banks controlled the bulk of financial transactions, although a few ‘de novo banks’ were allowed in Hungary and Poland. Simply transferring existing loans from the central bank to the new state-owned commercial banks had its problems, since it involved transferring both ‘good’ and ‘bad’ assets. Moreover, each bank’s portfolio was restricted to the enterprise and industry assigned to them and they were not allowed to deal with other enterprises outside their remit.

As the central banks would always ‘bale out’ troubled state enterprises, these commercial banks cannot play the same role as commercial banks in the West. CEEC commercial banks cannot foreclose on a debt. If a firm did not wish to pay, the state-owned enterprise would, historically, receive further finance to cover its difficulties, it was a very rare occurrence for a bank to bring about the bankruptcy of a firm. In other words, state-owned enterprises were not allowed to go bankrupt, primarily because it would have affected the commercial banks, balance sheets, but more importantly, the rise in unemployment that would follow might have had high political costs.

What was needed was for commercial banks to have their balance sheets ‘cleaned up’, perhaps by the government purchasing their bad loans with long-term bonds. Adopting Western accounting procedures might also benefit the new commercial banks.

This picture of state-controlled commercial banks has begun to change during the mid to late 1990s as the CEECs began to appreciate that the move towards market-based economies required a vibrant commercial banking sector. There are still a number of issues lo be addressed in this sector, however. For example, in the Czech Republic the government has promised to privatize the banking sector beginning in 1998. Currently the banking sector suffers from a number of weaknesses. A number of the smaller hanks appear to be facing difficulties as money market competition picks up, highlighting their tinder-capitalization and the greater amount of higher-risk business in which they are involved. There have also been issues concerning banking sector regulation and the control mechanisms that are available. This has resulted in the government’s proposal for an independent securities commission to regulate capital markets.

The privatization package for the Czech Republic’s four largest banks, which currently control about 60 percent of the sector’s assets, will also allow foreign banks into a highly developed market where their influence has been marginal until now. It is anticipated that each of the four banks will be sold to a single bidder in an attempt to create a regional hub of a foreign bank’s network. One problem with all four banks is that inspection of their balance sheets may throw up problems which could reduce the size of any bid. All four banks have at least 20 percent of their loans as classified, where no interest has been paid for 30 days or more. Banks could make provisions to reduce these loans by collateral held against them, but in some cases the loans exceed the collateral. Moreover, getting an accurate picture of the value of the collateral is difficult since bankruptcy legislation is ineffective. The ability to write off these bad debts was not permitted until 1996, but even if this route is taken then this will eat into the banks’ assets, leaving them very close to the lower limit of 8 percent capital adequacy ratio. In addition, the ‘commercial’ banks have been influenced by the action of the national bank, which in early 1997 caused bond prices to fall, leading to a fall in the commercial banks’ bond portfolios. Thus the banking sector in the Czech Republic still has a long way to go.

In Hungary the privatization of the banking sector is almost complete. However, a state rescue package had to be agreed at the beginning of 1997 for the second-largest state bank, Postabank, owned indirectly by the main social security bodies and the post office, and this indicates the fragility of this sector. Outside of the difficulties experienced with Postabank, the Hungarian banking system has been transformed. The rapid move towards privatization resulted from the problems experienced by the state-owned banks, which the government bad to bail out, costing it around 7 percent of GDP. At that stage it was possible that the banking system could collapse and government funding, although saving the banks, did not solve the problems of corporate governance or moral hazard. Thus the privatization process was started in earnest. Magyar Kulkereskedelmi Bank (MKB) was sold to Bayerische Landesbank and the EBDR in 1994, Budapest Bank was bought by GE Capital and Magyar Hitel Bank was bought by ABN-AMRO. In November 1997 the state completed the last stage of the sale of the state savings bank (OTP), Hungary’s largest bank. The state, which dominated the banking system three years ago, now only retains a majority stake in two specialist banks, the Hungarian Development Bank and Eximbank.

The move towards, and success of privatization can be seen in the balance sheets of the banks, which showed an increase in post-tax profits of 45 percent in 1996. These banks are also seeing higher savings and deposits and a strong rise in demand for corporate and retail lending. In addition, the growth in competition in the banking sector has led to a narrowing of the spreads between lending and deposit rates, and the further knock-on effect of mergers and small-hank closures. Over 50 percent of Hungarian bank assets are controlled by foreign-owned banks, and this has led to Hungarian banks offering services similar to those expected in many Western European countries. Most of the foreign-owned but mainly Hungarian-managed banks were recapitalized after their acquisition and they have spent heavily on staff training and new information technology systems. From 1998, foreign banks will be free to open branches in Hungary, thus opening up the domestic banking market to full competition.

As a whole, the CEECs have come a long way since the early 1990s in dealing with their banking problems. For some countries the process of privatization still has a long way to go but others such as Hungary have moved quickly along the process of transforming their banking systems in readiness for their entry into the EU.

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Let the Lawsuits Begin – Banks Brace For a Storm of Litigation

In an article in The San Francisco Chronicle in December 2007, attorney Sean Olender suggested that the real reason for the subprime bailout schemes being proposed by the U.S. Treasury Department was not to keep strapped borrowers in their homes so much as to stave off a spate of lawsuits against the banks. The plan then on the table was an interest rate freeze on a limited number of subprime loans. Olender wrote:

“The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value – right now almost 10 times their market worth. The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

“. . . The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC . . . .

“What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back.”1

The thought could send a chill through even the most powerful of investment bankers, including Treasury Secretary Henry Paulson himself, who was head of Goldman Sachs during the heyday of toxic subprime paper-writing from 2004 to 2006. Mortgage fraud has not been limited to the representations made to borrowers or on loan documents but is in the design of the banks’ “financial products” themselves. Among other design flaws is that securitized mortgage debt has become so complex that ownership of the underlying security has often been lost in the shuffle; and without a legal owner, there is no one with standing to foreclose. That was the procedural problem prompting Federal District Judge Christopher Boyko to rule in October 2007 that Deutsche Bank did not have standing to foreclose on 14 mortgage loans held in trust for a pool of mortgage-backed securities holders.2 If large numbers of defaulting homeowners were to contest their foreclosures on the ground that the plaintiffs lacked standing to sue, trillions of dollars in mortgage-backed securities (MBS) could be at risk. Irate securities holders might then respond with litigation that could indeed threaten the existence of the banking Goliaths.

STATES LEADING THE CHARGE

MBS investors with the power to bring major lawsuits include state and local governments, which hold substantial portions of their assets in MBS and similar investments. A harbinger of things to come was a complaint filed on February 1, 2008, by the State of Massachusetts against investment bank Merrill Lynch, for fraud and misrepresentation concerning about $14 million worth of subprime securities sold to the city of Springfield. The complaint focused on the sale of “certain esoteric financial instruments known as collateralized debt obligations (CDOs) . . . which were unsuitable for the city and which, within months after the sale, became illiquid and lost almost all of their market value.”3

The previous month, the city of Baltimore sued Wells Fargo Bank for damages from the subprime debacle, alleging that Wells Fargo had intentionally discriminated in selling high-interest mortgages more frequently to blacks than to whites, in violation of federal law.4

Another innovative suit filed in January 2008 was brought by Cleveland Mayor Frank Jackson against 21 major investment banks, for enabling the subprime lending and foreclosure crisis in his city. The suit targeted the investment banks that fed off the mortgage market by buying subprime mortgages from lenders and then “securitizing” them and selling them to investors. City officials said they hoped to recover hundreds of millions of dollars in damages from the banks, including lost taxes from devalued property and money spent demolishing and boarding up thousands of abandoned houses. The defendants included banking giants Deutsche Bank, Goldman Sachs, Merrill Lynch, Wells Fargo, Bank of America and Citigroup. They were charged with creating a “public nuisance” by irresponsibly buying and selling high-interest home loans, causing widespread defaults that depleted the city’s tax base and left neighborhoods in ruins.

“To me, this is no different than organized crime or drugs,” Jackson told the Cleveland newspaper The Plain Dealer. “It has the same effect as drug activity in neighborhoods. It’s a form of organized crime that happens to be legal in many respects.” He added in a videotaped interview, “This lawsuit said, ‘You’re not going to do this to us anymore.'”5

The Plain Dealer also interviewed Ohio Attorney General Marc Dann, who was considering a state lawsuit against some of the same investment banks. “There’s clearly been a wrong done,” he said, “and the source is Wall Street. I’m glad to have some company on my hunt.”

However, a funny thing happened on the way to the courthouse. Like New York Governor Eliot Spitzer, Attorney General Dann wound up resigning from his post in May 2008 after a sexual harassment investigation in his office.6 Before they were forced to resign, both prosecutors were hot on the tail of the banks, attempting to impose liability for the destructive wave of home foreclosures in their jurisdictions.

But the hits keep on coming. In June 2008, California Attorney General Jerry Brown sued Countrywide Financial Corporation, the nation’s largest mortgage lender, for causing thousands of foreclosures by deceptively marketing risky loans to borrowers. Among other things, the 46-page complaint alleged that:

“‘Defendants viewed borrowers as nothing more than the means for producing more loans, originating loans with little or no regard to borrowers’ long-term ability to afford them and to sustain homeownership’ . . .

“The company routinely . . . ‘turned a blind eye’ to deceptive practices by brokers and its own loan agents despite ‘numerous complaints from borrowers claiming that they did not understand their loan terms.’

“. . . Underwriters who confirmed information on mortgage applications were ‘under intense pressure . . . to process 60 to 70 loans per day, making careful consideration of borrowers’ financial circumstances and the suitability of the loan product for them nearly impossible.’

“‘Countrywide’s high-pressure sales environment and compensation system encouraged serial refinancing of Countrywide loans.'”7

Similar suits against Countrywide and its CEO have been filed by the states of Illinois and Florida. These suits seek not only damages but rescission of the loans, creating a potential nightmare for the banks.

AN AVALANCHE OF CLASS ACTIONS?

Massive class action lawsuits by defrauded borrowers may also be in the works. In a 2007 ruling in Wisconsin that is now on appeal, U.S. District Judge Lynn Adelman held that Chevy Chase Bank had violated the Truth in Lending Act by hiding the terms of an adjustable rate loan, and that thousands of other Chevy Chase borrowers could join the plaintiffs in a class action on that ground. According to a June 30, 2008 report in Reuters:

“The judge transformed the case from a run-of-the-mill class action to a potential nightmare for the U.S. banking industry by also finding that the borrowers could force the bank to cancel, or rescind, their loans. That decision was stayed pending an appeal to the 7th U.S. Circuit Court of Appeals, which is expected to rule any day.

“The idea of canceling tainted loans to stem a tide of foreclosures has caught hold in other quarters; a lawsuit filed last week by the Illinois attorney general asks a court to rescind or reform Countrywide Financial mortgages originated under ‘unfair or deceptive practices.’

“. . . The mortgage banking industry already faces pressure from state and federal regulators, who have accused banks of lowering underwriting standards and forcing some borrowers, through fraud, into costly adjustable loans that the banks later bundled and sold as high-interest investment vehicles.”

The Truth in Lending Act (TILA) is a 1968 federal law designed to protect consumers against lending fraud by requiring clear disclosure of loan terms and costs. It lets consumers seek rescission or termination of a loan and the return of all interest and fees when a lender is found to be in violation. The beauty of the statute, says California bankruptcy attorney Cathy Moran, is that it provides for strict liability: the aggrieved borrowers don’t have to prove they were personally defrauded or misled, or that they had actual damages. Just the fact that the disclosures were defective gives them the right to rescind and deprives the lenders of interest. In Moran’s small sample, at least half of the loans reviewed contained TILA violations.8 If class actions are found to be available for rescission of loans based on fraud in the disclosure process, the result could be a flood of class suits against banks all over the country.9

SHIFTING THE LOSS BACK TO THE BANKS

Rescission may be a remedy available not only for borrowers but for MBS investors. Many loan sale contracts provide by their terms that lenders must take back loans that default unusually quickly or that contain mistakes or fraud. An avalanche of rescissions could be catastrophic for the banks. Banks were moving loans off their books and selling them to investors in order to allow many more loans to be made than would otherwise have been allowed under banking regulations. The banking rules are complex, but for every dollar of shareholder capital a bank has on its balance sheet, it is supposed to be limited to about $10 in loans. The problem for the banks is that when the process is reversed, the 10 to 1 rule can work the other way: taking a dollar of bad debt back on a bank’s books can reduce its lending ability by a factor of 10. As explained in a BBC News story citing Prof. Nouriel Roubini for authority:

“[S]ecuritisation was key to helping banks avoid the regulators’ 10:1 rule. To make their risky loans appear attractive to buyers, banks used complex financial engineering to repackage them so they looked super-safe and paid returns well above what equivalent super-safe investments offered. Banks even found ways to get loans off their balance sheets without selling them at all. They devised bizarre new financial entities – called Special Investment Vehicles or SIVs – in which loans could be held technically and legally off balance sheet, out of sight, and beyond the scope of regulators’ rules. So, once again, SIVs made room on balance sheets for banks to go on lending.

“Banks had got round regulators’ rules by selling off their risky loans, but because so many of the securitised loans were bought by other banks, the losses were still inside the banking system. Loans held in SIVs were technically off banks’ balance sheets, but when the value of the loans inside SIVs started to collapse, the banks which set them up found that they were still responsible for them. So losses from investments which might have appeared outside the scope of the regulators’ 10:1 rule, suddenly started turning up on bank balance sheets. . . . The problem now facing many of the biggest lenders is that when losses appear on banks’ balance sheets, the regulator’s 10:1 rule comes back into play because losses reduce a banks’ shareholder capital. ‘If you have a $200bn loss, that reduced your capital by $200bn, you have to reduce your lending by 10 times as much,’ [Prof. Roubini] explains. ‘So you could have a reduction of total credit to the economy of two trillion dollars.'”10

You could also have some very bankrupt banks. The total equity of the top 100 U.S. banks stood at $800 billion at the end of the third quarter of 2007. Banking losses are currently expected to rise by as much as $450 billion, enough to wipe out more than half of the banks’ capital bases and leave many of them insolvent.11 If debtors were to deluge the courts with viable defenses to their debts and mortgage-backed securities holders were to challenge their securities, the result could be even worse.

PUTTING THE GENIE BACK IN THE BOTTLE

So what would happen if the mega-banks engaging in these irresponsible practices actually went bankrupt? These banks are widely acknowledged to be at fault, but they expect to be bailed out by the Federal Reserve or the taxpayers because they are “too big to fail.” The argument is that if they were allowed to collapse, they would take the economy down with them. That is the fear, but it is not actually true. We do need a ready source of credit, so we need banks; but we don’t need private banks. It is a little-known, well-concealed fact that banks do not lend their own money or even their depositors’ money. They actually create the money they lend; and creating money is properly a public, not a private, function. The Constitution delegates the power to create money to Congress and only to Congress.12 In making loans, banks are merely extending credit; and the proper agency for extending “the full faith and credit of the United States” is the United States itself.

There is more at stake here than just the equitable treatment of injured homeowners and investors in mortgage-backed securities. Banks and investment houses are now squeezing the last drops of blood from the U.S. government’s credit rating, “borrowing” money and unloading worthless paper on the government and the taxpayers. When the dust settles, it will be the banks, investment brokerages and hedge funds for wealthy investors that will be saved. The repossessed will become the dispossessed; and unless your pension fund has invested in politically well-connected hedge funds, you can probably kiss it goodbye, as teachers in Florida already have.

But the banking genie is a creature of the law, and the law can put it back in the bottle. The imminent failure of some very big banks could provide the government with an opportunity to regain control of its finances. More than that, it could provide the funds for tackling otherwise unsolvable problems now threatening to destroy our standard of living and our standing in the world. The only solution that will be more than a temporary fix is to take the power to create money away from private bankers and return it to the people collectively. That is how it should have been all along, and how it was in our early history; but we are so used to banks being private corporations that we have forgotten the public banks of our forebears. The best of the colonial American banking models was developed in Benjamin Franklin’s province of Pennsylvania, where a government-owned bank issued money and lent it to farmers at 5 percent interest. The interest was returned to the government, replacing taxes. During the decades that that system was in operation, the province of Pennsylvania operated without taxes, inflation or debt.

Rather than bailing out bankrupt banks and sending them on their merry way, the Federal Deposit Insurance Corporation (FDIC) needs to take a close look at the banks’ books and put any banks found to be insolvent into receivership. The FDIC (unlike the Federal Reserve) is actually a federal agency, and it has the option of taking a bank’s stock in return for bailing it out, effectively nationalizing it. This is done in Europe with bankrupt banks, and it was done in the United States with Continental Illinois, the country’s fourth largest bank, when it went bankrupt in the 1990s.

A system of truly “national” banks could issue “the full faith and credit of the United States” for public purposes, including funding infrastructure, sustainable energy development and health care.13 Publicly-issued credit could also be used to relieve the subprime crisis. Local governments could use it to buy up mortgages in default, compensating the MBS investors and freeing the real estate for public disposal. The properties could then be rented back to their occupants at reasonable rates, leaving people in their homes without the windfall of acquiring a house without paying for it. A program of lease-purchase might also be instituted. The proceeds would be applied toward repaying the credit advanced to buy the mortgages, balancing the money supply and preventing inflation.

LOCAL AND PRIVATE SOLUTIONS

While we are waiting for the federal government to act, there are also private and local possibilities for relieving the subprime crisis. Chris Cook is a British strategic market consultant and the former Compliance Director for the International Petroleum Exchange. He recommends getting all the parties to settle by forming a pool constituted as an LLC (limited liability company), in a partnership framework that brings together occupiers and financiers as co-owners under a neutral custodian. The original owners would pay an affordable rental, and the resulting pool of rentals would be “unitized” (divided into unit interests, similar to a REIT or real estate investment trust). Among other advantages over the usual mortgage-backed security, there would be no loans at interest, since the property would be owned outright by the LLC. Eliminating interest substantially reduces costs. The former owners would be able to occupy the property at an affordable rental, with the option to buy an equity stake in it. For the banks, the advantage would be that they would be able to find investors again, since the risk would have been taken out of the investment by insuring full occupancy at affordable rates; and for the investors, the advantage would be a secure investment with a dependable return.14

Carolyn Betts is an Ohio attorney who served in Washington as issuer’s counsel for MBS trusts formed by various federal governmental entities, and represented Resolution Trust Corporation in its auction of defaulted commercial mortgage loans during the last real estate crisis. She proposes a squeeze play by the states, in the style of that brought against the tobacco companies by a consortium of state attorneys general in the 1990s. She notes that at the end of 2007, at least 20% of the funds held by the Ohio Public Employees’ Retirement System (PERS) were in mortgage backed securities and similar investments. That makes Ohio public money a major investor in these mortgage-related securities. Ohio governments have an interest in not having homes foreclosed upon, since foreclosures destroy local real estate markets, contribute to lower tax revenues and losses on PERS investments, and cause a strain on state and local affordable housing systems. A coordinated series of actions brought by state attorneys general could eliminate the culpable banker middlemen and return the properties to local ownership and control.

Andrew Jackson reportedly told Congress in 1829, “If the American people only understood the rank injustice of our money and banking system, there would be a revolution before morning.” A wave of private actions, class actions and government lawsuits aimed at redressing injurious banking practices could spark a revolution in banking, returning the power to advance “the full faith and credit of the United States” to the United States, and returning community assets to local ownership and control.

1 Sean Olender, “Mortgage Meltdown,” San Francisco Chronicle (December 9, 2007).

2 See Ellen Brown, “The Subprime Trump Card,” webofdebt.com/articles, June 26, 2008.

3 Greg Morcroft, “Massachusetts Charges Merrill with Fraud,” MarketWatch (February 1, 2008).

4 Henry Gomez, Tom Ott, “Cleveland Sues 21 Banks Over Subprime Mess,” The Plain Dealer (Cleveland, January 11, 2008).

5 Ibid.

6 Marc Dann Resigns as Attorney General,” NBC24 (May 14, 2008).

7 E. Scott Reckard, “California Atty. Gen. Jerry Brown Sues Countrywide,” Los Angeles Times (June 26, 2008).

8 Cathy Moran, “And the Truth (in Lending) Shall Set You Free,” mortgagelawnetwork.com (June 11, 2008).

9 Gina Keating, “Mortgage Ruling Could Shock U.S. Banking Industry,” Reuters (June 30, 2008).

10 Michael Robinson, “City of Debt Shows US Housing Woe,” BBC News (December 30, 2007).

11 “Is the Latest Liquidity Crunch in Remission?”, NakedCapitalism(March 26, 2008).

12 See E. Brown, “Dollar Deception: How Banks Secretly Create Money,” webofdebt.com/articles (July 3, 2007).

13 For more on this funding solution and why it would not inflate prices, see E. Brown, “Waking Up on a Minnesota Bridge: How to Solve the Infrastructure Crisis Without Selling Off Our National Assets,” ibid. (August 4, 2007).

14 Chris Cook, “Peak Credit and a Flight to Simplicity,” Asia Times (April 3, 2008).

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