Saturday, April 27, 2013

Libor and ISDAfix: Big Banks Collude Instead of Compete

Evony and many similar games have a very simple objective. Players first build up resources and armies, then join with an alliance before they begin attacking their neighbor and neighboring alliances. The goal of the game is to completely dominate your world/server?

Despite the simplicity of these games, they actually serve as very interesting social experiments. According to a friend who wastes way too much time playing these sorts of games. He said he finally stopped playing when he discovered the biggest alliances on a server began colluding with one another instead of competing. According to my friend, the top of each of the major alliance had colluded together to covertly attacking members of their own alliances instead of attacking each other.

The reason I bring up this gaming example is because Rolling Stone Magazine is reporting this week that the biggest banks in the world are playing the same sort of corrupt game.

Rolling Stone Magazine reports that the London-based firm ICAP, the world's largest broker of interest-rate swaps, that the worlds largest banks including Barclays, UBS, Bank of America, JPMorgan Chase and the Royal Bank of Scotland are colluding together in fixing ISDAfix.

Interest-rate swaps are a tool used by cities, major corporations and sovereign governments to manage their debt. These credit-default swaps are worth about a $379 trillion or 100 times the size of the United States federal budget.

Like the LIBOR fixing scandal before, these banks will likely just receive a slap on the hand in terms of a fine. And a few middle managers may loose their job.

Since 2007, we have seen the Big Banks who were supposedly in trouble because of the Housing Bubble rewarding their CEO's with record bonuses. The unknown here is what will happen to the markets when the manipulation ceases. TARP and Quantitative Easing have yet to produce significant inflation in the real markets because LIBOR and now ISDAfix has kept money out of the real economy because of this manipulation resulting in what is called Sterilization.

Sterilization is what is happening now with the banks. Big banks borrow $10 from their respective central banks like the FED and thanks to fractional reserve principles and the money multiplier, they can create money out of thin air and lend to you and me $100 or even more based on that original $10. When all is said and done, you end up paying the big bank back $200 and they in-turn pay back their central bank $20. That means the big bank just created $180 in profits and new money in the economy.

Seeing how the big banks create wealth almost from nothing, it's hard to see how they could possibly get into trouble. Even if %80 of their borrowers defaulted, any money that comes back is profit. And then the banks recoup losses by repossessing and selling your house. The banks may loose some profits, but its all profit.

So, how did big banks get into trouble? The banks have to hold onto reserves to lend. But they can't hold %10 reserves as cash because of inflation. So, the banks were investing in mortgaged back security derivatives which were a bet on the US housing market. When the housing market tanked, the derivatives became worthless and banks could't lend.

The big banks didn't loose their profits but lost their reserves. Banks needed to repossess houses and begin selling them to recoup loses. However, repossession and reselling assets takes time. That is when the FED stepped in with TARP to restore the big banks reserves until the big banks could start liquidizing all their repossessed homes.

Again let me remind you that all that derivative money didn't vanish. Goldman Sachs, the company selling these bets, was at the same time betting against the very housing derivatives they were selling to the banks. So, when the Basil 2 Accords were implemented and the housing bubble burst, all the banking money went to Goldman Sachs. They were on the winning side of the bet.

However, the FED hasn't stopped giving free money to the banks. We have been in a kind of perpetual big bank bailout or QE infinity. With all this free money going around, why haven't we seen more inflation? This is what sterilization is all about.

Real investors have all their money in Australia, Brazil and China right now. Investors are building up the "BRICS". The situation is just like before WW2 how Western investors were in Germany helping to build up Hitler's military industrial complex. Russia and China are being built up in the same way to strike the West in the not-to-distant-future.

So what about LIBOR and ISDAfix? Well with the big banks getting all this free money, you would think that some of that free money would trickle down to the the average joe six-pack causing inflation. I mean if the big banks are borrowing for free, then why can't governments and smaller banks and you and I not borrow for free?

This is the heart of the LIBOR and ISDAfix scandal. LIBOR fixing artificially made interests rates high for big banks with free money to lend to smaller banks. ISDAfix made interest rates artificially high for the big banks to lend to governments.

The big banks had to artificially manipulate lending rates to keep the free money out of the real economy. This is sterilization. Therefore, despite the big banks getting all this free cash, local governments, local banks, you and I still borrow at the usual rates.

So, the big banks are holding onto all this extra cash. What are they doing with it? The big banks are using all their cash to buy US stock which is artificially inflating the stock market and they are buying government bonds to continue to artificially prop up local and national deficits and debt.

All this manipulation is helping us in the US feel like we are in some sort of recovery since 2008. Yet, we all know US jobs and real investment are still hemorrhaging to China. The question is, what will happen when Basil 3 is implemented increasing banking reserve requirements? And what will happen when the FED stops printing unlimited bailout money or if LIBOR or ISDAfix manipulation stops?

By the way, increasing banking reserve requirements wouldn't have prevented 2007-8. The problem was the derivatives that became worthless not the percent reserves. 2008 would have happened with 1% or 50% reserves the same.

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