“Implicit” Government Guarantees To Bail Out Bank Creditors Tighten Their Grip On US Taxpayers

Wolf Richter's picture

One of the few rebellious Fed heads, Richmond Fed President Jeffrey Lacker, fired another salvo when he was testifying at the House Judiciary Committee’s hearing. And he hit Wall Street risks that are wrapping their growing tentacles ever more tightly around the economy and taxpayers.

The hearing, according to Chairman Bob Goodlatte, would examine whether the Bankruptcy Code is “best equipped” to deal with the insolvency of large banks, such as the “unusual level of speed” needed for their “efficient and orderly resolution,” and the “unique threats” their collapse would pose to the “broader stability of the economy.”

Lacker was on his turf. For years, he has spoken out against QE. Earlier this year, he committed heresy by admitting that “labor market conditions are affected by a wide variety of factors outside a central bank’s control“; he’d yanked away the Fed’s fig leaf for its QE and zero-interest-rate policies. And in June 2012, before QE3 had appeared on the horizon, he’d stunned his listeners when he said, “Monetary policy doesn’t have a lot of capability right now for enhancing growth.” He dissented at the FOMC meetings in 2012 when he last was a voting member. His concerns were confirmed by QE3’s subsequent failure to budge the economy, though it inflated glorious assets bubbles all around.

Now, in his prepared remarks, he told the Committee that the Bankruptcy Code should be tweaked to make it “feasible to resolve failing financial firms in bankruptcy.” The financial crises showed “glaring deficiencies” in the way “distress and insolvency” of big banks are handled, he said. Meaning, they were all bailed out by the Fed and to a much smaller extent by TARP, when there should have been a system in place to wind the failing ones down in bankruptcy. The bailout of investors has created, he said, “two mutually reinforcing expectations”:

First, many financial institution creditors feel protected by an implicit government commitment of support should the institution face financial distress. This belief dampens creditors’ attention to risk and makes debt financing artificially cheap for borrowing firms, leading to excessive leverage.

This belief also encourages the riskiest types of borrowing, “such as short-term wholesale funding,” that could evaporate at a moment’s notice and leave banks and other companies high and dry, which is what had happened during the financial crisis. And these types of funding then “prompt the need” for an implicit government or Fed “protection,” he said.

Second, policymakers may well worry that if a large financial firm with a high reliance on short-term funding were to file for bankruptcy under the U.S. bankruptcy code, it would result in undesirable effects on counterparties, financial markets, and economic activity. This expectation induces policymakers to intervene in ways that allow short-term creditors to escape losses, such as through central bank lending or public sector capital injections. This reinforces creditors’ expectations of support and firms’ incentives to grow large and rely on short-term funding, resulting in more financial fragility and more rescues.

He cited the Richmond Fed’s research into how expectations of creditor bailouts – the implicit guarantees – have grown over time.

In its 2013 estimate, using 2011 data, the Richmond Fed found that there were $44.5 trillion in total liabilities in the financial system, such as bank deposits and bonds. Of them, $10.6 trillion (23.8%) carried explicit guarantees, such as FDIC deposit insurance. And a stunning $14.83 trillion (33.4%) carried implicit guarantees. Unlike FDIC insurance, these guarantees are issued for free to the beneficiary, and when they come due during a bailout, all Americans are forced to pay, through either government or Fed action, to protect the wealth of the creditors. These implicit guarantees in 2011 amounted to 97% of GDP!

They have done nothing but balloon. The Richmond Fed’s first estimate, using 1999 data, found that implicit guarantees amounted to $3.4 trillion (18% of the liabilities in the financial system). A mere 27.6% of GDP. Another screaming data point – as if we needed anymore – in how Wall Street’s risks have been wrapping their ever larger tentacles around the US economy and the taxpayer.

How could this happen? How could these expectations of creditor bailouts balloon so fast so much? Who encouraged it? Well, the Fed and the government. “Through gradual accretion of precedents,” Lacker explained. One bailout followed by a bigger one, followed by an even bigger one, etc., followed by the massive bailouts during the financial crisis. It has been going on for four decades, he said.

While these implicit guarantees have altered risk-taking on Wall Street, banks have become fewer and bigger. In the mid-1980s, there were over 18,000 federally insured banks. Now there are 6,891. Of the goners, 17% collapsed; the rest were mergers and consolidations, based on FDIC data cited by the Wall Street Journal.

Of the survivors, 98.6% are banks with $10 billion or less in assets that control 12% of all assets in the banking industry. Then there are 70 regional banks with up to $250 billion in assets. They make up 1.2% of all banks but control 19% of all bank assets. Should any of them fail, it would entail private-sector losses and ownership changes with minimal governmental intervention. And then there are 12 megabanks – 0.17% of all banks that control 69% of the banking assets!

Their “owners, managers, and customers believe themselves to be exempt from the processes of bankruptcy and creative destruction,” Dallas Fed President Richard Fisher pointed out when he once again vituperated against TBTF banks that, as “everyone and their sister knows,” were “at the epicenter” of the financial crisis. They “capture the financial upside” of their bets but are bailed out when things go wrong, “in violation of one of the basic tenets of market capitalism.”

While Chairman Bob Goodlatte bent over backwards to address ostensibly the collapse “of large and small financial institutions,” everyone knew he was talking about just 12 banks, the only banks in the country exempt from the Bankruptcy Code. Their bondholders are benefiting, free of charge, from implicit guarantees in the size of America’s GDP. These guarantees have encouraged banks, aided and abetted by the Fed, to pile on mountains of risk as if the financial crisis had never happened.  

Bu it has done nothing for the real economy, a rather drab place, where consumers try to make ends meet as they entered the holiday shopping season with shootings, stabbings, tramplings, fights, pepper sprayings.... “Only in America people trample each other for sales exactly one day after being thankful for what they already have,” a tweet explained. But it’s been tough for retailers too. Read.... Strung-out Consumers, Desperate Retailers, Crummy Sales

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
steveo77's picture

Just another clue?

Giant Sturgeon found dead in Washington Lake, Pounded by Radiation?


q99x2's picture

“unique threats” their collapse would pose to the “broader stability of the economy.”

I think he meant to say, "will pose" not "would pose." Bankers are continuing to build a false reason for their takeover of the United States of America as well as for their criminal and immoral behavior. I say let's shut them down and re-establish the new deal with the re-building of the United States.

Global Observer's picture

In the next inevitable meltdown, the banks will not be bailed out. They will go through a restructuring where shareholders will be wiped out and depositors will be converted to shareholders. It will likely hit even depositors whose accounts hold amounts well below the FDIC limit, since FDIC doesn't have the balances to cover all the deposits in the event of a system-wide collapse. Businesses that see their balances converted to bank shares and can't get a line of credit in the new restrctured banking system will have no choice but to shutdown. Unemployment will become more common than employment. Will the US collpase socially and politically immediately or will they buy a couple of more years by the government spending like Zimbabwe remains to be seen.

Mentaliusanything's picture

just bring back Glass/Steagall! Is only 30 pages of Insurance against gambling with money you have been given in Trust. if you co mingle it and it goes sour then you go to jail and lose all you have.. everything. Bernie Madoff must be shaking his head that JP MORGAN have a banking permit to operate while openly admitting to criminal activity. This is so badly fucked up I wonder if there is any true justice anymore. They should be broken up under the proceeds of crime act. once you hang one out to dry the others will tow the line.

Ghordius's picture

+1 and it worked quite well for some 60 years

SAT 800's picture

Jeffrey Lacker. Could have a one car accident. might slip in the shower.

Coldfire's picture

There are old Fed heads and there are bold Fed heads, but there are no old, bold Fed heads.

willwork4food's picture

With any luck there will be swinging' old & bold Feds. On a tree.

Son of Captain Nemo's picture

No wonder PMs and jobs are in the toilet for this Country?... that keep going to China! 

Think this might be one of the smoking gun(s) among many.

Maybe Jamie will be able to enlighten Congress along with the $13 billion in fraud settlements he already has on his plate.


screw face's picture

Who was that lawyer?

mobydick's picture

The little old lady who won the bet should have done a bobbit on those balls. Eunuchs would make for a hell of a lot better banker than those greedy, over-entitled, testosterone fuelled bastards we're plagued with. 

assistedliving's picture

A little old lady went into JPM CHASE bank one day, carrying a bag of money. She insisted that she must speak with the president of the bank to open a savings account because, "It's a lot of money!" After much hemming and hawing, the bank staff finally ushered her into the president's office. The bank president then asked her how much she would like to deposit. She replied, "$165,000!" and dumped the cash out of her bag onto his desk. The president was of course curious as to how she came by all this cash, so he asked her, "Madam, I'm surprised you're carrying so much cash around. Where did you get this money?" The old lady replied, "I make bets." The president then asked, "Bets? What kind of bets?" The old woman said, "Well, for example, I'll bet you $25,000 that your balls are square." The president laughs, "That's a stupid bet. You can never win that kind of bet!" The old lady challenged, "So, would you like to take my bet?" The president agrees, "Sure, I'll bet $25,000 that my balls aren't square!" The little old lady then said, "Okay, but since there is a lot of money involved, may I bring my lawyer with me tomorrow at 10am as a witness?" "Sure!" replied the confident president. That night, the president got very nervous about the bet and spent a long time in front of a mirror checking his balls, turning from side to side, again and again. He thoroughly checked them out until he was sure that there was absolutely no way his balls were square and that he would win the bet. The next morning, at precisely 10am, the little old lady appeared with her lawyer at the president's office. She introduced the lawyer to the president and repeated the bet "$25,000 says the president's balls are square!" The president agreed with the bet again and the old lady asked him to drop his pants so they could all see. The president complied. The little old lady peered closely at his balls and then asked if she could feel them. "Well, Okay," said the president, "$25,000 is a lot of money, so I guess you should be absolutely sure." Just then, he noticed that the lawyer was quietly banging his head against the wall. The president asked the old lady, "What the hell's the matter with your lawyer?" She replied, "Nothing, except I bet him $100,000 that at 10am today I'd have Jamie Dimon's balls in my hand." --------------------------------------------------------------------------------

Colonel Klink's picture

Good joke but guaranteed that at 9am Obama had Jamie Dimon's balls in his mouth.

Spankrupt's picture

Benicopter is the desperate drunk guy throwing himself on the ugly economy at closing time at Cheers.

Disclosure: I have not done this at Gabriels Gate on Allen Street......ever.

Coldfire's picture

I never thought I'd hear of Gabriel's Gate again. My car broke down late one icy winter night in Buffalo in 1987. The Gate was the only place open. We waited there until my brother drove down from Toronto to rescue us. The front doors, the crowd, the Zeppelin and the spinning dolls made a big, if vaguely satanic, impression on us. Gabriel's Gate rocked. Glad to see it's still rocking.

notadouche's picture

But why would we need to worry about banks going out of business because they have all been healed with the magic salve that is Fed produced liquidity?

maskone909's picture

how much longer until we enter the laffer curve? 

when your money printing exceeds the tax revenue generation, there is a problem.


printing money leads to inflation, which inherently exacerbates the decreasing value of revenues from taxation.  in theory, if we are already on the descending end of the curve, the money printing will no doubt accelerate the decent (and greatly distort the feds/congress interpretation of actual revenue from taxes since CPI inputs are not accurate). 

jughead's picture

"First, many financial institution creditors feel protected by an implicit government commitment of support should the institution face financial distress. This belief dampens creditors’ attention to risk and makes debt financing artificially cheap for borrowing firms, leading to excessive leverage."

all those words could be summed up with just two - moral hazard.

willwork4food's picture

Funny how it started around the Clinton era with NAFTA. I won't even mention the revocation of G/S.

TrustWho's picture

Inflation protects the power base as they can say: "Don't blame me for your inability to buy your shit, it's just inflation and not my fault.

Hey Bernanke...."PRINT MOAR"

Whiner's picture

You see ZHers why Jamie wears the presidential cuff links given to him by his White House boy which he wears on his sleeve as to say, " I own that boy (and you too MFs ).

Its_the_economy_stupid's picture

What did Frank Nitty pull out of his wallet?

"please show Mr nitty every courtesy" signed Mayor of Chicago (or some such)

joego1's picture

That's the problem with humans they all want a guarantee.

RaceToTheBottom's picture

"And then there are 12 megabanks – 0.17% of all banks that control 69% of the banking assets!"

Normally I am not a proponent of nationalization, but this is country risk on a massive scale.  I say nationalize them for 6 months while you break them down and turn them into smaller regional banks with Public Utility CEO price ranges.

Let them form blocks of companies if they feel they need scale to compete internationally but right now the only risk is on the US public.

artless's picture

I have a better idea. How about we just follow the dog gamned rule of law and allow them to go bankrupt? As it SHOULD have been with GM it should be (should have been) with Goldman Ballsack and The JP Morgue which are both BY admition criminal entities.

Oh but we can't have that cause a bunch of jackasses WHO HAVE PROFITED FROM THIS SCAM RIGHT ALONG WITH THE MEGA CARTELS might lose their 401fucking Ks.

Tough Shit. All the retirement funds, bonds, and god knows everything else has assraped this country of its future. Why? How?

Because all that debt is the basis of the financing of THE Criminal Entity otherwise known as Washington, DC.

Yes all you fucks are complicit. You deserve to lose your shirts.

And no. I do not think it will ever happen not when those getting fuct continue to accept it. Or even worse try to get in on the game.

Debeachesand Jerseyshores's picture

At the same time,bring back Glass/Seagell and separate the normal dull banking sector from the wild west investment sector.

Boris Alatovkrap's picture

Bankster who is buy AmeriKa political class is not, how you say, comfortable with Glass-Steagal regulation. Is, how you say, so constraining and inconvenient. Central bankster is so very important and so much more smart, citizenry must give to bankster whatever bankster is ask.

SmittyinLA's picture

In was looking at the city of Bell CA finances, they took 5 million in sewer bond proceeds and dumped it into short term MM treasury funds.

Nice to see where your property taxes are going directly to speculative fed "investments".

ebworthen's picture

The FED was created to protect the interests of the largest banks at the expense of the taxpayer.

Mr. Lacker either isn't aware of this, or is simply playing the foil to maintain the appearance that the FED serves citizens not banks.

PTR's picture

Sometimes you gotta admit that a bad apple will make its way through the system.



falak pema's picture

maybe he is covering the option of not being called to the guillotine further down the road! 

Boris Alatovkrap's picture

All central bankster is covenant with Lucifer, no matter what pretend. Cannot shake devil hand and say you are only is kidding.

Tom_333's picture

Me thinks the cabal involves more playas...Likely near-future scenario involves radically lowered asset valuations (like 2008), sharply increased taxation (directly and indirectly, nothing new even the Supreme Court thinks that ACA is a tax ) and general confusion on what to do...more fiat printing...or...what. The consequences will breed even more socialism and general support for confiscations of middle-class wealth (what´s left of it). And so on.

This is like a disease that will have to run it´s course. We are looking at maybe 10 - 12 years of this before a new generation reaches the voting ballots. A generation that have seen the mayhem and destruction the current combination of socialism-oligopoly creates. Unlikely that todays unwashed brainwashed masses anytime soon will develop an understanding of where their support is leading them.

The thing here is to try to stay out of this perfect storm as much as possible.

Pegasus Muse's picture

Thought for the Day:

“Does holding the knowledge that, after examining hundreds of examples of monetary manipulation, depreciation and crime over thousands of years, gold is the ultimate store of value in an insane world dominated by fiat-issuing bankster sociopaths and their government lackeys count as "knowledge that can make you money"?” --akak

Coldfire's picture

And like the man says: you get in bed with the Devil, sooner or later you gotta fuck.

rubiconsolutions's picture

"First, many financial institution creditors feel protected by an implicit government commitment of support should the institution face financial distress."

Excusez-moi si ça ne vous dérange pas trop.....but fuck you and the QE you rode in on.