Banking on Speculation

[marmar]

another excerpt from David Korten's "Agenda for a New Economy: From Phantom Wealth to Real Wealth":


Leveraging - also known as borrowing - became the name of the Wall Street game. Banks used their power to create money to feed the speculative frenzy by creating a complex pyramid of loans to each other. In 2006, by (Kevin) Phillips' calculations, the U.S. financial sector debt, which consists largely of financial institutions lending to other financial institutions to leverage financial speculation, totaled $14 trillion, which was 32 percent of all U.S. debt and 107 percent of the U.S. GDP.
According to the Virgina-based Financial Markets Center, in the late 1960s....

U.S. banks began borrowing Eurodollars in huge volumes from their offshore branches....In each decade since 1969, the ratio of financial sector debt to GDP has nearly doubled....With financial institutions channeling half of new lending to other financial firms, credit markets increasingly are being used less to facilitate economic activity and more to leverage bets on changes in asset prices.

The Wall Street alchemists used a combination of complex derivative instruments, creative accounting tricks, and their capacity to create money from nothing by issuing loans to create phantom financial assets that served as collateral to support additional borrowing to create more phantom assets to......Apparently, some major portion of this trading of loans between financial institutions that borrowed from their own branches. Talk about insider trading. Wall Street has no shame.

Gambling with borrowed money is highly risky for both lender and borrower. But the Wall Street players convinced themselves they had eliminated the risk. In their hubris, they seem to have truly believed that they had mastered the art of creating wealth from nothing.

At the time of its collapse, Lehman Brothers was leveraged 35 to 1, which means it financed its gambling in the global financial casino with 35 dollars in borrowed money for every dollar of equity. This can be highly profitable in a rising market. It is disastrous when the market is falling and the highly leveraged bets start going bad. Just as gains are leveraged during the rise, so, too, are the losses leveraged during the decline. When others start demanding payment, liabilities can quickly exceed a firm's net equity, which throws the firm into insolvency, as Lehman Brothers and much of the rest of Wall Street learned.