Empire Of Dirt – “Let Them Fail” Why Failing Banks Should Fail

On September 3, 2011 Bank of America (NYSE:BAC), JP Morgan (NYSE:JPM), Citigroup (NYSE:C), Goldman Sachs (NYSE:GS) and 17 other banks were sued in federal court by the Federal Housing Finance Agency on behalf of Fannie Mae and Freddie Mac in an attempt to recover $196 billion dollars. At the core of this massive lawsuit is the FHFA accusing said banks of misleading Fannie Mae and Freddy Mac about the soundness of the mortgages underlying the securities. In other words, they are accusing the biggest banks in the country of lying to the United States Government.

The FHFA, the regulator and conservator of Fannie Mae and Freddie Mac, lost almost all credibility when Fannie Mae and Freddie Mac imploded in 2008. They were largely responsible for causing one of the worst financial crisis’ in our nation’s history. Fannie and Freddie are still in receivership today and will be for years to come. The FHFA lost credibility because they took the word of banks who claimed that subprime mortgages were safe, supported by the fact that all the ratings agencies had given these securities the coveted AAA rating.

In another legal action against these same banks they have been accused of  paying off the ratings agencies for these AAA ratings. How can a regulator who has the responsibility to protect consumers and investors be trusted when they have allowed themselves to be so misguided as to put our nation’s economic stability at such peril?

Why Has the FHFA decided to file this lawsuit years after their catastrophic mistake in 2008?
First, after giving failing financial institutions over 1 trillion dollars through programs like TARP in which the U.S. Government assumed responsibility for the bad debts and made them a liability of the tax payer, they have come to the realization that the economy hasn’t improved at all as a result. They are recognizing that “banks survived and the rest of the economy is still suffering”.

Secondly, it has become evident in recent months, due to the onset of the European debt crisis, that the interdependence of U.S. and European banks is way beyond what they initially believed. A condition has evolved in which European banks have leveraged their portfolios off of bad debt from sovereign entities and our banks in turn have leveraged our debt off of those same entities. The likely result will be a contagion which we do not have the wherewithal to contain. In other words, the FHFA and the federal government are realizing that the “too big to fail” policy may have to extend to banks all over the world due to this interdependence.

This scenario of including foreign banks in the too big to fail model is impossible because it would accelerate our already out of control deficit, initiate American austerity with drastically higher taxes, unemployment and a plunging Gross Domestic Product. The end result will severely damage every aspect of the economy; especially the consumer, with consumer confidence being at a twenty year low. This decline would be catastrophic since the consumer is responsible for 70% of the Gross Domestic Product.

The original sin was committed when banks like Citigroup (NYSE:C) hid their exposure to subprime mortgages on their balance sheets as short term debt. After this contemptible act of deceit, they received billions of dollars of tax payer bailout money and the government took all their bad debt on its balance sheet creating a future liability when a percentage of this debt defaults. The banks blamed their problems on a bad economy and the fact that individuals couldn’t afford to pay their mortgages. The lie in this statement is that despite the economic downturn, it was banks using these loans to create leverage and issue new loans which created the catastrophe. Banks continue to blame consumers and have failed to take responsibility for their reckless behavior.

Yes, in fact banks do have high levels of cash reserves. The truth is they have high cash reserves because the tax payers supplied it through government funded bailouts. These high cash reserves were “intended” to be used for making loans to qualified borrowers like small businesses. However, qualified small business have gone out of business because their bank loans have been pulled; statistics show that we have not seen any decrease in the number of small businesses going out of business since 2008. High cash reserves give the illusion of health when, in fact, banks are only concerned with self preservation and feeding themselves from their reserves.

Banks used tax payer dollars given to them through government bailouts to sure up their balance sheets and have not contributed 1 penny to helping small businesses get on their feet and start hiring again. They have, however, contributed to our incredibly high unemployment rates since small businesses will not hire if they can’t borrow to grow.

It must end because it can no longer be contained within the borders of the United States. We have become a global economy with an interdependent banking system. The end result of our first bank bailout established bigger banking institutions. Another bank bailout would undoubtedly establish even bigger multinational financial institutions with an even greater future liability and taxpayerliability with potential austerity measures that could collapse economies on a global scale. As the International Monetary fund has recently discussed the use of a program which creates liquidity by printed money (like we did in our two failed quantitative easing programs (with a third on the way, although they won’t call it quantitative easing)) as a means to fund a bank bailout will unleash inflation like we have never seen in history. Inflation combined with low levels of growth resulting through austerity measures will create stagflation which is a far worse condition than a double-dip recession.

If banks fail it will create severe consequences to the consumer and investors alike, as well as severely hinder an economic recovery. However, allowing banks to fail will end the policy of rewarding banks for acting in a reckless, irresponsible manner with the money they have been entrusted with. It will also end the future burden on the tax payer who should never be penalized for the bad behavior of others.

It will re-establish the concepts of capitalism which have made our economy great; namely –  free enterprise means that businesses succeed and fail every day in a free market. In the seeds of failure are the seeds of success and many great industries have risen from failure. We can eagerly anticipate a new banking system to emerge in which fiscal responsibility, accountability and thrift once again become the cornerstones of the banking industry. It is only through a free market in which individual can succeed or fail on their own merit that we will once again gain the economic freedom we desire.