Introduction
In this third edition of Wizards we are going to take a look at how banks bet that poverty will pay off for them. We will be taking a close look at predatory lending whereby banks seeking high returns prey on the poor who, as noted in past editions of Wizards, have little to no voice in the financial system. We will also look at banks’ appetites for homes through this predatory lending followed by the foreclosure process.
In this investigation of banks activities in low income neighborhoods it will be most appropriate to look at the relationship between the father of the banks, the Federal Reserve, and the poor. But before exploring the relationship between powerful creditors (money creators) and low income people let’s first review some important points learned from earlier editions of Wizards. We recall that money is created “out of thin air” by the banks and the Federal Reserve System, and is not backed by anything at all but our trust in the monetary system. We also recall from Wizards, Part 2 that, in the absence of anything real actually backing money, the US dollar is the backbone of the international monetary system. This trust in the US dollar is little more than a group psychological phenomenon that could collapse simply by people starting to question the faith they have in it.
Because people don’t stop to think about it too much the above realization can initially cause some shock and confusion, and maybe also some hope. To get more comfortable with this very different way of looking at money and to get a better understanding the trickery and sleights of hand at work, there is an excellent text which was written in 1965 that you should be aware of. It is called “A Primer on Money, Banking and Gold” and I would highly recommend this to those who wish for a more detailed technical understanding of the mechanics that were described at a “big picture” level throughout Wizards Part 1 on “How Money is Created”.
This book was written by a Mr. Peter Bernstein all those years ago, when the monetary system was still bound to the gold standard and so was actually a bit different than it is today. Nevertheless Mr. Bernstein, who had a long and distinguished career in the banking industry, including many years at the Federal Reserve, wrote the best text I have ever seen on this subject. Even though the monetary system has lost its gold backing and several other key changes have been made, much of this text is still relevant today. Professor James Tobin, Nobel Prize Winner in Economics and famous among activists for his Tobin Tax proposals, has also given the book much praise. It is very sad that such books are not widely available, nor incorporated into the core school curricula so that the monetary system could be clearly identified for what it really is. It is Mr. Bernstein himself, who sums up this dilemma over educating people about the monetary system so eloquently. He says in his book that when we “ask what the American Dollar is really based upon, we would have to say that it exists essentially on promises and bookkeeping machines. If anyone were to set up such a system by decree or legislation, it would probably never work. Indeed, it is just as well that most people never stop to realize that the money they earn for their efforts is only a number in a bookkeeping machine, or a piece of paper convertible into nothing more than another number in a bookkeeping machine.”
The English word “credit” can be traced back to its Latin origins as being synonymous with “belief, faith, confidence, and trust”. While many bankers may be aware that this trust is not well founded once you get past the smoke and mirrors surrounding money (or credit) creation, it is not in their best interest to advertise this fact. This is because the system works to their advantage. If public confidence in the monetary system is to be shaken it will have to come from those hurt by it. But first they themselves will have to get to the point of questioning the system they have placed their trust in. The growing abuses of credit creation powers over the poor, and the growing awareness of these abuses that we will discuss in Wizards today, may act as a catalyst to get people to this realization.
In this edition we are going to go and chat with some people at the American Association for Retired Persons (or AARP) who just gave some informative testimony to the Senate Banking Committee about what some of the hungry banks have been up to lately. It seems that after the Asian financial crisis the banks’ appetite for foreign adventures was diminished for just a little while and they had to look closer to home for those high return loans. The elderly must have seemed an attractive target market for their high equity (mostly home equity), low income profiles. This is the type of thing that makes a mischievous bank lick its chops, for such a demographic is a prime target for what is known as “equity stripping”.
We will talk more about equity stripping when we go visit the AARP. But to draw some parallels with earlier editions of Wizards, this equity stripping is very similar to what happens in foreign investing, followed by IMF bailouts. The big banks and financial players (that is the ones too big to fail) whose loans start to default, but who can’t have the defaults hit their books, need someone to get the money out from somewhere. That’s when the IMF steps in with is bailout packages and austerity programs to squeeze the money out of the country that doesn’t have any money (“hard” money that is). The IMF completes its mission by “equity stripping” – selling off the real assets and labor of the country to generate the cash to pay back the banks. In the domestic retail equity stripping examples we’ll look at today, we’ll see that this is pretty much what shady banks do directly to those easily preyed upon at home. We will also see that many of these shady operators are actually subsidiaries of the large, well-established banks like Citigroup, JP Morgan Chase and Bank of America.
Today’s study of predatory lending will take us to one of the cities where abusive lending practices are some of the worst in the country, and the state with one of the most bank-friendly foreclosure laws on the books. Interestingly it is also the place where the Federal Trade Commission has recently filed suit against Citigroup for the predatory practices of its subsidiary, Associates First Capital, in what could become the largest and most public case against a predatory lender ever seen in this country. This location is Atlanta, Georgia.
The “Science” Behind Our Monetary System
This predatory behavior of banks is most pronounced where there are easy targets. The easy targets are the poor, but lets not just focus on the relationship between banks and the poor. First we’ll look at the relationship between the father of the banks, the Federal Reserve, and the poor. And in order to do this we’ll look at some of the principles or ideas that might be influencing the behavior of those that “make money”.
The famous extreme capitalist and private property advocate, Ayn Rand, who we mentioned in the second edition of Wizards as the author of “Atlas Shrugged”, once said “If money is the root of all evil, then what is the root of all money?” This might make you chuckle if you recall that Alan Greenspan, the Chairman of the Board of Governors of the Federal Reserve, worked with her extensively on her book “Atlas Shrugged”, released in 1957, which many right-wingers claim to be the most influential book since the Bible. In subsequent years Greenspan also contributed to Rand’s publication “The Objectivist”. Today Rand’s protégé is right at the center of all money, and perhaps her question is answered.
Since money has become the backbone of so much of our social fabric and it is, after all is said and done, just based on faith and belief in it, we better know something about the beliefs of those at the center of it. That Greenspan has a long history in the banking and finance sectors, including the obligatory stint at JP Morgan, is hardly surprising in the world of central bankers. What is perhaps more worthy of attention is his service to Rand in her work. This is evidence of his rigorous training in her philosophy, which is known as “objectivism” and whose fundamental features seem to overlap extensively with today’s so-called neoliberal economic policy.
This philosophy of objectivism largely rejects the idea that capitalism and capitalists should have any social goals at all, and promotes the idea that all acts and intentions should be purely selfish. Not surprisingly Rand’s work was a huge hit with the powers that be in America at the time, hot on the heals of the McCarthy era. Her ideas are actually very different to Adam Smith’s philosophy but we wont go into that here. In coming up with her rather extreme, but very influential, theories it appears that Ms Rand must have been skipping her physics lessons. If she had bothered to look into the revolutionary developments in Physics that took place in the early 1900’s in the form of Quantum Mechanics and Special Relativity her philosophy may have hit some stumbling blocks. Both of these radical developments in physics shook the foundations of Western thought premised on objectivity, independence of objects, the absolute nature of time, and certainty. Gradually this new way of looking at the world, which has many parallels with eastern religions, has replaced the old Newtownian (or classical) mechanics way of looking at the world in physics, and is seeping its way into other sciences such as chemistry and biology. A fabulous text on these developments in physics and their parallels with Eastern Philosophy, written for the lay person, is the book called “The Tao of Physics” by Dr. Fritjof Capra. 1975.
These days it seems that students of business and economics are also too busy to attend physics classes, and this is one of the problems with having isolated disciplines of study. Today it is the economists, business-people and politicians who are the furthest behind in picking up on these turn-of-the century revolutionary developments in physics. The only thing they gleaned from this scientific revolution was knowledge of how to make the atomic bomb and blow things up in a spectacular fashion. What they could have learned is some pretty interesting flaws in their own field of economics. Not only are today’s mainstream economic theories, and philosophies like objectivism, outdated by being based on the Newtonian or classical worldview, but these same outdated views are reflected in our current monetary system. Nothing illustrates this better than having a disciple of Rand at the helm of the Federal Reserve!
This digression into modern physics, while talking about the relationship between the Fed and the poor, may seem rather odd. Nevertheless it brings home the point that money is a social and psychological phenomena and so the beliefs and “science” adopted by those that create money and control the monetary system must be scrutinized. In later editions of Wizards we are going to explore further some of the foundations of contemporary mainstream economic theory that are challenged by the worldview shift brought about by modern physics, that the economists have yet to pick up on. It is rather ironic that mainstream economics, claiming to be so scientifically based, ignores the developments in the most objective of science of all. The emerging field of so-called Ecological Economics is doing a much better job of incorporating modern physics.
Lets just note here that these changes in perspective, long incorporated into eastern philosophy, force us to think about time differently, to always acknowledge the interconnectedness of everything, and to recognize ever present uncertainty in everything. The private property markets of today do not operate in this fashion. Rather they treat people and objects as independent economic units, and discount the future as less important than the present. Furthermore they have limited mechanisms for coping with uncertainty.
The Federal Reserve and the Poor
Under this old or classical world view central bankers use more or less traditional techniques for exercising some control over the economy, and a large part of this is maintaining the confidence of the markets in the monetary system. So people that don’t have much money don’t factor into central bankers’ decisions very much at all. On the surface many might think that there is no relationship between the Federal Reserve and the poor to speak of. However this ignores the interconnectedness of everything and this is perhaps best considered within the context of the “Zero Sum Game” that we spoke about in Wizards Part 1.
As income and wealth gaps have widened few people have more money, and the majority of the people are getting less. Many of those that have accumulated lots of the money go looking for lots of places to invest it, or gamble with it, so that it will make more. This has lead to an explosion in non-bank financial institutions and the use of corporate bonds in lending. Neither mechanism “creates money out of thin air” because the players don’t have a banking license. But because the players have accumulated so much of the existing money they can become financiers themselves by lending out the piles of dough they’ve accumulated. Thus, according to Martin Mayer in the book “The Fed”, only one fifth of commercial and industrial financing now comes from the banks. The rest comes from people and non-bank institutions that have accumulated lots of the existing money.
This has several implications. First the Fed’s powers over the market is more limited because there are so many non-bank financiers, so the Fed has to do whatever it can to please these non-bank markets and keep their confidence in the whole financial system alive. By necessity this means always pleasing the people that already have lots of money. Second, banks go looking all over the place for new people and entities to lend to since the domestic non-bank corporations abandoned them. This search has been a big part of banks overseas lending adventures and the phenomenal growth in lending to the sub-prime domestic markets over the past decade. The sub-prime market is people with bad credit histories, which often correlates with low income. This loan market has grown 300% from about 75 billion in 1993 to over 300 billion by 2000, according to the Wall Street Journal. Previously the banks wouldn’t touch this market with a ten-foot pole, but in their never-ending search for new borrowers, especially at high yields, this has become a huge growth area.
In past years the practice of redlining has been common amongst banks, whereby banks mark maps with a red marker for areas they would and wouldn’t lend to and these distinctions were often made along racial lines. These days a similar map marking process might be used to distinguish between prime and sub-prime markets – that is, who gets access to credit on reasonable terms and who gets lumped into the sub-prime category which is where the exploitative terms of credit prevail.
Public concern over discriminatory practices in lending and the limited availability of credit in poorer neighborhoods lead to the passing of the Community Reinvestment Act (CRA) in 1977, under which bank examiners are supposed to check bank’s record of meeting the credit needs of the entire community including low to middle income groups. This means that the Federal Reserve has some responsibility for this but, as already noted, the Fed is mostly concerned with monetary policy, which means making sure that people that have the most money keep confidence in the monetary system. So as Martin Mayer points out in “The Fed”, “discrimination against low income people in lending operations was a subject guaranteed to be of no interest to the Federal Reserve System”. And as Kenneth Thomas, a Wharton School lecturer on finance points out, “banks are always happy with the ratings given by the easiest CRA grader in the business”, meaning that the Fed doesn’t take the CRA review of banks too seriously at all.
Mayer also notes in “The Fed” that “Both publicly and privately, the Fed has always refused to acknowledge the existence of discrimination in any part of the American banking system.” Consistent with this observation the Fed has behaved rather anti-socially during the approval process for mergers and acquisitions with respect to complaints filed with it regarding unfair and exploitative lending practices. Basically it has ignored consumer complaints and public concerns and nowhere was this more noticeable than during Citigroup’s recent acquisition of the huge Mexican banking group Banamex.
The July 30th edition of the American Banker daily paper reported, in reference to the Greenlining Coalition’s request for a hearing on the takeover, that “Comparing the Fed’s approval to “Alice in Wonderland” where a verdict is reached before the trial, the SanFrancisco-based umbrella group for 37 religious, minority and ethnic organizations said the hastily crafted approval would embarrass even an old style Banana Republic Regime”. That same issue of American Banker contained another story about Citigroup’s alleged gag orders on ex-employees about abusive and fraudulent practices in its sub-prime lending unit. We can hardly be surprised by all this when, after all, Citigroup is the largest shareholder of the Federal Reserve Bank of New York and its CEO is on this Fed bank’s board. The relationships between the Fed and the big banks are all just too cozy for public comfort. In an observation that would meet with approval in the Rand school of thought, Mayer concludes that “there are people in high places who still believe government should not interfere with the freedom of contract between the loan shark and the needy”.
Before closing out this section on the relationship between the Fed and the Poor we should just note the interesting results of one of Mr Greenspan’s recent data analysis projects. The June 4, 2001 edition of Business Week reported on a study commissioned by the Fed that found that 50% consumer spending in the year 2000 was attributable to the top 20% of income earners. Also, amazingly, 80% of directly held equity or stocks was attributable to the top 20% bracket. The conclusion of this study was that the economic boom of the middle to late 90’s was almost entirely driven by the spending of the top 20% of earners, whose spending in turn was driven by confidence derived from an inflated equity market. Now that the markets are sliding this spending has stopped, we are sliding into recession, and layoffs are increasing in response to low company earnings. What then is a Federal Reserve Chairman to do? It seems his role is to keep the stock markets up and keep the top 20% – the speculator class – happy. So maybe it’s not just that the poor are irrelevant to the Fed’s decisions, but the irrelevancy may run as high as 80% of the American people! Not to mention the rest of the world.
