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Wizards of Money – Complete Transcript

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This will become the complete transcript once I have worked through the full audio series.

THE WIZARDS OF MONEY Part 2: “Financial Risk Transfer”

Audio Version


2.1) Introduction to Financial Risk Transfer
2.2) Capital Buffers in the Global Casino
2.3) Risks Taken By Speculators and IMF Bailouts
2.4) Risk Transfer in Action – Asian Financial Crisis
2.5) IMF Bailout Prevention Solutions
2.6) Bank Supervision and the Basel Capital Accords

SONG/MUSIC: “The Merry Old Land of OZ!” The Wizard of OZ Soundtrack

This is the Wizards of Money, your money and financial  management series… but with a bit of a twist.

My name is Smithy, I’m from the Land of Oz.

2.1) Introduction to Financial Risk Transfer

In this second edition of Wizards we are going to take a look at Financial Risk Transfer. How do the big gamblers of the financial system, like the Wall Street firms and the currency speculators, get transferred
to the public who have no say and no gain in these gambling adventures? How does this risk transfer work to increase income and wealth gaps globally, which then further increase financial risk, which in turn exacerbate global income inequality, and the cycle starts over again.

We will first look at how and why bodies like the International Monetary Fund (IMF) facilitate such risk transfer, this is a timely issue given the upcoming protests set to take place at the IMF/World Bank meeting in Washington, DC soon. Then we’ll see that these two bodies are simply a necessary evil of a much bigger financial infrastructure.

Presently the big financial players are merrily increasing the financial risk to be transferred to the public and the public is not really noticing all that much. What many are noticing are the consequences of risk transfers that have happened in the past and then materialized through such things as the IMF bailouts. Not too many concerned citizens are noticing the risk transfers that are being set up today for the public to digest in the future. This is not really the publics fault as the mechanisms through which all this is done is not only shrouded in wizard secrecy, it is also something of an Alice in Wonderland world that is very hard to understand.

The financial instruments through which speculators gamble are getting more and more complex, they started of course with things like stocks and bonds but these days financial instruments are developing on top of stocks and bonds, sort of derived from stocks and bonds, and then more financial instruments are being developed on top of these financial instruments that where developed on top of stocks and bonds. This surreal speculator world requires a whole new vocabulary – we need things like options, swaps, naked calls, floors, caps and collars. Then these instruments seem to mate and have hybrid offspring like – swaptions, captions, knock-out options and roller coaster swaps. Not even the players themselves really know what’s going on. They are just there for a quick profit, and have stolen the best mathematical minds money can buy to help them do this. Lets not go into the details of how these multiplying and magical instruments work. Rather we note that their growing use makes real economies more wobbly everyday, and that these financial markets are becoming far too complex to regulate. On top of all this, for every regulation curtailing speculator activity a new instrument suddenly materializes to circumvent the regulation. In this way speculator instruments multiply like new strains of bacteria, gaining resistance to the old regulatory treatments.

In this Wizards Part 2 we’ll be taking a look at some of the ways that banks are likely to further increase the riskiness of their activities and then be able to transfer the costs of those risks to those who can least afford it. In this context it will be most appropriate to look at the supervision of banks and ask the question “Who is supervising the banks anyway, or are they just supervising themselves?” The latter seems to be becoming more the reality these days. And this at a time when the Wonderland of Finance is becoming ever more complex and desperately in need of more supervision.

Finally we’ll take a look at some arrangements being made under the new Basel Capital Accord, this is an effort sponsored by the Bank for International Settlements in Switzerland, to address the issue of bank and speculator risk. The Bank for International Settlements (BIS) might be considered the third arm of the major global financial institutions, the other two being the World Bank and the International Monetary Fund, which have achieved widespread fame in recent years. In comparison the BIS seems to be quite shy and gets very little public attention, which might make one suspicious that it is up to no good. The BIS is owned by the central banks of the richer countries.

The central banks in other countries are sort of like the Federal Reserve is here. That is, they are responsible for monetary policy or, as we saw in Wizards Part 1, responsible for creating base money out of thin air. The real activities of the BIS are extremely well shrouded in secrecy, as is the fine tradition of the banking sector. In fact I don’t think I know anyone who really knows what the Bank for International Settlements does. But one thing we do know about them is that they host the discussions and rule-making about how countries should supervise their banks to make sure there banks are not getting into too much mischief, which might in turn upset the global financial system. While the Bank for International Settlements hosts these bank supervision meetings, which are closed to the public, of course, the BIS says they are not responsible for the Basel Capital Accords, which set international bank supervision standards. They say this most probably because supervision is much despised in banking circles, and the banks would rather get rid of supervision, so they could just supervise themselves.

2.2) Lets Talk about “Capital Buffers” for Managing Financial Risks in this Global Casino

Now we are going to talk about the concept of Capital Buffers for managing Financial Risks in this Global Casino.

Recall that in the first edition of Wizards we spoke about how money is created and who creates it. In that edition we discussed that all money is created “out of thin air” through the loan creation process. And we saw that for every amount of money there is a corresponding amount of debt owed to the banking system.

But how much money can a bank create through this lending process? A lot of that depends on how risky its loans are. Banks can create new loans (or bank money) up to a certain maximum multiple of their shareholder capital – shareholder capital is the amount the shareholders have invested in the bank, which is also the excess of the bank’s assets over its liabilities. Now remember that a banks assets are its loans to the non-bank public, and its liabilities are deposits of the non-bank public. Capital for a bank can be thought of as a safety net – so the more capital a bank has, the safer it is. That multiple of shareholder capital that banks can create as money will depend on how risky the loans are that they choose to make. If they are very risky loans, the multiple will be lower. Put another way, a bank that makes risky loans will have to hold more capital (i.e. more of a safety net) as a percentage of total loans than a bank that makes less risky loans.

Risky loans in this context means loans that are more likely not to be paid back in full, and this is the financial risk “created out of thin air” we spoke about in the first edition of Wizards. If lots of risky loans ends up in default (that is, not paid back) then a bank reports this as a loss and people start to lose confidence in the financial system, which can ultimately lead to financial crises and sometimes financial collapse. So, although these risks are created “out of thin air” they can create very real consequences because our whole global economy is tied to the financial system and therefore is completely dependant on continued confidence in it.

Holding more capital for risky loans makes sense because capital is a buffer against unexpected losses. If a financial risk results in a loss –  just like if you lost at the roulette wheel when you went to the casino – then you would have to dip into your capital (or safe money) supplies. So even if you love to gamble, when you go up to the casino, you don’t bet all  your life savings. You leave some of your money at home or in your bank account so that if you lose all your bets that day, you will be able to tap into your untouched savings the next day, buy what you need to conduct business as usual. So to buy food, pay rent etc. This is exactly what banks must do to make sure they can remain viable entities in the long run. The more risks you take with your money the higher a capital buffer you need because more risks means a higher probability of loss. For many banks these “risk based” capital levels were set under the Basel Capital Accord of 1988. These capital accords are now being revised, through the Bank for International Settlements process and the banks are complaining that they have to hold too much of a capital buffer.

Banks would like to hold as little of a capital buffer as possible, so that they can create a maximum amount of loans that can bring in higher profits. From their perspective a safety net has an “opportunity cost” which limits the profits they can make. Well you might ask “aren’t they worried about not having enough of a safety net if their bets go bad?”. Well, not if they are “too big to fail” and the public will be called upon to bail them out if their bets go bad. This is where a growing danger lurks for all of us. From a public interest perspective conservative or higher capital levels are a good thing. They help to prevent banks from taking excessive risks which often lead to publicly funded bailouts to rescue them from insolvency.

10:26 Song/Music: “The Temple” – The Afghan Whigs

2.3) Financial Risks Taken by Banks and other Speculators are on the Increase

It really is very scary to note that financial risks taken by banks and other speculators are certainly on the increase.

Banks and other gamblers take excessive risks, of course, because higher risk investments bring in higher returns. This means more profits for shareholders and higher bonuses for the CEO and others. The disincentive for higher risks is that a risky investment is more likely to fail and you could lose some or all the money you put in. High risk investing is exactly like gambling – in fact it really is gambling. Such speculation is of concern to the public because the gamblers are playing with the financial system and currencies upon which all real economies are dependent, and because the public is often called upon to bail out speculators to avert financial and economic crises.

As income inequality grows in the world, fewer people have more and more money to play with and so financial activity becomes increasingly about speculation in the markets, through the Alice in Wonderland world of speculative financial instruments alluded to earlier, rather than about the purchase of real goods and services. Hence financial risk increases as income inequality grows. As we’ll see, this risk taking then often leads to devaluation of foreign currencies against the US dollar, and publicly funded bailouts, whose costs fall disproportionately on the poor (or those who are not major players in the financial system). This widens the income and wealth gaps even more, and further increases speculative activity and financial risks that will later trigger another bailout. And so the cycle continues. This positive feedback loop has set the world on a very dangerous path – it’s dangerous to everyone.

As a key part of this feedback loop very serious problems have arisen because certain players in the market know they will always get bailed out if the losses on their risky investments get too big. This is known as “moral hazard” and many economists and business commentators have noted that the International Monetary Fund poses such a moral hazard to the world’s largest financial institutions who are now “too big to fail”.

This problem is compounded further because the big players are getting even bigger through global mergers and acquisitions in the wake of global financial deregulation. Furthermore, the Asian financial crisis, caused by excessive financial speculation in the first place, bankrupted a slew of Asian (even including Japanese) banks. Many of these were then sold off (fully or partially) at fire-sale prices to Western financial institutions who were just as responsible for the crisis due to their unchecked speculative activity and who did not go bankrupt because they were key beneficiaries of the IMF bailouts. It is ironic that these beneficiaries were the very same players who instigated so much of the excessive risk taking that caused the crisis. This shows you just how much the moral hazard of bailouts can distort what is supposed to be but is not a “free market”.

As noted before, the public should understand how banks and other gamblers increase the risks in the financial system, since the public always pays the price for excessively risky bets that go wrong through various bailout mechanisms. This is exactly what happened during the US Savings and Loans crisis in the 1980’s. Also, the public of effected countries pays for IMF bailouts which always come as a result of excessive risk taking in the financial markets and then the realization that some of the risk takers are really gamblers (which are generally those on Wall Street) are just too big to fail. Compounding this problem is the fact that speculators trade against other countries’ currencies and thereby instantly devalue the hard won earnings of many of the local people of those countries.

In what is probably a less understood and less publicized financial crisis, but one that recently almost took down the entire US and therefore world banking system, the Federal Reserve had to step in and arrange a bail-out of the Long Term Capital Management Fund in 1998. While the public actually did not have to fund this bail out, it came very close to having to do so. The LTCM crisis revealed a shocking level of risks taken by US banks, and worse, a shocking lack of supervision of their gambling activities. It is not at all comforting to know that this type of risk taking prevalent in the LTCM case is increasing, and the supervisory bodies are doing very little or nothing to stop it. These types of funds like LTCM, also known as “hedge funds”, are the new trendy playthings of the wealthy – why, even Barbara Streisand is in one! But they are completely unregulated on the premise that they involve “sophisticated” investors, you see. This is exactly why they need regulation – for it’s this very same sophisticated speculation that later triggers bailouts. And its seldom the sophisticated speculators themselves who pay for the bailout messes they create.

Banks are supposed to manage risks to prevent themselves from going insolvent or losing market confidence. Regulators and supervisors are supposed to be watching to make sure they actually manage these risks both in their own interests and to prevent broader financial crises. In this fashion the regulators should represent the public interest to ensure that banks are not taking such excessive risks that the public may eventually have to bail them out to avert a financial disaster. But more and more it seems that crisis prevention and the exercise of the precautionary principle are being pushed out the back door in favor of the wishes of a global finance sector that wants less and less supervision. It prefers a system of cure (in the form of bailouts) after risk taking gets out of hand, it prefers this to the publicly preferred system of prevention whereby financial players take on less risk and accept lower returns.

This preference for cure over prevention is definitely encouraged by the bailout mechanisms.

One “cure” (or bailout) leads to another crisis down the track, leading to another bailout, another crisis and so on. For every bailout income and wealth gaps increase, because the funding of the bailout must come from places that are not accounted for in the financial system. This is simply because the financial system would be put at risk if the full costs of the risk taking had to be born by it. Then investors would lose confidence and the whole financial system may collapse. The costs that do not appear on the financial accounts are additional burdens to the poor and excessive natural resource extraction. In effect, that is what often funds bailouts so that the cost of the bailout will not hit the books of the financial system. This is the mechanism whereby risk takers do not take full responsibility for the risks they assume but rather pass that responsibility on to those outside the financial system. This system of cure over prevention obviously provides higher overall returns to the banking system than would a corresponding regulatory regime focused on prevention.

18:52 Song/Music: “Everything’s Alright” in Jesus Christ Superstar

2.4) Lets Run Through A Case Study of Risk Transfer in Action

Now lets run thourgh a case study of risk transfer in action.

To better understand risk transfer let’s look at some of the aspects and drivers of the Asian financial crisis.

Many identify the trigger of this crisis to be the devaluation of the Thai Baht (the Thai currency). This currency had been pegged to the US dollar, which meant that the Thai Central Bank was trying to keep a fixed exchange rate between the Thai Baht and the US Dollar. At this time the fixed exchange rate was about 1 USD to 25 Baht and a devaluation of the Baht would mean that 1 baht would buy less than 1/25 US dollar, or conversely a USD would buy more than about 25 Baht. Prior to the devaluation of this currency, currency speculators (many of whom were with the Western financial institutions) were having a whale of a time

performing what is known as arbitrage in transactions involving the Thai Baht. Arbitrage means that speculators can make profits without really taking any risks. They do this by noticing what is known as an anomaly in the market, little pricing differences where they realise they can step in and make some profits without really having to put any money down on the table. So the sort of profits that come completely for free, without having to do anything or put any money down. For example in this case the arbitrageurs had noticed an anomaly in the interest rates between short term investments based in USD and short term investments based in the Thai Baht. What was happening was that such investments in USD would earn a rate of 6% and such investments in the Thai Baht would earn a rate of 12%. Now if the exchange rate between the two is fixed both when you invest money and when you receive your money but the exchange rate is fixed over a period of time, you can see a way there to make profits, basically out of nothing without even having to make any kind of investment. The way that the arbitrageurs did this was to borrow US dollars at the low short-term 6% rate that USD where earning,ex change them into the Thai Baht at the fixed exchange rate and invest these new Thai Baht at the much higher 12% rate that the Thai Baht was earning. And then because the Thai Central Bank was trying to peg the Baht to the US dollar, after a certain time, the Western and other gamblers could take their proceeds from the much higher 12% investment, and convert them back at the same fixed exchange rate back into US dollars. They then paid off the lower 6% loan and pocketed the difference, which was 6% of the borrowed amount. I say that no risk was taken to get this return because actually these gamblers didn’t have to put any money down or put any money at risk to pocket these profits which really came out of nowhere, the money was all borrowed and then guaranteed to be returned in full dollars by the Thai Central Bank. This is how arbitrage works and these are the kinds of deals that currency speculators go looking for and these are the types of transactions that put immense amounts of pressure on other countries currency’s.

As noted, the Thai Central Bank was on the other side of all of these bets trying to prop up its own currency, so that when the baht finally collapsed, in part due to this massive speculation against it, the central bank was in very bad shape. Confidence in Asian markets fell and neighboring economies starting falling like dominoes. When I say that the baht collapsed I mean that its value versus hard currency, like the US dollar, fell dramatically. It is the local people of Thailand who then got hammered by the subsequent devaluation. Their hard earned money was worth less when it came to any goods or services made from imports.

The US dollar is the hard currency or reserve currency of the world now that the gold standard has collapsed. Every currency is measured in terms of the US dollar. And whereas banks once held gold in their vaults to back their currencies, now they generally hold US dollars in their reserves. This US Dollar standard of money means that if the value of the US dollar ever collapses relative to other currencies, it probably will result in the collapse of the global financial system. This point might be of interest to some anti-globalization activists, who might want to see if they can think up a clever way to instigate massive trade against the US dollar. This method is very slick because it’s perfectly legal, nobody has to get arrested and it doesn’t require any police beatings. But just a word of warning before you try this – make sure you have another system of trade ready on the sidelines! Otherwise things could get rather nasty.

Now, Back to the Asian Crisis: Around the time of this Thai Baht arbitrage feeding frenzy JP Morgan was, on the one hand, advising the Thai’s to devalue their currency. But they were was also operating in Malaysia and selling financial instruments to Korean banks that would lose money if the Thai baht was devalued! So that’s how the Korean banks got immediately walloped by the devaluation. The Koreans banks then started dumping a bunch of Brazilian bonds that they’d been holding since one of the deals that ended a previous speculator induced crisis, and that was the Latin American debt crisis. This caused the cost of borrowing to shoot up in Brazil and this stripped Brazil of a quarter of its bank reserves in a single month. So then Brazil had a financial crisis on its hands. And so on, and so on, the crisis spread. Meanwhile, back on Wall Street, JP Morgan seemed to get out of everything just fine and dandy. This interesting little story from the Asian crisis came from the book called “The Fed” written by Martin Mayer and recently published by the Free Press.

The western financial institutions were also over extended in loans to Asia because the 1988 Basel Capital Accord did not adequately set capital requirements to loans to banks in these countries. They also did not differentiate between various types of commercial borrowers. Hence the banks were incented to lend extensively to foreign banks where they could get higher returns, and to more risky corporate ventures. Central banks of these Asian countries meanwhile were putting their countries financial reserves at risk by allowing their banks to invest them in high risk, high return investments. And much of the loan activity of the time was around over-priced real estate, similar to what happened in our own Savings and Loan crisis in the 80’s. In summary the financial risks taken by banks world over were huge, and the distribution of bank capital could not bear the brunt of the costs if those risky bets should go bad.

Well as ws we know the bets went very bad and various economies almost collapsed. Many of the financial players did suffer large losses and those losses were born by both Western financial institutions and foreign players. However, as usual, the Western institutions escaped the gambling extravaganza bearing a disproportionately small share of the costs. While a myriad of Asian banks were allowed to collapse, not a single Western financial institution went under. At the end of the crisis most major Japanese banks (and insurance companies) were technically insolvent and later dependent on these western institutions to inject capital through acquiring ownership rights – something the Japanese never welcomed to their banking system before. Banks collapsed throughout the rest of Asia, the most dramatic case being Indonesia where we still have images of the physical run on banks fresh in our minds.

The western institutions were not allowed to fail (as was the case in the S&L debacle) because if they did, the entire global financial system would go down with it. To prevent such a collapse the IMF bailouts primarily work to ensure that the market does not lose confidence in the financial system. Generally this translates into making sure that the larger financial system players are not hit with large enough losses that could cause them to drop below minimum capital requirements, or go insolvent, or suffer a loss of confidence in them by investors and depositors. When the press speaks of  bailouts they often say that this country or that country got an IMF bailout package. This really means that they receive funds from, or their debt is consolidated
by, the IMF so that they will not default on the loans made to them by large western investors. In a true “free market” those western institutions would bear those defaults and suffer the consequences, which would be consequences for all of us, because we are dependent on the financial markets they dominate.

It is at this point that the IMF as loan consolidator, or lender of last resort, steps in with its structural adjustment programs to somehow make the country generate the hard currency needed to pay back the western investors who loaned them hard currency. Because hard currency is needed to repay the loans the country’s activities get directed toward exports and other things that will bring in hard currency from those that have some – i.e. western investors and consumers. The things that generate hard currency the quickest to repay these loans are the exploitative labor and natural resource extraction practices that we see resulting from IMF policies. These problems are compounded by the fact that the local currency has dropped in value against the hard currencies.

29:24 Song/Music: “The Temple” – The Afghan Whigs

2.5) This Sounds all Very Grim but Are there Solutions?

This sounds all very grim, so are there solutions?

The above gives an overview of how very abstract, seemingly innocent, risky financial transactions end up as costs born by those pretty much outside the financial system. Surely the solution lies in people creating their own monetary and trade systems and weaning themselves away from dependence on the very risky, and very destructive global financial system of today. Why continue to trust in, and be a part of, a system that works against you?

Should the current global financial system collapse tomorrow the world would have no back-up mechanism for continuing trade, and in all likelihood the resulting confusion and collapse of order would result in massive catastrophe, maybe worse than Germany in the 1930s, but on a global scale. The risk of global financial collapse continues to increase with increasing income inequality. This leads to an increasing amount of financial activity being driven by those who have so much excess money that the bulk of their transactions are purely speculative. This inequality and these risks increase with each publicly funded bailout, which then further increases income and wealth gaps. And so the cycle continues, with this positive feedback built in to make the whole system more and more unstable.

Those who are currently actively involved in setting up alternative economies and currencies are actively hedging their bets that the dominant system will eventually fail. They are certainly providing hope for a more promising future.

2.6) Bank Supervision and The Basel Capital Accord

However, setting up alternative financial and economic systems in a meaningful way will take a lot of time and effort. The existing global financial order will be with us until it either collapses or people come up with an alternative,
or both. In this time it’s important for activists to challenge the financial world on their trend towards increasing speculation and reliance on cures in the form of bailouts for financial crises. Along this line of thinking it might be more fruitful to work towards reducing the need for IMF bailouts, rather than just worry about them once they already exist. That is – maybe people should also be focused on prevention as well as the specific nature of the cure. Otherwise we may see that increasing speculative activity may end up increasing the frequency and severity of IMF bailouts.

One of the best means of prevention of financial crises (and therefore IMF bailouts) is stricter supervision of banks and other financial services companies, so that they don’t make too many risky bets that destabilize the markets. That is in the best public interests of a public that depends on stability of the banking system, and doesn’t yet have an alternative monetary system to fall back on. Let’s just talk here about supervision of banking institutions and leave other financial institutions to later editions of Wizards.

One would think that bank supervision would be done under the guise of a government body so that there could be some democratic accountability of the supervisor, and some representation of the public’s interests. Well think again – Under the Gramm-Leach-Bliley Financial Services Reform Act of 1999
the regulator of all bank holding companies in the US is the Federal Reserve. They are also the supervisory body which will monitor bank’s risk taking activities and their associated capital buffers under the new Basel Accord. As we saw in Wizards Part 1 the Federal Reserve is 100% owned by the private banking industry. So the banks seem to be supervising themselves!

This does not bode well for the idea of getting banks to behave better with respect to risk taking. Apart from this issue of ownership, the conflicts of interest with respect to the “central bank” of a country also supervising the banks are so profound that no other major industrialized nation has dared to do it. In most other countries the central bank – who is the driver of monetary policy – the driver of the creation of money out of thin air – and the bank supervisor – trying to make sure that the financial system is safe – are two entirely different bodies.

On the one the hand, the Fed, when it wants to increase the money supply would encourage banks to take more risks to achieve this monetary goal. For example William McDonough, the president of the Federal Reserve Bank of New York, is documented to have told an audience at a Group of 30 meeting at the IMF/WB
meeting, in 1998 in the midst of the worry about the Asian crisis, and this according to Martin Mayer in the book “The Fed” Mr McDonough said:

“If you’re a banker, go out and lend – you don’t have to cross every i and dot every t. If you’re a bank supervisor, don’t criticize your banks for making loans, even if they’re loans you might not have approved just a little while ago.”

So he was speaking there as a key player in monetary policy, not as a supervisor who should be concerned about risks in the financial system. Mr McDonough, as the head of the New York Fed is also vice-chair of the Federal Reserves Open Market Committee that we talked about in Wizards Part 1, this committee is responsible for the creation of base money out of thin air, which they call an interest rate announcement. Now, not only is Mr. McDonough now responsible for supervising the activities and capital levels of the New York area banks, he is now also the chair of the Basel Committee on Bank Capital requirements! In many cases his role as central banker (and therefore driver of monetary policy) will conflict with his role as both supervisor of banks and chair of this capital committee – both of which SHOULD be representing the public’s interests in bank risk taking.

Alan Greenspan, the Governor of the Federal Reserve Board, that overseas all the Federal Reserve Banks, said in his bid for being the bank regulator of choice, that regulation by a separate government body (such as the Office of the Controller of the Currency) devoted only to managing safety and soundness of the banking system would “inevitably have a long term bias against risk taking and innovation”. He forgot to mention that these risks are usually born by the public, so that such a focus of a supervisor would be entirely appropriate.
Unfortunately, Mr. Greenspan, being raised as a prodige of, and assistant to, author Ayn Rand – during her Atlas Shrugged phase – often forgets that there is a public to worry about. Well that is, until a public bailout is needed of course.

The conflicts of interest and evidence of the “fox guarding the hen house” does not stop there. The Board of the Federal Reserve Bank of New York always has the biggest New York bankers on it. So it is not surprising that Sanford Weill, CEO of Citigroup is on the Board of the Federal Reserve Bank of New York. The Federal Reserve Bank of New York is the Supervisor of CitiGroup! As noted, the president of the NY Fed is also the chair of the Basel Committee setting capital requirements that are supposed to protect the public from
banks taking excessive risks for excessive profits. So the supervisors and the supervised are pretty much one and the same.

The latest draft of the Basel Accord was released in the year 2000 for public comment until May 31, 2001. Around this time Mr. McDonough took over as chair of the Basel Committee coming up with these capital (i.e. safety) requirements. Evidently the American bankers were starting to get pretty cheesed-off at some of
the conservatism and safety margins proposed by the European bank supervisors. So they thought they better step in and take over, as is the American way.

This change at the helm of the Basel Committee will probably bode well for the big bankers whose comments on the proposed accords can be pretty much summed up as whining about how the proposed capital (or safety) levels were just too high and how this would eat into their profit margins. It is especially useful to look at Citigroup’s comments on the proposed Basel Accord since, as noted, Citigroup is supervised by the Federal Reserve Bank of NY, whose president chairs Basel, and on whose board CitiGroup has representation. In this way it could be construed that, unless pressure is applied otherwise, CitiGroup’s desire for holding less capital, and making the financial system more volatile and risky will become a reality. The following is a quote from the response by Jay Fishman, the COO of Citigroup to the new proposed Basel Capital requirements for banks:

“We urge the Committee to keep in mind that although capital has an important
role to play in assuring safety and soundness by supporting a banking organization’s
assets, it has a significant opportunity cost”.

Translation: This means lower profits for Citigroup. This “would effectively translate into higher costs to users of funds and/or lower returns to investors in organizations subject to the New Accord”. He goes on to say that this would end up “reducing competition and choice for customers of banks”. This is rather laughable given that the multitude of recent acquisitions of banks by Citigroup all across the globe has done more to reduce competition and choice that any capital requirement could.

Furthermore in appealing to competition, that bastion of the free markets, Mr Fishman forgets to point out that his organization is a primary beneficiary of the IMF bailout mechanism because they are way to big to fail, and this is more of a threat to competition and free markets than any supervisor could ever dream up with any capital requirements.

Mr. Fishman, in his May 31st letter on the Basel Accords, calls for capital requirements to be primarily set by the banks themselves, especially those “sophisticated banks” with “sophisticated risk management techniques”. Mmm – there’s that sophisticated word again – its seems to somehow be synomous with regulation-free in the financial markets. Mr Fishman forgets to point out that these fancy risk management models failed completely to manage the risks of their bets in Mexico, Asia, Latin America and Russia during the 1990’s.

Finally he argues that the increased disclosure requirements of the proposed new Basel Accord will increase the costs to banks, and only serve to confuse everybody.

The comments of a bank that has the highest degree of moral hazard posed by bailout mechanisms such as the IMF, and hence has the biggest incentive to take excessive financial risk, must surely be taken with a grain of salt. However I feel that without the involvement of the NGOs fighting these institutions the new Basel Accords and associated capital requirements will slip through with exactly what the banks want. That is – more profits through higher financial risk taking that will only serve to increase the frequency and severity of publicly funded bailouts and further compound the transfer of wealth from the poor to the rich.

A full copy of the current Basel Accords and all public comments can be found on the Web at Only one
anti-globalization NGO (that I could find) submitted a comment with public
interest concerns. That was the Inner City Press/Communities on the Move and Fair Finance Watch,
based in the Bronx, NY. You can visit their websites at and

That does it for this edition of The Wizards of Money.

Song/Music: “The Merry Old Land of OZ!” The Wizard of OZ Soundtrack

Song Lyrics

Part 2: 10:26 & 29:24 Song/Music: “The Temple” – The Afghan Whigs

Moneylenders and Merchants:
Roll on up–for my price is down
Come on in–for the best in town
Take your pick of the finest wine
Lay your bets on this bird of mine
Roll on up–for the price is down
Come on in–for the best in town
Take your pick of the finest wine
Lay your bets on this bird of mine
Name your price I got everything
Come and buy it’s going fast
Borrow cash on the finest terms
Hurry now while stocks still last
My temple should be a house of prayer
But you have made it a den of thieves
Get Out! Get Out!
Mine time is almost through
Little left to do
After all I’ve tried for 3 years, seems like 30, seems like 30…
See my eyes I can hardly see
See me stand I can hardly walk
I believe you can make me whole
See my tongue I can hardly talk
See my skin it’s a mass of blood
See my legs I can hardly stand
I believe you can make me well
See my purse I’m a poor poor man
Will you touch will you mend me Christ
Won’t you touch will you heal me Christ
Will you kiss you can cure me Christ
Won’t you kiss won’t you pay me Christ
There’s too many of you–don’t push me
There’s too little of me–don’t crowd me, please don’t crowd me
Heal Yourselves!

Part 2: 18:52 Song/Music: “Everything’s Alright” – Jesus Christ Superstar

Try not to get worried, try not to turn on to
Problems that upset you, oh.
Don’t you know
Everything’s alright, yes, everything’s fine.
And we want you to sleep well tonight.
Let the world turn without you tonight.
If we try, we’ll get by, so forget all about us tonight

Everythings alright, yes,
everything’s alright, yes.

Sleep and I shall soothe
you, calm you, and anoint you…
Myrrh for your hot forehead, oh.
Then you’ll feel
Everything’s alright, yes, everything’s fine.
And it’s cool, and the ointment’s sweet
For the fire in your head and feet.
Close your eyes, close your eyes
And relax, think of nothing tonight.

Everything’s alright,
yes, everything’s alright, yes.

Woman your fine ointment, brand new and expensive
Could have been saved for the poor.
Why has it been wasted? We could have raised maybe
Three hundred silver pieces or more.
People who are hungry, people who are starving
Matter more than your feet and hair

Try not to get worried, try not to turn on to
Problems that upset you, oh.
Don’t you know
Everything’s alright, yes, everything’s fine.
And we want you to sleep well tonight.
Let the world turn without you tonight.
If we try, we’ll get by, so forget all about us tonight.

Everything’s alright,
yes, everything’s alright, yes.

Surely you’re not saying we have the resources
To save the poor from their lot?
There will be poor always, pathetically struggling.
Look at the good things you’ve got.
Think while you still have me!
Move while you still see me!
You’ll be lost, you’ll be so so sorry when I’m gone.

Sleep and I shall soothe
you, calm you and anoint you…
Myrrh for your hot forehead, oh.
Then you’ll feel
Everything’s alright, yes, everything’s fine.
And it’s cool and the ointment’s sweet
For the fire in your head and feet.
Close your eyes, close your eyes, and
relax… [improvised ending]

Everything’s alright,
yes, everything’s alright, yes.

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